The shine is coming off the boom stocks of 2020

As investors think about which stocks to hold going into 2021, there may be no bigger red flag than a huge third-quarter earnings beat. That’s because of what the pandemic has done to consumer behaviours and corporate earnings this year — impacts that may turn out to be more transitory than real-time-obsessed investors may anticipate.

We’re already seeing the shine coming off the stocks of some of the early pandemic winners, an impact that may broaden as people turn their attention to next year’s business prospects. Two companies where this “pandemic boom followed by bust” arc has played out are Netflix Inc. and Kimberly-Clark Corp. During the most intense phase of the pandemic in March and April, video streaming services and toilet paper were the ultimate shelter-at-home amenities.

That shift in consumer behaviour flowed through into first-quarter results. Netflix subscriber growth soared above the rates it had seen during the same period in earlier years. Kimberly-Clark, maker of toilet paper brands like Cottonelle and Scott, similarly showed strong growth. In mid-April, as they were reporting earnings, both companies’ stocks were up on the year while the S&P 500 Index had fallen more than 10%.

But with two more quarters of earnings reports behind us, we’ve seen that those gains were more like a one-time windfall. Netflix is still on pace for a strong year of subscriber growth, but it has added very few new customers since April. And Kimberly-Clark’s revenues tied to supplying office buildings have slumped, while consumers are now well stocked, leading to the company’s disappointing guidance in its third-quarter earnings report.

Both companies’ stocks fell about 5% after reporting their results last week, and their stocks are little changed since mid-April, despite the S&P 500 rallying around 20% since then.

This is the lens through which investors should examine strength in third-quarter earnings. To the extent companies are reporting better results than they ever have, how much of that represents being winners in some post-pandemic world versus a one-off windfall as consumers shifted their behavior over the past few months?

A great example of this phenomenon might be Whirlpool Corp., which reported earnings per share of $6.91, smashing consensus estimates of $4.20. An appliance maker reporting strong results isn’t a surprise when it’s been difficult to find items like refrigerators in stock for months. Yet after rallying strongly after hours on Wednesday afternoon, the stock closed down on Thursday, with investors perhaps wondering if this is as good as it gets for pandemic-related home-improvement purchases.

What we might be seeing in the third quarter is a peak, whether in actual sales or investor expectations, of pandemic-related goods purchases. Over many decades the purchase of goods like automobiles and home appliances has shrunk relative to services in the consumer spending basket, but as my colleague Tim Duy notes, that has reversed dramatically during the pandemic.

Assuming the public-health crisis fades in 2021 through a combination of mass vaccinations and other medical advances, it’s likely that consumers will shift their spending back to services to some degree, perhaps even overshooting in the opposite direction. If 2020 was the year that Americans bought a second refrigerator or did an extra home-improvement project, then 2021 might be the year Americans take that bucket-list trip to a national park or splurge on dining out after being unable to do so for months.

If so, that would be bad news for the fortunes of companies that made products like recreation vehicles, which have already seen their sales boom this year. Notably, the stocks of companies in that industry, such as Thor Industries Inc. and Camping World Holdings Inc., had sagged over the past few months even before a downturn in sales. It also means caution for pandemic-related e-commerce winners like Etsy, Wayfair and Overstock.com, because of the risks of consumption shifting back to services away from goods, and to stores away from shopping online.

Housing might be the wild card in all this, with the industry’s many structural tailwinds related to demographics, low interest rates, low supply and growing production. That being said, despite robust economic data for the housing industry over the past few months, the iShares U.S. Home Construction ETF remains stuck around mid-August levels, suggesting that a lot of optimism is already built into prices.

Even if it’s now looking like it will be at least the middle of next year before society gets fully back to normal, forward-looking investors are trying to price that in ahead of time. So any blowout earnings reports we get over the next few weeks might signal the end of the good times rather than a trend to ride into 2021.