Seemingly defying the Covid-19-fuelled economic recession battering the US, the S&P 500 reached a new high for the year on August 18, despite historic job losses and shrinking corporate profits. So, what does the latest round of earnings announcements tell us about the future of the US equity market? Heading into this earnings season, expectations were low. The consensus was for a 45 per cent year-on-year decline in earnings, with limited corporate guidance as companies were essentially flying blind, not knowing the potential consequences of the pandemic on the US economy or what the official response would be to easing or tightening restrictions. Those overly grim expectations meant the actual results were better than forecast. With close to 92 per cent (by market capitalisation) of the S&P 500 companies having reported second-quarter earnings, actual results have been 25 per cent above expectations, as 83 per cent of companies reported higher earnings than analysts’ forecast. This meant the level of overall earnings growth fell by only 35 per cent compared to a year ago. Markets react to surprise. Even with the big drop in earnings, the fact the pain wasn’t as bad as markets had feared is one reason for the continued US equity market rally. Another reason is the surprise factor in the economic data. The economic outlook may be clouded by politics, whether it is the political impasse on further stimulus and income support for households, or the increasingly strained US-China relationship, but the trend is improving. The Citigroup Economic Surprise Index measuring the degree to which economic data is better or worse than economists’ predictions is over 200 right now. Previously, even in the rebound from the 2008 global financial crisis, the index has never managed to break 100. Even with the rosy economic outlook and the prospects for politicians coming together on further stimulus measures, not all sectors will benefit. The earnings season has highlighted the difference between the corporate “haves” and the “have nots”. The “haves” include the information technology, health care and utilities sectors. Tech stocks have been on a strong run, given the secular tailwinds of cloud computing and helped by the sudden mass work-from-home experiment. Working from home forcing firms to evolve business practices Meanwhile, health care and utilities were the only two sectors to report positive earnings growth for the quarter. Health care is buoyed by advances in life sciences and biotech, which offset the drag from the delay in elective procedures on other parts of the sector. Unsurprisingly, those sectors facing the greatest impact from the stay-at-home directive were among the worst performers. The consumer discretionary sector was hit as both eating out and travelling ground to a halt. Bricks-and-mortar retailers faced a challenge from the rise of online shopping , and it was a similar story in the industrial sector as passenger numbers on airlines plummeted due to travel restrictions . The wooden spoon goes to the energy sector; the only one to post negative earnings for the second consecutive quarter as the oil price halved compared to a year ago. The second quarter no doubt marks a low in US earnings, so what should we expect from here? First, the market divide is likely to continue as long as some form of social distancing is required and hampers the outlook for those sectors most reliant on the physical presence of people for profits. Second, even as more companies have provided guidance in the current quarter than last, earnings visibility, at least in the near term, remains poor. The consensus is that we will see continuous improvement in earnings for the rest of this year but, ultimately, we will end the year with earnings levels lower than a year ago, with a full recovery not expected until the end of 2021. Earnings in the next few years will determine whether the run in US equities is justified. Potential pitfalls lie ahead, such as the deteriorating US-China relationship and the US election outcome. These could derail the market narrative and interrupt a smooth path back to higher levels of corporate earnings. Meanwhile, the development and distribution of a vaccine is key to unlocking the next stage of economic and market recovery, as those sectors still affected by the restricted movement of people and services recover. Kerry Craig is a global market strategist at JP Morgan Asset Management