With one-third of the S&P 500 reporting, there's a battle shaping up between two stories.
One is somewhat bearish: The reopening is slowing, and the second half will not see the V-shaped recovery anticipated at the height of reopening euphoria in June.
The other is generally bullish: Regardless of whether the reopening has bumps in the road, the second quarter was the bottom and there will be incremental improvement in the third and fourth quarter.
Sherwin-Williams is a great example of the stay-at-home success stories. Earnings were way above consensus as consumers stayed home and painted their houses, and the company raised guidance for the full year, one of the few companies to do so.
Home builders are also killing it. D.R. Horton had a big beat on a huge increase in orders for new homes. It was helped by record low mortgage rates.
The no-guidance trend continues from big cyclicals companies: 3M, Xerox, Raytheon and Cummins all declined to provide guidance. Harley-Davidson posted a surprising loss (a small gain was expected), and also declined to provide guidance. McDonald's posted a small miss on earnings and they too declined to provide guidance.
So why does the market keep holding up? Aside from a brief drop of roughly 15% in mid-June, which came as the market realized the perfect V-shaped recovery was not going to happen, stocks have held up remarkably well. Partly this is due to expected strong earnings from technology stocks, which stand to benefit regardless of whether the reopening story goes smoothly or not.
But the key to understanding the rally is the persistent belief that the second quarter was the bottom of the pandemic and its economic impact.
Here is McDonald's CEO Chris Kempczinski on this morning's earnings call: "I believe that Q2 represents the trough in our performance as McDonald's has learned to adjust our operations to this new environment."
Even 3M, which declined to provide guidance, spoke about a "broader improvement" in business recently on the conference call. CEO Michael Roman said, "We're seeing demand come back."
John Wren, CEO of Omnicom, expressed a similar sentiment, saying "visibility has improved in the past couple of months but remains low" but that "based upon current marketing conditions, we think the worst is behind us."
But there is another crowd that is not so interested in debating whether the second quarter was technically the trough quarter. This crowd is more interested in emphasizing that the recovery is not going so smoothly, and that "lower for longer" is the key theme.
Here's Xerox on its earnings release: "The continued uncertainty around the spread and resurgence of the virus has changed our prior expectation for an inflection point following the second quarter. ... We now expect a slower pace of gradual recovery in the second half of the year."
The same sentiment from truck engine maker Cummins: "While customer demand did improve in some regions as the quarter progressed, significant uncertainty around the pace of recovery in our markets remains."
For the moment, the bull argument still has the upper hand.
"It [the reopening] doesn't have to go smoothly, it just has to get a little better," said Nick Raich, who monitors corporate earnings at Earnings Scout, noting that in his opinion earnings growth for the second half of the year "was set too low. You typically don't see estimates get raised in the middle of earnings season," but that is what is happening.
He's right about that. Earnings estimates for the third quarter were expected to be down 25% in the beginning of July, but they are now expected to be down 23.5%. That may not seem like much, but it is improving and earnings estimates usually come down going into earnings season, not up.
- Transcripts partly supplied by Sentieo.