We now forecast S&P 500 EPS of $110 in 2020, a decline of 33% from 2019. On a quarterly basis, this reflects year/year growth of -15%, -123%, -21% and +27% (Exhibit 1).
We have cut our 2020 earnings forecast three times in 30 days (-37% in total) as the magnitude of the economic slowdown has become increasingly apparent. Our economists have incorporated similar expectations into their revised annual average US GDP growth forecast of -4% in 2020, including –24% annualized growth in 2Q. At the sector level, we expect large declines in Energy, Consumer Discretionary (e.g., Cruises, Hotels, Restaurants), and Industrials (e.g., Airlines). On the other hand, stockpiling may partially insulate Consumer Staples EPS.
It is incredible how much can change in one month. On February 19th, the S&P 500 reached an all-time high of 3386, Senator Bernie Sanders was the front-runner to win the 2020 Democratic nomination, and investors were evaluating the extent to which the novel coronavirus would create supply chain disruptions. One month and one day later, the S&P 500 sits 32% lower, former Vice President Joe Biden has a large delegate lead, and people around the world are now isolated in their homes.
Each day contains a month’s worth of market news. Global monetary and fiscal policymakers have taken dramatic steps to arrest the economic devastation that is disrupting civilian life and business activity. Volatility has soared. In March, the typical daily move in the S&P 500 index has been 5%. US federal, state, and local governments have taken increasingly drastic measures to “flatten the curve” of new coronavirus cases. The list of travel restrictions grows almost hourly. California, home to 1 in 8 Americans, mandates people “stay-at-home.” NYC closed schools and restaurants and 100% of the non-essential workforce must stay at home.
Government measures taken to slow the viral spread have impaired near-term sales and earnings for many firms. As a result of the social distancing taking place across the US, many retailers have reduced store hours (WMT, TGT, and HD) or closed physical stores altogether (M, JWN, and KSS). Airlines have cut routes in response to low passenger demand and hotel occupancies stand at record lows.
The key question now is “V” or “U” or “L”? Early in the correction, investors were focused on quantifying the downside risk to near-term earnings, but were confident that EPS growth and share prices would recover later in 2020. As the virus spread and its economic impact intensified, investors have been forced to grapple with whether the sharp decline in near-term activity will be followed by an equally sharp recovery (“V”), last multiple quarters before improving (“U”), or create lasting economic damage that reduces the outlook for earnings in 2021 and beyond (“L”).
Policymakers have responded in force with startling speed. The Fed has slashed the policy rate effectively to zero and taken steps to boost credit availability, such as reintroducing the Commercial Paper Funding Facility (CPFF) backstopping corporate borrowing for terms out to 90 days. Our economists expect Congress and the Trump administration will continue to enact legislation that provides a fiscal boost of $1 trillion (5% of GDP) or greater.
If all goes according to plan, S&P 500 EPS will leap by 55% to $170 in 2021, and the index will end 2020 at 3000 (30% above the current level). Earnings and investor sentiment will be recovering later in 2020. Using the Fed Model, applying a Treasury yield of 1% and a yield gap of 465 bp, suggests a P/E multiple of 18x on 2021 EPS and a year-end 2020 level of 3000.
In the near-term, we expect the S&P 500 will fall towards a low of 2000. The stock market is a leading indicator of business trends, and corporate activity continues to deteriorate with no signs yet of a bottom. The first quarter has not even ended and companies have yet to release 1Q results but equities have already collapsed by 32% in one month. The speed of business erosion is unprecedented.
The difference between a “V” and “U” in the stock market will depend on three developments:
- whether the virus can be contained quickly, an answer difficult even for epidemiologists;
- whether companies, both large and small, have access to enough capital and liquidity to last the 90 to 180 days most investors expect (hope) will encompass the worst part of the crisis; and
- whether fiscal stimulus will act quickly enough to stabilize the economic and earnings outlooks.
One possibility is that business activity cannot normalize by late 2020 because the viral spread is worse than expected or has a hiatus and recurs in the fall. In addition, if short-term shutdowns lead to business defaults, closures, and permanent layoffs, the damage to corporate earnings growth could persist well after the virus is contained.
It’s just conincidence, I guess, that the Goldman earnings downgrade exactly match how far the bourse has already dropped.
In Q3 I expect the US to be in full blown financial crisis. Beyond that, I’m not sure you’d call it a v-shaped recovery, but the US has so horribly mishandled the pandemic that it could fail to flatten the virus curve, see a wave of megadeath, then come out of the crisis ahead of other nations.
That might compress the depression into a shorter time frame and give the US a shot at recovery in 2021.
That’s about as positive as I can manage.