In lieu of our usual Weekly Bulletin, we are publishing special reports to discuss the market reaction to evolving news on the coronavirus outbreak. We would stress the following observations as developments continue to unfold.
Stocks retreated last week on somber economic comments from Federal Reserve Chairman Powell, renewed China-U.S. trade tensions, and the extremely weak economic readings resulting from the virus-induced economic shutdown. Now that we have first-quarter earnings results and commentary and several months of stock market performance since the crisis began, we have a clearer picture of which industries are well positioned for the social-distancing world we will be living in for the foreseeable future.
While first-quarter S&P 500 earnings declined by 14%, there were major divergences on the sector and industry level. The defensive Health Care and Consumer Staples sectors both posted 5% earnings gains and these sectors remain well positioned for further earnings gains in the coming quarters. The non-discretionary products (food and drugs) produced by these sectors will remain in demand, despite the potential for further economic weakness. Health Care continues to outperform—in part from the flurry of interest in new treatments for COVID-19. Aging demographics are very favorable for the sector.
Technology was an earnings leader, posting earnings gains of 6% in the quarter. We were positive on tech prior to the crisis and the work from home directives are accelerating many of the sectors secular trends. Software, semiconductors, communication services and others were benefitting from the movement to advanced communication systems (5G) and these trends are accelerating as a result of the crisis. We continue to see strong market leadership from the technology sector.
The Consumer Discretionary sector was a big loser with earnings down 49%. However, there are clear winners and losers in this space. Online retailing and home improvement are well-positioned for the stay-at-home world. In contrast, travel and leisure, restaurants, and brick-and-mortar retailing are posting very poor results, with many facing potential bankruptcy. We would continue to be selective in this sector.
The Financial sector was the second worst first quarter performer with earnings down 41%. While poor earnings were driven by higher loan-loss reserves for potential bad loans, bankruptcies are rising as a result of the severe economic contraction we are experiencing. Zero short-term interest rates and low long-term rates are also challenging interest income. Bad loans and ultra-low interest rates should remain headwinds in the coming quarters. Financials have been a major underperformer since the crisis began and we are closely watching the sector’s performance for signs of a sustainable economic and stock market recovery.
The Industrial and Energy sectors both saw first-quarter earnings drop by about 30%. The sectors have underperformed the broader stock market indexes since the start of the crisis with the bombed-out energy sector now showing signs of stabilization. We are watching for the performance of these deep cyclical, globally exposed, sectors for signs of a durable U.S. and global economic recovery.
While we expect the second quarter to mark the low in economic and profit performance, this is dependent on the highly uncertain path of the virus. We anticipate current earnings and stock market performance trends will persist near-term and recommend conservative portfolios that favor Technology and the defensive Health Care and Consumer Staple sectors.
Past performance is no guarantee of future performance and future returns are not guaranteed. There are risks associated with investing in stocks such as a loss of original capital or a decrease in the value of your investment.
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