Here’s How Bad Earnings Could Be. The Market Likely Will Bottom Before the Worst of It. By Al Root April 2, 2020 6:30 am ET Photograph by Spencer Platt/Getty Images Good riddance to the first quarter of 2020. The Dow Jones Industrial Average dropped more than 23%. It was the worst first quarter in the Index’s 135-year history. Unfortunately, investors now must turn to the first earnings reports to be given in a Covid-19 world. Here is a preview: Earnings will be bad and outlooks worse. That, however, is expected. And stocks have already been hammered. But what will Covid-19 do to the long-term outlook for S&P 500earnings? It is too early to tell for sure. Investors are used to recessions, debt crises and stock bubbles, but not pandemic. History can help. It can tell investors how long it takes for earnings to hit new highs and, more important, when stock prices might recover. READ MORE JPMorgan and Other Big Banks Will Report Earnings Soon. Good Luck With That. There have been three recessions over the past 30 years. During the 1990-91 recession—brought on by war and an oil-price shock—sales for S&P 500 companies dropped about 7% peak to tough and earnings dropped about 30%. Earnings drop faster than sales because companies have fixed costs, including people, plants and equipment. (By the way, oil-price shocks used to be when prices went up. Now, with U.S. producing more oil, price shocks are applied to big drops in prices too.) At that time, it took less than a year for S&P 500 sales to recover. It took a couple of years for earnings to hit new highs. The stock market, however, hit bottom around the fourth quarter of 1990, just before Operation Desert storm, and a few quarters before earnings bottomed. Stock markets historically bottom well in advance of the bad fundamental numbers. U.S. Real GDPSource: Commerce Department via St. Louis FedNote: Billions of chained 2012 Dollars .billionRecessions are shaded19902000’10’20750010000125001500017500$20000 During the dot.com bust around 2000, sales at S&P 500 companies dropped about 10% and earnings dropped around 25%. The gap between sales and earnings declines was smaller than in the 1990s. It could have been the decline in stock-based compensation or the nature of tech businesses. It took a couple of years before sales and earnings hit new highs, but the stock market bottomed about one to two quarters before the worst earnings were reported. The next recession was the 2008-09 financial crises. Sales at S&P 500 companies dropped about 9% peak to trough and earnings dropped about 50%. That was a severe drop in earnings. Again, it took a couple of years for sales and earnings to hit new highs. And again, the stock market bottomed about one to two quarters before the worse numbers were reported. It is possible to build a simple aggregate financial for the entire S&P 500. For starters, assume a drop in sales of 15% for S&P 500 companies because of Covid-19, worse than any recent recession. That takes sales from about $12.8 trillion to $10.9 trillion. Operating earnings—with that level of sales declines—could be cut in half, to less than $900 billion. Arriving at a 50% haircut is a function of triangulating from earnings declines during the three previous downturns. Then, after paying interest on more debt—presumably taken to offset cash burn from a moribund economy—earnings could fall 60%, to around $500 billion on an annual basis. (S&P 500 companies have about $10 trillion in debt currently.) It sounds terrible. Earnings estimates for S&P 500 companies are down about 20% compared with January. Deeper cuts are coming in the second quarter. That’s the first lesson from this analysis. But the second lesson is the market will bottom far in advance of the worst numbers actually reported. Timing a market bottom is hard, but figuring out what will do it can be easier. Stocks during the first Gulf war recovered when it was clear the U.S. would remove Iraqi forces from Kuwait. Stocks during the financial crisis bottomed around the time government officials bailed out AIG (ticker: AIG). That action took a lot of the worst outcomes off the table for the financial sector. (AIG was a huge provider of default insurance. If the insurer defaulted, then the financial sector was left with no protection.) Before stocks bottomed in the past they were volatile. A Covid-19 bottom will come when investors—and all people—have confidence the outbreak is waning. The world isn’t at that point yet. That could come when cases peak or when the health-care industry comes up with a vaccine or antibody test. Antibody tests will let people know they have had the virus and are in the clear. For investors, entering earnings seasons, don’t worry about earnings. They will be terrible. It is more important to follow the Covid-19 case totals. Write toAl Root at allen.root@dowjones.com https://www.barrons.com/articles/co...-bottom-sales-recover-peak-trough-51585776853