Americas CIO View

Strong S&P 500 EPS results for the third quarter, probably the best for the year

Earnings season shows the economic recovery had a strong start this summer

Powerful direct fiscal assistance to small businesses and households, forbearance programs, business reopening's and warmer weather all helped the U.S. economy put in a V-shaped bottom this summer. S&P 500 earnings-per-share (EPS) trends are benefitting from this recovery, especially financials and many consumer-goods industries. We are curious to see how much the improved conditions this summer helped energy and industrial capital goods. These sectors benefit from the recession ending, but still face challenging conditions. We expect tech and health care to deliver good results with quarterly sequential and year-over-year (y/y) growth as pandemic related new norms continue to boost many of these businesses. We think third-quarter S&P 500 EPS is probably the high for 2020 as the pandemic's second wave threatens growth in Europe and the United States and more stimulus before the election remains unlikely. We are concerned that support packages will be modest until the new Congress is seated.

Third quarter S&P 500 EPS (week 2): Bottom-up is now 35 dollars with 23.5% aggregate beat so far

130 S&P 500 companies or 38% of index earnings reported. Sizable beats from banks and some others pushed bottom-up third quarter EPS up to 35.00 dollars from 32.80 dollars at September end. The aggregate beat on EPS is 23.5% so far, but 14% ex. financials with banks mostly reported. We expect good beats to continue, as many tech and health-care firms have yet to report. Third quarter S&P 500 EPS will be 36 dollars if the rest of the companies beat by 5%, 37 dollars if they beat by 9%. Third quarter S&P 500 EPS looks likely to be about 37 dollars or down 12% y/y, but up 30% from the second quarter.

The young vs. old sector divide in earnings growth continues. We call the resilient sectors – tech+internet retailers, communications, health care, staples, utilities – the young & healthy. The other six sectors the old & vulnerable. Now about half of S&P 500 EPS is from young & healthy and old & vulnerable each. In the second quarter of 2020, earnings of young & healthy were flat y/y while those of old & vulnerable were down two-thirds. For the third quarter of 2020, the bottom-up EPS of young & healthy is down 3% y/y, while EPS of old & vulnerable down 32% y/y. The EPS decline at the old & vulnerable is less severe than in the second quarter, but the young & healthy continues to show dominating strength in comparison.

Loan-loss-reserve build stops a bit over mid-cycle levels, but half of the financial-crisis levels

The total loan book of FDIC[1] banks is 11 trillion dollars at the end of the second quarter. About 45% of that is S&P 500 banks and 30% from the big four. Loan books expanded through the second quarter, but contracted a bit in the third quarter. Loan-loss reserves at S&P 500 banks dropped from 132 billion dollars in the second quarter to 128 dollars in the third quarter, but as a % of total loans it climbed slightly from 2.51% in the second quarter to 2.56% in the third quarter on smaller loan books. At this level, the loan-loss-reserve ratio is higher than usual mid-cycle level of 1.5%-2%, but only half of that during the financial crisis of 5%+.

Near-term inflation jump risks are still low, but longer-term it is rising for monetary reasons; albeit slowly because loan growth has slowed and so far Federal-Reserve asset purchases have been funded mostly by bank excess reserves and the Treasury department's account. Cash in circulation is rising at a faster pace than normal, but it is not surging at this time. But if loan growth picks up, excess reserves will fall and cash in circulation rise. Same as the Treasury department spends. Thus, inflation risk remains a longer-term risk, after the job market improves, dependent on future fiscal policy and its interaction with monetary policy.

Democratic sweep likely benefits muni bonds, if Trump stays energy benefits

We remain skeptical about the merits of rotating to cyclical-value upon a Democratic sweep. We explained last week why greater regulation, a higher U.S. statutory corporate tax rate and dividend taxation likely weighs more on value than growth sectors. Upon Trump's surprise win in 2016, value had a burst of outperformance into early 2017. Suggesting that Trump policies were good for value and a reversal would be challenging. If Democrats sweep, we would probably seek more value opportunities in foreign equities. Europe and Japan could deliver better returns than U.S. value indices. And we still think MSCI AC Asia ex. Japan offers attractive growth to help diversify from U.S. growth/tech.

Biden infrastructure priorities: clean power generation and electric vehicles

The polls at a few key swing states, including Florida, tightened last week. Odds still favor Biden, but it’s still far from certain. In the debates last week, Biden stated his aim to more rapidly transition from fossil fuels. We think utilities would benefit from policies that promote electric vehicles, renewable energy generation and upgrades to the power grid to ensure reliability and handle two-way power flow. We think next generation infrastructure projects will be less about new roads / bridges, but rather how to power and operate what’s on them.

Appendix: Performance over the past 5 years (12-Month Periods)

 

09/15 - 09/16

09/16 - 09/17

09/17 - 09/18

09/18 - 09/19

09/19 - 09/20

MSCI AC Asia ex Japan Index

16.8%

22.7%

1.5%

-3.4%

17.8%

S&P 500

15.4%

18.6%

17.9%

4.3%

15.1%

Past performance is not indicative of future returns.
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 10/19/20

 

1. Federal Deposit Insurance Corporation

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