As it is well known, expectations rule supreme on the stock exchange. No matter how dismal the situation may be, what counts is the future. However, expectations are usually based on historical data. What is the problem for market participants in the wake of the Covid-19 crisis? Figuring out the extent to which current company sales, earnings or cash flows represent a one-off event, rather than an indication for the next several quarters. Throughout the first half of 2020, earnings were strongly influenced by a violent, v-shaped, up and down and up of many macroeconomic data series. We believe that makes the second half of the year all the more important when it comes to forecasting 2021.
Our "Chart of the Week" illustrates the clash between estimates and market developments. The chart looks at how equity-price changes in the year to date compare with fundamental developments. Specifically, it contrasts market moves with changes in economic-growth forecasts for 2020, as well as earnings estimates for 2020 and 2021. Some regional differences are quite easily explicable: China has fought the pandemic rigorously and the economic slump of five percentage points looks set to be comparatively mild. By global standards, corporate-earnings declines in China for both 2020 and 2021 may also be relatively modest. As the chart shows, this has been rewarded with a hefty 12.6% jump in Chinese equity prices since the start of the year.
At the other extreme, Latin America has been particularly hard hit by the pandemic, as well as by falling commodity prices and a strong dollar. This is why its 2020 earnings estimates have been cut by almost two-thirds this year. Analysts also believe that U.S. companies will likely earn 30% less than previously thought. The U.S. economy appears on track towards an 8% year-on-year decline in economic output. On the stock market, however, the S&P 500 is trading almost back at the level seen at the beginning of the year. The global figures also fit more or less into this pattern: very generous stock markets in light of meager economic-growth and earnings estimates.
It is understandable that investors seem to be graciously ignoring the current year and looking ahead towards 2021. But even if the consensus estimates for 2021 prove correct in assuming a 30% jump in earnings compared to 2020, the 2021 (global) earnings estimates are almost a fifth below the 2021 estimates at the beginning of this year. Conversely, investors seem willing to pay a significantly higher valuation  for 2021 earnings than at the beginning of the year. And this is despite the fact that the reliability of the forecasts has certainly not improved. Much will depend on the upcoming earnings season.
Appendix: Performance over the past 5 years (12-month periods)
|06/15 - 06/16||06/16 - 06/17||06/17 - 06/18||06/18 - 06/19||06/19 - 06/20|
|MSCI China Index||-23.3%||32.3%||21.3%||-6.7%||13.1%|
|MSCI Emerging Markets (EM) Latin America Index||-7.6%||15.0%||-0.2%||18.4%||-32.5%|
|MSCI Japan Index||-8.9%||19.2%||10.5%||-4.2%||3.1%|
|MSCI World Index||-2.8%||18.2%||11.1%||6.3%||2.8%|
|Stoxx Europe 600||-10.4%||18.8%||3.5%||5.1%||-3.8%|
Source: Bloomberg Finance L.P., DWS Investment GmbH as of 6/30/20
Past performance is not indicative of future returns. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect.