Investor Essentials Daily

The coming “Big Bath” in Forbes—Wall Street is wrong about Q2 earnings

June 1, 2020

Q1 was the S&P 500’s worst earnings quarter in years. So far, Wall Street analysts seem bullish that companies are already getting back on track for Q2.

While there’s reason to believe we’re poised for a quick recovery from the current recession, the data says we haven’t reached our worst earnings quarter yet.

Wall Street is missing the looming “Big Bath,” but that doesn’t mean it’s not coming.

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Q1 earnings season in the U.S. is mostly a wrap, and the results were unsurprisingly weak. S&P 500 EPS fell roughly 64% both quarter-over-quarter and year-over-year to $12.56 as huge parts of the economy were forced to fully shut down beginning in March.

The huge drop in earnings didn’t come as a surprise. Wall Street analysts, financial news reporters, and most investors prepared for a rocky quarter.

Now that we’re entering the final month of Q2 for most U.S. companies, these same outlets and investors are turning their sights to the next quarter of earnings results.

Initial forecasts are surprisingly bullish. Wall Street analysts are calling for roughly 75% growth from Q1 figures. This is still well below pre-pandemic figures, but it’s a strong step in the right direction.

Unfortunately, these estimates are not to be trusted. Logically speaking, Q2 earnings should be much worse than Q1 for S&P 500 companies.

In the U.S., widespread shutdowns didn’t begin until the middle of March, just a few weeks before the end of the first quarter. Compare that to Q2, which began during the peak of the lockdown and went nearly two months before the country began opening up again.

Two months versus two weeks, there’s a clear disconnect between Wall Street and reality.

Last week, we published in Forbes about the next “Big Bath.” Not only should Q2 be weaker than Q1 from an operations standpoint, but it’s the perfect opportunity for smart executives to reset their financial statements for the next bull market.

If Wall Street analysts were the financial historians they should be, they would know this happens frequently during a recession.

As readers of the Investor Essentials Daily, we want you to know not to panic when companies start missing their earnings targets.

The same thing happened during the Great Recession, and frankly we’re surprised more people aren’t talking about it this time.

As we highlight in the Forbes article, there’s a positive to the “Big Bath” as long as you know it’s happening.

Widespread earnings misses are likely to drive stocks lower in the short-term. As an investor, if you can avoid succumbing to the emotional impact of a big bath, it can be a fantastic buying opportunity.

Once corporations have cleaned up their balance sheets and income statements, we’ll likely see earnings start to trend higher in the following quarters.

So long as the credit markets hold up, as we have discussed in prior Monday Macros, the “Big Bath” is a good starting point for the next bull market.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research