The stock market is rebounding without the most important ingredient it needs for long-term gains — and one quant chief warns it's a setup for another crash
- Andrew Lapthorne, the global head of quantitative research at Societe Generale, is skeptical of forecasts for a “perfect” v-shaped recovery in corporate earnings.
- The consensus forecast among analysts is that by the end of 2021, profits will be growing at nearly the same rate as they were in late-2019.
- Lapthorne considered the unique nature of this crisis and concluded that the consensus is too optimistic.
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Wall Street’s expectations for recovery from the coronavirus crisis seems too good to be true.
That’s according to Andrew Lapthorne, the global head of quantitative research at Societe Generale. He is skeptical that the stock market’s strong rebound from its trough in March matches up with the reality that will unfold in the months ahead.
In particular, Lapthorne is skeptical of the “perfect” recovery that is reflected in real-time consensus forecasts for earnings, the biggest long-term driver of stock prices. Data he compiled shows that analysts expect global profits to fall by 21% this year and then rise 21% in 2021.
In other words, the prediction is that economic conditions will recover so quickly that by December 2021, corporate profits will be back to where they were when COVID-19 began to spread in late-2019.
“Clearly this will not be the case,” Lapthorne said in a recent note to clients.
In the alphabet soup of economic scenarios, analysts expect a V-shaped recovery that is turbocharged by effective containment of the outbreak and abundant government stimulus.
Many countries around the world are clearly not close to fully reopening their economies. But the latter condition — stimulus — has been successful and unprecedented, ranging from the Federal Reserve’s purchases of select junk-rated corporate debt to the checks wired straight to Americans’ accounts.
This helps explain why the S&P 500 has already retraced more than half of its losses after its fastest 30% decline ever. Once again, investors are buying equities knowing fully well that the Fed is ready to act as lifeguard.
“Yet there is zero evidence historically that markets can go up on a sustained basis whilst profits continue to slump,” Lapthorne said. “Equity markets may have bounced but investors still seem to be positioning themselves for a drop.”
For proof of the ongoing risk to corporate profits, keep tabs on what companies are doing with their cash. Goldman Sachs strategists estimate that cash spending among S&P 500 companies will fall by a record 33% to $1.8 trillion this year.
The decline includes cuts to dividends — another area where proof of cashflow constraints can be found. By adjusting for the expected drop in EPS this year, UBS estimates that the median S&P 500 dividend will fall 28% to $1.47. The largest expected dividend reductions are in cyclical sectors like energy and materials.
Lapthorne is not the only strategist concerned that earnings expectations are still too high, even though they have been reined in by the pandemic.
“We are concerned 2021 numbers now need to be cut more aggressively,” said Lori Calvasina, the head of US equity strategy of RBC Capital Markets, in a recent note.
Her 2021 EPS forecast that factors in a “healthy economic recovery and margin expansion” is $153, below the consensus forecast for $170.
In addition, she noted that several executives have told analysts on earnings calls that the journey to get the economy back to its pre-coronavirus strength will be slow and uneven.
These observations contrast the market’s march higher — at least in Lapthorne’s books. And the mismatch is one that may be corrected by another sell-off.