Earnings season is back

We are now less than three weeks away from the start of the third quarter’s earnings season. After a poor season for the April to June quarter (Q2), expectations appear more reasonable this time but still leave room for positive surprises. However, earnings are unlikely to matter much for the broader equity market with the best opportunities lying at the stock level, in particular in Europe.

Another better-than-feared quarter?

In Q2, an unprecedented 85% of US companies surpassed consensus earnings expectations by an aggregate margin of 22%. A similar outcome does not appear to be on the cards for the third quarter. While the disruptions caused by the pandemic made it almost impossible to forecast companies’ earnings earlier in the year, visibility has improved somewhat since July.

As such, while the consensus expects S&P 500 companies to report a 23% year-on-year (Y/Y) decline in earnings per share in Q3, the actual figure may end up being in the mid-to-low teens. But within that, a high degree of dispersion is likely between the “haves” (technology and healthcare) and the “have nots” (such as travel and leisure or cyclicals).

Not much to expect in Europe

In Europe, although only half of listed companies are expected to report full profit and loss data, the decline in earnings is likely to be much more severe at the index level. Indeed, the consensus anticipates a 30% Y/Y decline after a 50% drop in Q2. While positive surprises are probable, their magnitude will likely be held back by the recent strengthening of the euro. That said, again the dispersion between winners and losers may be significant.

Not a catalyst on its own

Earnings seasons typically offer investors the opportunity to leave aside the macroeconomic backdrop and refocus on fundamentals. This time, however, it will be difficult to ignore the noise coming from Washington or any news about the much-awaited COVID-19 vaccine. As such, the Q3 earnings season is unlikely to be a major driving force of equity indices. Instead, much of the action should take place at the sector and stock levels.

More beneath the surface

Earnings trends could reinforce current trends and solidify the dominance of “high quality” companies or serve as a catalyst for a rotation towards beaten-down value stocks. As uncertainty runs high, both in terms of a possible second wave of COVID-19 and indecision regarding further fiscal stimulus in the US ahead of the presidential election, companies may struggle to sound optimistic. As such, it appears doubtful that Q3 numbers will be enough to lift value sectors. This should ultimately be positive for growth-heavy US indices and possibly negative for value-oriented European ones.

Staying active, in particular in Europe

Going into the Q3 earnings season, we continue to favour stock picking and active management when investing in equity markets. This is particularly true in Europe where the construction of the main indices leaves the region particularly exposed in the current environment. We also believe that opportunities extend beyond public markets with an attractive potential pool of private companies offering growth and visibility well in excess of most of their listed peers.

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