Cam Hui, CFA | cam@pennockideahub.com Page 1

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Quantitative & Strategy

EARNINGS MONITOR: CAUTION AHEAD

July 28, 2020

EXECUTIVE SUMMARY

Q2 earnings season is now in full swing. So far, 26% of the S&P 500 has reported. To this

point, the tenor has been cautious.

FactSet reported the EPS beat rate rose to 81% from 73% last week, which was well above

the 5-year average. The sales beat rate fell to 71% from 78% last week, but it remains ahead

of the 5-year average of 60%. However, much of the tone of the earnings calls has turned

negative.

As we pointed out last week (see Earnings Monitor: Waiting for Congress), the “elephant in the

room of the earnings outlook is what happens when the fiscal support from CARES Act

expires at the end of July”.

The rest of the FANG+ stocks are expected to report this week, namely Facebook (FB),

Apple (AAPL), Amazon (AMZN) and Alphabet (GOOG). We believe their reports will

probably be overshadowed by events in Washington.

Cam Hui, CFA cam@pennockideahub.com

Table of Contents

Q2 Earnings Monitor ................................ 2

An Upbeat Tone ....................................... 3

From the Ground Up ................................ 4

Valuation Still Elevated ............................ 6

The Market Reaction ................................ 7

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Quantitative & Strategy

Q2 Earnings Monitor

Q2 earnings season is now in full swing. So far, 26% of the S&P 500 has reported. FactSet

reported the EPS beat rate rose to 81% from 73% last week, which was well above the 5-year

average. The sales beat rate was fell to 71% from 78% last week, but it remains ahead of the 5-

year average of 60%.

The bottom-up consensus forward 12-month estimate rose 1.05% last week. The market is

trading at a forward P/E of 22.2, which is well ahead of historical norms.

Exhibit 1: A Strong Earnings Season

Source: FactSet Information Services

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July 28, 2020

Quantitative & Strategy

An Upbeat Tone

So far, earnings reports have taken on an upbeat tone. Both the EPS and sales beat rates are

well ahead of their historical averages. As a consequence, analysts have upgraded quarterly

earnings estimates across the board, except for Q2 2020 earnings.

Exhibit 2: Quarterly EPS Estimates

Source: FactSet Information Systems, Pennock Idea Hub

Earnings visibility is improving. More companies are now providing earnings guidance in Q2

compared to Q1. The sectors in which there are more companies with guidance exceed those

without are healthcare and technology.

Exhibit 3: Earnings Guidance by Sector

Source: FactSet Information Systems

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The percentage of companies issuing negative guidance is 22%, which is much better than the

5-year average of 69%. That said, 53% of companies are still not issuing or have withdrawn

guidance. They cite the uncertainty surrounding the pandemic as the reason for their cloudy

outlook.

Is this an upbeat earnings season, or a case of “if you can’t say anything positive, don’t say

anything at all”?

From the Ground Up

Courtesy of The Transcript, which monitors the earnings calls, the tone of the earnings calls

had turned negative last week.

The economy was rebounding in May and June, but the recovery seems to have stalled out as infections

have rebounded. CEO commentary was particularly negative last week. Business leaders are rapidly

losing confidence and do not see a V-shaped recovery materializing. There’s a sense that government

stimulus appears to be the only thing propping up the economy and it’s creating distortions in

unemployment and financial markets. Still (perhaps because of this stimulus) the hot housing

market suggests that consumers may not actually be in such bad shape after all–just spending on

different things.

Here is a summary of the macro outlook.

The economy was rebounding, but activity is slowing with the surge in infections

(Southwest Airlines, Blackstone)

Optimism is fading (Marriot International, Delta Air Lines)

CEOs are losing confidence in a V-shaped recovery (Manpower Group, Neogen,

Unilever)

The world has been turned upside down (Southwest Airlines)

Businesses are breaking (Airbnb, Southwest Airlines)

And life is unlikely to return to normal until there is a vaccine (Accenture, American

Airlines, Unilever)

We’re facing a very, very bumpy ride (Goldman Sachs)

But government stimulus is keeping the economy afloat for now (Everbrite, Capital

One)

It’s also creating distortions (Manpower Group)

The biggest distortion of all is probably in financial markets (Goldman Sachs)

A new generation of day traders has been born (Interactive Brokers)

From a sector perspective, there were downbeat assessments from consumer services, oil and

gas, and materials. On the other hand, the housing market is on fire, and the technology sector

outlook is holding up well.

“We spent 12 years building our business and within six weeks, lost about 80% of it. When a

business drops that quickly, not only is there this feeling of losing much of what you created, but things

start breaking.” – Airbnb (AIRB) CEO Brian Chesky

“We’re in an environment where it’s almost like we’re starting our business from scratch” – Southwest

Airlines (LUV) CEO Gary Kelly

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Quantitative & Strategy

“We believe that North America production is likely to remain structurally lower in the foreseeable

future and has slower growth going forward. The shrinking demand for shale oil and limited access

to capital markets, the inevitable rationalization will continue, and we expect to see a more disciplined

market with stronger operators and service companies.” – Halliburton (HAL) CEO Jeff Miller

“I am very pleased to report that the recovery in new home demand that we experienced over the course

of the second quarter was nothing short of outstanding. Our second quarter results show a remarkable

rebound in demand as April net new orders fell 53% from last year, only to see year-over-year orders

increased 50% for the month of June. Led by strong demand among first-time buyers, we saw

meaningful improvement across all buyer groups and geographies as the quarter advanced. This

improvement culminated in June orders increasing 77% for first time, 48% for move up and 21% for

active adult over June of last year…buyer demand is clearly experienced a dramatic recovery in the

quarter and has remained strong through the first three weeks of July.” – PulteGroup (PHM) CEO

Ryan Marshall

“…we continue to see good mortgage activity in the U.S. In fact, in the second quarter, we saw

mortgage growth, and we actually had record mortgage loan balances at the end of the quarter ” –

UBS (UBS) CFO Kirt Gardner

“I am optimistic, because the combination of low mortgage rates, still in under supplied markets and

the broader nesting trend which we see across consumers, I think spells good news for the builder

channel” – Whirlpool (WHR) CEO Marc Bitzer

“The combination of strong demand and limited inventory has also allowed us to raise prices across

many of our communities. In fact, more than half of our divisions report raising prices in 50% or

more of their communities. The typical price increase is in the range of 1% to 3% and includes changes

in base price and/or reductions in incentives” – PulteGroup (PHM) CEO Ryan Marshall

“The last months have accelerated the shift to digital, which was already underway..” – eHealth

(EHTH) CEO Scott Flanders

“…we’ve seen an acceleration in adoption rates of technology initiatives with multiple years of

consumer adoption being compressed into 10 or 12 weeks’ time.” – Tractor Supply (TSCO) CEO

Harry Lawton

“I would say, in the last five months is that digital technology is no longer viewed as just new project

starts, but it’s becoming perhaps the most key for business resilience.” – Microsoft (MSFT) CEO

Satya Nadella

“…we are also already seeing evidence that this crisis is accelerating the technical and soft skills

transformations that we have been tracking and predicting for some time. Acute skills shortages in

tech, cyber security, software development, and data analysts for example continue unabated,

reinforcing that the need for skills revolution is here in force” – ManpowerGroup (MAN) CEO

Jonas Prising

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Quantitative & Strategy

Valuation Still Elevated

The market valuation is still elevated. The forward 12-month P/E ratio is 22.2, which is well

above its 5-year average of 17.0 and 10-year average of 15.3. We estimate what were to happen

if we were to eliminate the technology, consumer discretionary (AMZN) and communication

services (GOOG, NFLX) sectors from the P/E calculation. The forward P/E would fall to

18.6, which is still above the market’s 5- and 10-year averages.

Exhibit 4: S&P 500 Forward P/E

Source: FactSet Information Services, Pennock Idea Hub

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Quantitative & Strategy

The Market Reaction

For the companies that have reported earnings, the market reaction has been positive. The

market has rewarded earnings beats at a rate above the historical average, and even earnings

misses have seen prices fall less than average.

Exhibit 5: Earnings Report Reaction Has Been Positive

Source: FactSet Information Services

Despite the upbeat tone of the earnings reports, the S&P 500 traded with a heavy tone last

week. In particular, the equal-weighted S&P 500 diverged and underperformed the float-

weighted S&P 500 since early July, which is the period coinciding with earnings season.

Exhibit 6: S&P 500

Source: StockCharts

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July 28, 2020

Quantitative & Strategy

The tone of earnings calls indicate that the macro outlook is turning sour. As we pointed out

last week (see Earnings Monitor: Waiting for Congress), the “elephant in the room of the earnings

outlook is what happens when the fiscal support from CARES Act expires at the end of July”.

High-frequency data is increasingly telling a story of a softening economy. The CARES Act

support is expiring, and so are tenant eviction moratoriums. Last weekend was the deadline for

an agreement so that states can re-program their computers to conform to a new support

package.

The Democratic-controlled House passed a $3-trillion rescue package two months ago as the

opening offer in negotiations. The Republicans were scheduled to table a proposal last

Thursday, but they were divided and could not present a united front. In all likelihood, there

will be a rescue package, but the market will be focused on the details and the level of support.

Time is of the essence. Small businesses are failing or operating at low capacity, which results

in a job shortage. If a rescue bill makes further cuts to aggregate household income, it will

depress demand, and add to a death spiral of more failing businesses, more job losses and

further nosedive demand.

Exhibit 7: Small Business Are Failing

Source: TraclTjeRecpveru/prg

State and local government budgets are under tremendous pressure. Without aid, employment

in that sector will collapse. Previews of the upcoming July Employment Report outlook is

already starting to look ugly.

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July 28, 2020

Quantitative & Strategy

Exhibit 8: State and Local Government Employment Have Been Stagnant

Source: FRED, Federal Reserve Bank of St. Louis

The rest of the FANG+ stocks are expected to report this week, namely Facebook (FB), Apple

(AAPL), Amazon (AMZN) and Alphabet (GOOG). Their reports will probably be

overshadowed by events in Washington.

Stay tuned, and brace for volatility.

Cam Hui, CFA | cam@pennockideahub.com Page 10

July 28, 2020

Quantitative & Strategy

Disclaimer

I, Cam Hui, certify that the views expressed in this commentary accurately reflect my personal views about the subject company (ies). I am

confident in my investment analysis skills, and I may buy or already own shares in those companies under discussion. I prepare and edit

every report published under my name. I depend on my colleagues for constructive criticism on my research methods and conclusions but

final responsibility is my own.

I also certify that I have not and will not be receiving direct or indirect compensation from the subject company(ies) in exchange for publishing

this commentary.

This investment analysis excludes any target price, and is not a recommendation to buy or sell a stock. It is intended to provide a means for

the author to share his experience and perspective exclusively for the benefit of the clients of Pennock Idea Hub (PIH). My articles may

contain statements and projections that are forward-looking in nature, and therefore subject to numerous risks, uncertainties, and

assumptions. The author does not assume any liability whatsoever for any direct or consequential loss arising from or relating to any use of

the information contained in this note.

This information contained in this commentary has been compiled from sources believed to be reliable but no representation or warranty,

express or implied, is made by the author or any other person as to its fairness, accuracy, completeness or correctness.

This article does not constitute an offer or solicitation in any jurisdiction.

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