- S&P 500 corporate profits are holding up far better than they did in past recessions, and it helping fuel the stock market’s summer rally, says James Paulsen, chief investment strategist at The Leuthold Group.
- Shrinking GDP typically drives profit declines roughly four to five times larger than what was seen during the 2020 downturn.
- Companies were able to limit earnings-per-share damage to “one of the mildest recessionary contractions of the post-war era,” Paulsen said. They did that despite the coronavirus fuelling the biggest economic downturn in nearly a century
- Outlined below are the four reasons why profits have held up so well during the coronavirus recession, according to the strategist.
- Visit the Business Insider homepage for more stories.
Some of the stock market’s extraordinary rally from March lows may have to do with how little corporate profits were pummelled by the coronavirus pandemic, says James Paulsen, chief investment strategist at The Leuthold Group.
Earnings weren’t supposed to hold up as well as they did. The coronavirus pandemic prompted the largest quarterly and year-over-year gross domestic product declines in US history. Unemployment skyrocketed, consumer spending slowed immensely, and overall activity ground to a halt.
Plunges in US GDP have historically driven earnings-per-share declines four to five times larger than what was seen, the strategist found. This year’s downturn reversed the trend. Though GDP has contracted nearly 11% from its recent high, EPS only dropped by 15%.
Companies were able to limit EPS damage to “one of the mildest recessionary contractions of the post-war era” despite the coronavirus fuelling the biggest economic downturn in nearly a century, Paulsen said.
“If firms are successful at minimising the earnings impact of a record collapse in the economy, why shouldn’t the stock market recover faster and more robustly?” he wrote in a note to clients.
Detailed below are the four factors Paulsen says reinforced corporate earnings before and during the coronavirus recession.
(1) Fed to the rescue
To start, the government and Federal Reserve’s response to coronavirus economic fallout was faster and larger than in any other recession. The Fed stepped in with unprecedented lending programs and asset purchase strategies, while Congress passed the historic $US2.2 trillion CARES Act to inject fiscal relief into the economy.
The response was more than double the size of aid efforts used during the financial crisis, and seven times larger than those used after the dot-com bust, Paulsen said. The cocktail of fiscal and monetary relief “buffered company sales trends” from the damage typically incurred in a recession, he added.
Sales data for S&P 500 companies shows just how directly the policy response buoyed earnings. For the first time in data going back to 1990, annual sales per share growth fell less than nominal GDP growth during a recession. The former even avoided contraction despite the dire backdrop.
(2) Companies battened down the hatches
Just as the government responded to the virus’s sudden shock, so did the nation’s biggest corporations. Firms slashed costs by unprecedented amounts through layoffs and liquidations to maintain their cash piles. By the second quarter, the US output gap – a measure of how much firms under-utilise the economy’s resources – sank to a post-war low.
Though the pandemic itself wasn’t anticipated, companies were prepared themselves for the resulting economic hit, Paulsen said.
“Because this recession was predictable, businesses moved more quickly and more assertively than ever in lowering breakeven points to preserve profits more effectively than in past cycles,” the strategist added.
(3) Shrunken household debt piles
In past recessions, US households entered downturns with increasingly high levels of debt. Such indebtedness tends to worsen slumps, as Americans lack the extra cash to restart the country’s economic engine.
This year has been different. The household debt burden sat near record lows when the recession started, leaving Americans with plenty more power to maintain spending and keep companies afloat. The personal savings rate heading into the recession was also double that seen before the 2000 and 2008 downturns. In all, these positive trends helped drive corporate sales and pad against a worse plunge than past recessions, the strategist said.
“The US consumer came into this crisis in uncommonly strong financial shape, surrounded by a robust job market and with fewer headwinds than one normally faces when entering the recession,” Paulsen said, adding the lack of hurdles could be “why many consumer spending categories have bounced back quicker and stronger than most expected.”
(4) Bolstered rainy-day funds
Companies also entered the coronavirus recession in better positions than usual. S&P 500 firms’ debt to earnings ratios stood at historic lows, and cash flow per dollar of sales was higher than in past downturns. Combined, the gauges reveal companies had less debt to worry about and healthier cash buffers once the pandemic stifled sales.
“Having financial strength and flexibility, as opposed to the worsening vulnerabilities that often characterise the health of businesses in advance of a recession, provides far greater options when challenges emerge once in a recession,” Paulsen wrote.
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