The trend of earnings coming in better-than-expected for the current season continued last week. It should be noted however, that the dynamic of another strong earnings season has done little to lift the overall stock market. Although earnings are strong, stock prices have merely recovered from their corrective lows and appear to remain mired in a trading range.

Part of this divergence between earnings and stock prices can be explained by the fact that in general, revenues have not been stellar. Thus, traders remain concerned about the potential for earnings to continue to grow in what appears to be a stagnating environment. On that note, a second aspect of the dilemma has to do with the fact that the economy has clearly slowed down. Q2 GDP was reported Friday at just 2.4%, which was below the consensus as well as the rate seen in the first quarter. Whether or not this soft patch is temporary or a sign of the times has investors focusing on the macro view.

The current obsession with the macro view has produced a “risk on, risk off” type of market for traders (who appear to be the only ones in the game at the moment). Thus, the market has become one big macro trade on a daily basis. This has pushed stock correlations to the S&P 500 near record highs and stock pickers have struggled to outperform the market.

Another reason why the current earnings season has not done much to push prices higher is from an historical standpoint, stock returns tend to peter out when earnings soar. While this sounds a bit counterintuitive, Ned Davis Research shows that when year-over-year changes in the S&P 500 earnings are +20% or higher, the market gains just 1.5% per year. However, when 12-month earnings growth has been between -10% and -25%, stocks have soared at more than +26% per year.

How can this be, you ask? There are two key points that explain this phenomenon. First, lest we forget, stocks look forward and not back. Thus by the time the year-over-year change in earnings is severely negative, the stock market has had time to discount the bad environment (via a bear market). And since most bears are relatively short-lived, things have usually begun to improve by the time the 12-month rate of change in earnings gets really bad.

The flip side is also true and is applicable at the present time. The Credit Crisis Bear market ended on March 10, 2009. Thus, eighteen months later, just about everybody on the planet knows that earnings have seen a nice bounce thanks to a huge dose of cost cutting as well a modest uptick in business conditions. But remember, something that everybody knows may not be worth knowing in terms of investment strategy. Thus, traders apparently aren’t willing to bid up prices on rear-view mirror data. Instead, they are looking ahead.

With the macroeconomic picture more than a little cloudy at the present time, it will take some improvement in the outlook to encourage traders to expand the current multiples.

The State of the Earnings Season

Looking at the state of the earnings season, StreetAccount reports that 161 companies in the S&P 500 reported earnings this week with 76% “beating” estimates. However, just 58% of the companies beat on the top-line revenue basis.

For the season, 80% of the companies have exceeded analyst estimates for earnings per share while 62% exceeded expectations from the revenue side. Both readings are above historic expectations but are trending lower.

Here is a summary of the results for the week and this quarter’s earnings parade:

S&P 500 earnings summary for the week:

• Total Reports this week: 161
  • # of Companies with Earnings Per Share above consensus estimates: 122 (76%)
  • Earnings Per Share “Misses”: 39 (24%)

  • # of Companies with Revenues above consensus estimates: 93 (58%)
  • Revenue “Misses”: 68 (42%)

S&P 500 earnings summary for the current earnings season through May21:

• Total Reports this season: 337
  • Earnings Per Share “Beats”: 88%
  • Earnings Per Share “Misses”: 12%

  • Revenue “Beats”: 62%
  • Revenue “Misses”: 38%

Data Source: StreetAccount

 

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