The market continues to behave like a roller-coaster. But will this ride ever end? In the past, the ups and downs of stock prices have always mirrored the ups and downs in earnings, but this relationship seems to have broken down – or has it? The below graph shows (up until December of 2019) how obvious the correlation is between the S&P 500 Index (blue line) and trailing earnings for the index (the orange line). The initial selloff anticipated a drop in earnings for the 1st Quarter which was only partially impacted by the coronavirus lock-down. The rock and roll pattern we’ve witnessed of late evidences the uncertainty of how the 2nd Quarter is going to pan out.
Most of the (upside) action in the stock market has been limited to the mega-caps (Microsoft, Apple, Amazon, Alphabet (Google) Facebook etc.) which now account for a substantial part of indices. We’ve also enjoyed a significant rebound in the energy sector. But the rest of the economy?
As reported in Institute for Supply Management®’s (ISM®) Spring 2020 Semiannual Economic Forecast, released Friday, they project the manufacturing and non-manufacturing sectors to contract this year, with manufacturing revenue forecast to decrease by 10.3 percent and services-sector revenue expected to drop by 10.4 percent. Capital expenditures also are projected to take a hit, and capacity utilization is expected to be down.
The great unknown isn’t really about the next quarter which will be awful, but what the rest of the year will look like in terms of earnings. Are the mega-caps really immune or just laggards? The ISM estimate of a decrease in revenues could underestimate what’s in store. And because corporations are highly leveraged (years of borrowing to buy back their own shares) the decline in earnings will be a serious multiple of the fall in revenues.
Many pundits who expected a double-bottom have changed their tune and now believe we’ve seen the bottom. It would be great if they are right, but if history is any guide the (revised) consensus, like every consensus should prove mistaken. It’s sort of like the roller coaster, once you think the scary part of the ride is over, another one sneaks up to test your intestinal fortitude.