Yesterday, I suggested that those waiting for all the bad news about rate hikes and omicron to really impact the market are starting from a wrong assumption. Even as we remain within spitting distance of a new record high on the S&P 500, maybe those bearish influences are already priced in. Could it be that the index would be trading significantly higher, say above 5k, if the bears weren’t having an impact? That could easily be the case, and would explain why there has been no dramatic selloff as negative stories have developed. Over the next couple of weeks, we will find out if that is the case as earnings season progresses. With that in mind, what should investors be watching as those earnings are released?
In the past, I’ve suggested that investors trying to draw inferences for the broad market from a series of individual releases need to look beyond the headline numbers. A company’s revenue and EPS tells us what happened to them over the previous three months, but their outlook and commentary tell us far more about what to expect, both for them specifically and for the economy as a whole. This quarter, though, the top- and bottom-line results for the last three months carry more weight than any forward-looking statements.
The cynic in me wants to say that we have all learned over the last couple of quarters is that CEOs don’t actually know more than the rest of us, and that most of what they have said has told us nothing. They have nearly all talked about supply chain issues and inflation, and of the continued impact of COVID-19, as if they were telling us something we didn’t already know. In reality, however, those things seem to have had a limited impact on actual profits. That makes the CEOs’ comments seem to be more about managing expectations to make themselves look good than about informing investors.
The real reason to pay more attention to facts than to forecasts this quarter is because those obvious-looking attempts to damp down expectations seems to have had an effect. According to FactSet, estimated earnings growth for Q4 has edged up over the last three months, but by a very small amount, and with a lot of the increases concentrated in a couple of sectors and industries. That suggests that in most cases, the bad news is indeed priced in. If the somewhat conservative estimates are beaten easily, that could trigger a big move up in the short-term, and it would signal underlying strength in stocks for a while to come.
As you might expect, some of the biggest negativity in earnings forecasts have been in the areas of the market that have been the hardest hit over the last week or so, such as tech stocks with high multiples. Amazon (AMZN), for example, has been the subject of one of the largest overall downward revisions of estimates over the last three months, being cut by over 10%. If you consider that when looking at the drop in AMZN of 12% from its high, things start to look a bit different. The drop looks more like a simple adjustment to earnings expectations, rather than the big “risk-off” market shift that some are portraying it as, and that has important implications. If the selling is simply a reaction to analysts’ earnings forecasts, and the bad news is what prompted those downward revisions, then the bad news is indeed priced in.
More importantly, that means that better-than-expected Q4 results for Amazon and others like it would have an outsized short-term impact and game-changing longer-term implications should they come about. In normal times, beats are so common, with around 70% of companies on average beating estimates for EPS, that they basically mean nothing. In this case, though, they would challenge the assumptions that prompted the selloff in the first place, forcing analysts and therefore traders and investors to rethink and adjust, and that 5k level could even be in sight as soon as this current quarter.
It should be an interesting earnings season.
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