Fidelity Pulse Survey: The coming solvency squeeze

The global shutdown will put a significant dent in corporate earnings this year, according to 150 Fidelity analysts surveyed this month, raising concerns about a looming solvency squeeze.

More than half of the analysts surveyed expect their companies to face solvency problems in the next year, if conditions stay the same as they are now. The industrials and consumer discretionary sectors are particularly at risk, with 53 per cent and 57 per cent of analysts respectively anticipating issues as soon as the next six months.

“The consumer discretionary outlook is getting worse every passing day,” noted one Europe equity consumer discretionary analyst. “A recent consumer confidence survey from the GfK shows that UK consumer confidence is at the lowest level since 1974.” Meanwhile, a counterpart in the fixed income team said: “The situation in European gaming has deteriorated. Most companies have limited to no revenues and are burning cash.”

However, among the cyclical sectors, financials and technology companies look in better shape to survive the squeeze. Only 17 per cent of financials analysts anticipate their companies will experience solvency issues, a result of improvements in capital structures since the financial crisis as well as current support for the banking sector from central bank policy. A Europe fixed income financials analyst said: “Early liquidity concerns improved [after] regulatory and policy response to ease the pain came in.”

Significant drop in earnings this year
Analysts are bracing for a full year earnings cut of an astonishing 44 per cent, on average across their companies, if the Covid-19 outbreak dampens economic activity for the whole of 2020. In the event that the economy recovers in the second half of the year, that cut is expected to be 27 per cent on average. Many investors are already bracing themselves for a steep decline in earnings, and some will already be marking this year down as a write off and starting to think of 2021. But the level earnings finally settle at for 2020 matters as it will provide the base upon which the recovery next year - and the year after - will be built.

Virus impact felt more broadly than previously thought
Overall, the survey responses reveal that analysts expect the impact of the virus to be felt more broadly and for longer. Almost three quarters of analysts expect the shutdown to affect earnings negatively for the full year, up from just over half when surveyed in March. Meanwhile, 91 per cent of analysts now expect a negative impact on earnings from Covid-19, up from 76 per cent last month.

As the virus spreads in the US, analysts covering sectors that were previously thought to be relatively defensive are revising their outlook. For example, 82 per cent of healthcare analysts expect the outbreak to hit earnings, up from 46 per cent last month, as clinical trials and elective surgeries are put on hold. Around a quarter expect their sector to be in a recession in 12 months’ time.

An equity analyst covering healthcare in Asia Pacific said: “A month or so ago, sector perception was that Covid-19 was limited to China. Hence impacts were for companies doing business in China or supply chain risks to China. However, the shift into the US, the largest healthcare market in the world by value, has significantly altered the sector outlook as most earn a significant proportion of earnings from the US.”

There are a few brighter spots, particularly in the consumer staples sector, where 37 per cent of analysts foresee a positive earnings impact from the Covid-19 lockdown. “[Companies in] the food retail sector are enjoying the best ever period in their lifecycles,” said a European consumer staples analyst. “Not only stockpiling, which has a more temporary nature, but also eating-in and school closures are supporting the food retailers.”

Economic cycle will reset next year
The recovery from this unprecedented economic halt is not expected to be immediate but analysts expect some green shoots within a year. Forty per cent of analysts expect their sectors to be in the initial expansion phase in 12 months’ time, while only 16 per cent expect their sector to be in recession.

However, this is unlikely to be a coordinated global recovery. Our analysts highlight that different sectors in different regions will experience recoveries at different times. And whether impaired demand is simply delayed or lost forever varies significantly by sector.

“Liquidity is high for most auto companies and they have been drawing down credit facilities,” said a Europe autos equity analyst. “The big question in Europe and the US remains what society looks like in the months after the lockdowns end. In contrast, China, the world's most important car market, is starting to recover.” Indeed, almost half of China analysts report that leading indicators in their sector are positive, but in other regions leading indicators are still broadly negative.

The survey was conducted between 3-7 April and featured 191 responses from 150 analysts around the globe (analysts who cover more than one sector or region take the survey more than once).