Virus surge threatens newfound U.S. corporate profit optimism

In a year that saw corporate forecasts canceled faster than travel plans, the third-quarter U.S. earnings season brought a sense of normalcy with better-than-expected profits and rising forecasts. Now a second wave of COVID-19 infections and renewed lockdowns threaten to cloud those views.

With results from most of the S&P 500 companies in, nearly 85% have beaten profit estimates, according to data compiled by Bloomberg. About half of those that have reported raised fourth-quarter earnings forecasts, the largest proportion to do so in at least a decade.

While an effective vaccine is expected to be widely distributed in 2021, surging U.S. infections are causing renewed angst as government officials re-impose the kind of restrictions that squelched the economy and roiled markets earlier this year. The outlook gets murkier when you add in President Donald Trump’s refusal to accept the election outcome and control of the U.S. Senate hanging in the balance until runoff elections in Georgia in January.

“The market is churning a bit as investors digest the recent ramp higher, grapple with a worsening in the COVID-19 spread and anticipate another highly contested election in Georgia,” Cannacord Genuity strategists including Tony Dwyer told clients in a research note this week. Their advice is to take advantage of any weakness to add exposure in assets including small-cap stocks, economically sensitive sectors, emerging markets and commodities, given the “backdrop of historic money availability and continued global economic recovery.”

So far, vaccine optimism appears to be holding sway. In the past month there’s been a broad shift in investors’ preferences. Shares of companies in energy, financial, travel and other industries most hurt by stay-at-home mandates outperformed those that thrive under them, including technology and home entertainment.

Financial stocks in the S&P 500, pummeled during the pandemic amid credit concerns and record-low interest rates, have rallied 14% in November on hopes that President-elect Joe Biden won’t be able to push through higher corporate taxes and more stringent bank regulations. The group is on track for the biggest monthly gain since 2011.

The developments caused Jefferies strategist Sean Darby to get more bullish on banks, saying this week that the stocks are likely to rise through 2021, given “improved visibility toward a successful coronavirus vaccine, easier lending conditions, little evidence of deflation and a sentiment switch from growth to value.”

Hedge funds raised their exposure to financial stocks in the third quarter to the highest since 2013, though they remained underweight, according to Goldman Sachs. Still, Darby and others have warned that spiking virus cases and stalled government stimulus could weigh on the sector.

No group has performed better than technology stocks this year. But earnings season failed to move the needle on their shares, despite solid results. Together, Facebook, Amazon.com, Apple, Microsoft and Alphabet Inc. have gained 50% in 2020. But they’re down about 1% since Microsoft became the first to report on Oct. 27.

The prospect of lockdowns and more economic turmoil may bode well for that group of megacap tech companies, seen as havens by investors seeking growth and cash-rich balance sheets. For others like Amazon and Netflix Inc., large numbers of homebound customers are undoubtedly good for business.

Even with a widely distributed vaccine, Cowen analysts including Gregory Williams and Paul Silverstein said in a note to clients this week that consumers won’t be abandoning many of the conveniences they’ve become accustomed to, and some of 2020’s winning stocks will continue to outperform. Among the firm’s top picks are internet providers like Charter Communications, video-game makers Electronic Arts Inc. and Take-Two Interactive Software Inc., telemedicine provider Teladoc Health Inc. and workout equipment maker Peloton Interactive Inc.

There are already signs that the spike in coronavirus cases is sapping some of the vaccine euphoria. The S&P 500 snapped a two-week streak of gains and is now off 1.9% from its Nov. 16 record. Meanwhile, stay-at-home stocks like Zoom Video Communications Inc. and DocuSign Inc. rallied.

JPMorgan Chief U.S. Economist Michael Feroli said on Friday that the restrictions associated with the COVID-19 surge “will likely deliver negative growth” in gross domestic product in the first quarter, while favorable news on vaccine trials increases his confidence in a brisk recovery in the second and third quarters.

Wall Street is projecting earnings to shrink 11% in the fourth quarter before swinging to growth in 2021, according to data compiled by Bloomberg Intelligence. Only the materials, technology and health-care sectors are expected to show growth, albeit in the single-digits. The profit picture is expected to improve markedly in 2021 with S&P 500 earnings growth in double-digits for all four quarters.