Earlier in the pandemic, it would be difficult to imagine any signs of positivity at this stage. Yet over recent weeks there’s been some better news about company profits and economies - from a large proportion of the big US companies announcing profits above expectations, to improving retail sales in some countries (albeit off a low base). But there’s also been concerning detail on the extent of recessions, including in the UK.
We have a long way to go. An end will come to the financial support provided by governments and we don’t know how companies or economies will cope as these lifelines are cut. Alongside this are the possibilities of a vaccine or a second wave of the virus – which will come first and what will it mean? And there’s the worrying escalation of tensions between the US and China, which could impact global markets. This month I consider some of these factors and what they may mean for company profits and economies.
Company earnings: from one extreme to another
As companies reported how much they earned over the second quarter of 2020 (what’s referred to as the earnings season each quarter), many beat the expectations of financial analysts. But it’s important to put this in context. Analysts had significantly reduced their expectations as they waited to see the extent to which Covid-19 would reduce company profits or lead to businesses incurring massive losses. In the end, results ranged from severe loss to remarkable growth across the different industries.
It’s no surprise that companies in the energy, financial and non-essential goods and services sectors reported considerable dents to profits. The four largest retail banks in the US came out with poor results but with strong capital positions; a marked contrast to the problems we saw in the banking sector as we came out of the global financial crisis. And going forward, investors will watch carefully the extent of the inevitable impact of people failing to repay their loans – a potentially significant increase.
Some areas in the financial sector, such as investment companies which carry out a lot of trading on stock markets, did much better as Covid-19 caused a surge in stock market activity.
Healthcare, consumer staple and technology companies were among those reporting the strongest profits. In many cases, these companies thrive as we all change the way we work, consume and occupy ourselves. So from Microsoft to Amazon, to Ocado delivering groceries – many companies were able to deliver their second quarter reports with a great deal of confidence and optimism.
But, in some instances, there are limits to this growth. For instance, strong results from well-known streaming service Netflix were accompanied by a more cautious outlook. With so many of us already subscribed there’s less scope for new subscriptions. Plus other providers such as Disney are seeking to gain share in this market.
Others meanwhile look to continue benefitting from life post-pandemic. As I considered in my last outlook, trends such as contactless payments and cloud storage look set to continue.
The big question for investors: how quickly will company profits recover?
The market is currently forecasting only two quarters of contraction before improvement. At Aberdeen Standard Investments, we expect a slower recovery. To put this in perspective, it took 17 quarters for profits to recover after the 2008 financial crisis. And it took 14 quarters for them to recover after the technology bubble burst in 2000. The ongoing impact of Covid-19 is arguably far more uncertain than either of those situations.
However, this said, many companies have been innovative and adapted well to the economic problems caused by the pandemic. Some, as I’ve talked about before, have even benefitted. The difference in experiences is something we continue to bear in mind as we meet the companies in which we invest and set forecasts for them.
Further monetary support measures from governments and central banks would certainly help support consumers and therefore company profits. On the other hand, what if more of us going out to spend leads to a rise in infection and subsequent lockdowns? Even without lockdown, the activity of many companies is greatly restricted. Social distancing means restaurants and visitor attractions having to reduce their visitor numbers. Meanwhile, offices, warehouses and factories have had to reduce the number of staff they can accommodate at any one time.
The economic situation is an incredibly fragile balancing act and will remain so until a vaccine is found or the virus is more contained. Even when this does happen, the impact of the virus will weigh heavily on company profits for a long time. Companies will have to recover from their own costs and losses, and may need to take on further debt to survive. They may also need to contribute to the collective recovery. Higher company taxes, especially in the US, are a real possibility as governments start to pay back the huge sums they’ve provided as support during the crisis. As companies try to recover their balance sheets, governments need to do the same for economies. However, bond market investors, who set the price at which governments can borrow and the quantity of borrowing available, have remained sanguine about the extent of borrowing being taken on by governments.
How are economies coping?
Across the world, the extent of economic damage varies region to region. It depends on the prevalence of the virus and the quality of the healthcare system in the region, how each government responded (and is responding) with support, and how successfully lockdowns have been lifted. The pandemic has caused unprecedentedly deep recessions almost everywhere. But, in some cases, the ‘first blast’ slump has been less severe, more short-lived, than anticipated.
In the UK, it’s been a mixed picture. Households relatively quickly increased their spending and the housing market is edging closer to normality. However, the UK’s economy suffered a bigger fall than other major European economies over the second quarter. Gross domestic product (GDP) fell by 20.4%, with all industries affected.
Elsewhere in Europe, the situation is fragmented; the response of governments and health services varying country to country. Given how integrated European economies are, this will have an impact on its collective recovery.
Under-resourced health systems have sadly had a big impact in India and Indonesia, while Mexico and Brazil (important countries economically in emerging markets) were slow to respond to the crisis.
And what about the world’s two largest economies – the US and China?
China was first hit and so was first to emerge from the peak of the crisis. Data suggests that its industries recovered strongly in March and April. But this is balanced with news that services have been slower to recover and that the virus is reappearing in some provinces.
In the US, the full impact of unemployment is still to be felt – there’s no word on whether the enhanced employment packages will be continued. However, while we’ve seen swift shedding of labour, we’ve also seen firms hire again quickly when they see demand returning. This has always been a feature of the US labour market but it means we’re likely to see more volatility in some of the US employment figures.
The two economic giants have also been hitting the headlines as trade tensions escalate further. An already fraught trade situation was stoked as the US suggested that Chinese hackers targeted US companies involved in virus research, then ordered China to close its consulate in Houston.
Here you have the world’s two powerhouses responsible for significant economic links and ‘flow’. If their relationship deteriorates further it may affect individual companies and countries. Countries may ‘pick sides’, or indeed be forced to do so, favouring business links with one rather than the other.
The ripple effect of economic damage
Manufacturing and supply is often interconnected across companies, industries and countries. It means that the impact of the pandemic and disputes over trade relations can have a considerable ripple effect. For instance, the manufacture of goods in one country often relies on component parts from other countries. If one of those remains in lockdown, or is unable to cope with tariffs and financial difficulty, it can hold up the whole production process.
The nature of supply chain management is also under pressure. Before the crisis, some companies with strong balance sheets were able to support their supply chains – even by making prompt payments to smaller businesses, or helping to promote them to others. While it’s never sensible to upset those in your supply chain, some companies simply won’t be able to support their stakeholders the way they used to. In other industries, such as airlines, it’s a fight for survival. Their priority is to find ways to stay in business and the decisions they make may affect many other businesses.
The pandemic has created a complex global web of economic repercussions. The situation between the US and China adds to the potential challenges. No matter where we live, we face enormous economic uncertainty. Central banks and governments are making forecasts in a climate of unknowns. Investing carefully, in a wide spread of quality companies from across the world (diversifying), is always important – but is especially so now.
Worried about your investments?
It’s also a good idea to consider getting financial advice, as an adviser can provide you with a tailored plan that meets your individual needs. You can find one yourself at unbiased.co.uk. There’s likely to be a cost for getting advice.
The information in this article should not be regarded as financial advice. Please remember that the value of investments can go down as well as up and may be worth less than was paid in. Information is based on Aberdeen Standard Investments’ understanding in August 2020.