Research and Market Commentary

Global Markets Insights: Reporting season fears, USD dips and oilpatch relief

July 17, 2020

With 20 companies reporting earnings next week, eyes are on significant year-on-year haircuts, but some improvements over Q1 as a recovery takes hold. Meanwhile the USD struggles as America fares poorly on the COVID front; the worst may behind us on the oil front; and a long-term view of the post-pandemic future of retail.

 

Equities

  • The TSX Q2/20 reporting season will get underway next week, with 20 companies slated to report. Some key highlights:

  • Ready for a 50% haircut: Q2/20 was marked by peak lockdown conditions, with extremely depressed activity levels and commodity prices. With close to 80% of TSX earnings typically coming from cyclicals & resources, it should be no surprise that the Q2 reporting season will be challenging. Consensus is pegging TSX Q2/20 EPS at $142, implying a 48% haircut YoY.

  • Sequential improvement: Nevertheless, Q2/20 EPS might sequentially be higher than in Q1/20 for two reasons: seasonality and banks’ PCL . TSX earnings exhibit notable seasonality, with Q2s being almost always superior to Q1s, mostly on the back of Nutrien’s Q2 earnings bump. Further, banks turbocharged their PCL last quarter, and any improvements on that front could make a significant difference on the TSX earnings pool. Bottom-up consensus is looking for banks’ EPS to recover +39% QoQ, which should offset sequential declines among several other sectors.

  • On a 12M trailing basis, TSX EPS could drop to C$812 in Q2/20 from $943 in Q1/20 and an all-time high of $1,063 hit in Q4/19. The contraction rate is accelerating to -22% YoY from -8% in Q1.

  • Top-line down double-digit: TSX quarterly revenues are expected to contract 14% sequentially and 23% YoY, the steepest decline since we began tracking quarterly TSX earnings in 2001. For reference, sales per share (SPS) contraction bottomed at -17% YOY during the global financial crisis of 2008-09.

  • 10 out of 11 sectors should report YoY EPS contraction, with Energy and Discretionary expected to deliver the steepest drop. Utilities and Golds are two outliers, enjoying positive YoY EPS growth. While Financials/banks should suffer on a YoY basis, EPS are expected to improve substantially relative to Q1/20. Strong capital market activity (from trading to equity/bond issues), improving activity levels, and a potential peak in provisioning should all be supportive for a profitability rebound. In our view, peak PCL is likely required to renew investor appetite for the sector. Base metal stocks may also offer some positive surprise: sell-side consensus still seems based on commodity price forecasts that stand below realized prices in Q2/20.

  • As in the US, smaller companies should be hit disproportionately relative to larger ones. TSX Completion Q2/20 EPS is expected to contract 71% YoY versus -43% for the TSX 60.

  • Looking forward, sell-side is projecting a rapid recovery in earnings, with the shift from contraction/expansion being most notable in Energy, Industrials, Discretionary, and Financials.

 

—  Hugo Ste-Marie, Director Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy; and Simone Arel, Research Associate, Global Equity Research

 

Foreign Exchange

  • The USD has traded mostly lower over the course of the past week.  Despite volatile equity markets, which continue to be influenced by geo-political tensions and headlines related to the COVID-19 situation around the world, we have observed a clear weakening in broad FX correlations with risk appetite. The USD has generally failed to benefit from weaker equities while the JPY – the traditional “safe haven” for investors in times of uncertainty – is seeing an unusual, positive correlation with stocks. Generally, in market phases dominated by risk appetite, the JPY moves inversely with equities. We think this perhaps means investors are starting to move away from “risk on/risk off” as the over-arching driver of FX movement to more fundamentally-driven trading. If that is the case, the USD may ease further in the coming weeks. 

  • The US is clearly struggling to contain the coronavirus outbreak. Hotspots continue to emerge around the world but trends suggest that the likes of Germany and Japan (there’s been a recent outbreak in Tokyo) have managed the containment more efficiently and are poised to rebound more quickly. Equity market returns appear to be reflecting this, with stock market gains in Japan and Europe outpacing US markets since the spring. For US-based investors, potential returns have been further enhanced by the weak undertone of the USD. This trend appears to be driving investors away from US markets to Europe especially; demand for FX-unhedged European equity ETFs has picked up sharply since May and demand is providing some further underpinning for the EUR. EUR gains are likely to extend if EU leaders make progress towards agreeing on the EUR750bn recovery support fund at this weekend’s summit meeting. 

  • The CAD has picked up a little ground against the USD this week but it has slipped on some of the key crosses such as the EUR. The Bank of Canada policy decision Wednesday produced no surprises, although Governor Macklem strengthened forward guidance by stressing that its policy rate would not move up until inflation was “sustainably” on target. Market pricing reflects the belief (correct, in our opinion) that the benchmark overnight rate will remain at 0.25% for the foreseeable future whereas futures are pricing in around 10bps of additional easing by the Fed in the coming 12 months, which would take the effective Fed Funds target rate to zero. We anticipate some modest gains for the CAD versus the USD through the second half of the year and target a year-end rate of 1.32 (or 76 USc). 

 

—  Shaun Osborne, Managing Director, Chief FX Strategist, and Juan Manuel Herrera, FX Strategist

 

Energy

  • Global oil benchmarks: We believe the worst is now behind us and energy prices can slowly recover in the quarters ahead. The lingering impact of the Saudi-Russian oil market-share war is now gone and OPEC+ has returned to managing supply against deeply impacted demand from COVID-19. Though economies have only begun to reopen, demand is noticeably picking up and balances are trending closer to undersupplied with each passing week. Accordingly, we remain optimistic that benchmark WTI and Brent forecasts will continue to climb, albeit slowly, over the next handful of quarters, representing an undersupplied market, but also a market that must contend with an enormous inventory overhang built up during H1/20. Decimated global capex budgets with rebounded, but generally slowed, growth from U.S. shale and OPEC+ spare capacity are likely to keep pace with longer-term demand recovery.

  • Canadian heavy oil: The discount remains quite tight, reflecting lower supply volumes from Alberta, which has reduced transportation constraints. OPEC+’s (and especially Venezuelan) supply cuts have disproportionately affected the availability of heavy and medium sour grades in the USGC, thus providing support for WCS barrels to flow to PADDIII. Summer oil sands turnaround season, in addition to economically driven supply shut-ins, unsustainably tightened differentials beyond pipeline economics. However, the protracted unwind of OPEC+ supply caps plus additional pipeline egress should provide a relatively stable and tight pricing for the Canadian heavy barrel in the medium term.

  • Henry Hub: Though lower natural gas and liquids prices are taking a toll on drilling, daily production is not likely to fall fast enough to alleviate balancing concerns this summer. This is because dozens of LNG cargoes that should’ve been exported to other markets have been pushed back due to numerous force majeure declarations citing concerns of severely reduced demand from COVID-19 and invariably these cargoes end up on local storage. We also fear that a return of liquids production could increase associated gas volumes by nearly 8 bcf, further exacerbating the situation. That said, demand is expected to recover as economies reopen and HDDs rise into the winter. We expect a decent rally into the winter, but not to the extent that would call for additional supply investment.

  • AECO: Alberta’s gas market is relatively outperforming due to storage operators tightening supply fundamentals by rapidly filling local inventories. That said, there's more than enough capacity to soak up these volumes and temporarily tighten basis this summer, but this does dampen some pricing expectations into the winter given ample inventories when HDDs arrive. Longer term, improving pipeline infrastructure should work to permanently keep basis tighter than in prior cycles.

 

—  Michael Loewen, Director, Energy Strategist, Global Equity Research

 

Retail

In a recent report, Scotiabank’s Retail Equity Research team looked at the ways in which COVID has changed shopping, perhaps forever.

  • The need for social distancing measures and enhanced sanitization will remain at least until there is a vaccine, if not even beyond. While this means added cost pressures, it has serious implications for the traditional bricks and mortar retail model, which has as one measure of productivity, sales per square foot. Whereas pre-COVID the goal was to optimize capacity, retailers must now limit the number of customers in their stores. Already we have witnessed retailers trying to adapt to this with some apparel retailers booking appointments to shop. However, there is no doubt limiting capacity will impact operations. We suspect retailers will be trying and testing a number of changes to store operations to counter the challenges presented by social distancing.

  • The COVID-19 pandemic has served as a powerful catalyst for the shift from bricks and mortar shopping to online or eCommerce. Almost overnight, penetration rates anticipated several years out have materialized over the space of a few months or even weeks. We believe the migration online will continue. Many retailers have the pandemic to thank for forcing them to enhance their ability to deliver to consumers what they want when they want it and how they want it. Increasingly the how will involve some form of eCommerce.

 

  • Another shopping trend that emerged with the pandemic was a move to shop more locally. This trend likely reflects several dynamics. In the context of the pandemic and the dire implications for small businesses, consumers have been encouraged to support local businesses. In addition, concerns over health and safety see consumers wanting to spend as little time as possible securing goods and shopping local achieves this. This is a trend that could outlast the pandemic.

 

  • Retail as we know it is undergoing a significant reset as a result of the pandemic. COVID-19 is hastening a much need rationalization of an over-stored industry. With weaker players taking the tough decisions to close stores and, in some cases, exit the market, the retail landscape as we emerge will be markedly different. This is going to require some new thinking by municipalities and mall owners with respect to how to bring life and customers back to main streets and malls.

  • We believe consumers will be increasingly loyal to those retailers they believed behaved well during the crisis. Those that did not will lose customers. Consumers are paying close attention to the health and safety measures and to how retailers treated their employees and communities during the pandemic.

 

—  Patricia Baker, Director, and Ryan Madeley, Associate, Retailing, Global Equity Research

 

 

For Scotiabank, Global Banking and Markets Research Analyst Standards and Disclosure Policies, please visit www.gbm.scotiabank.com/disclosures.

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