By at least one measure, corporate earnings are the best in nearly a quarter-century. However, the stock market is not enthused!
Rather than rally on the back of upbeat results, the main equity benchmarks have sulked lower.
According to Thomson Reuters I/B/E/S, of the 343 companies, or about 70%, of S&P 500 members that have reported earnings to date, 79.9% have reported earnings per share that were above analysts’ expectations, putting the season on track for the highest earnings beat rate on record, going back to 1994.
So far, the first-quarter growth rate for EPS is 22%, compared with consensus earnings growth of 16.3% as of April 12, according to Lindsey Bell, investment strategist at CFRA. That outperformance is underpinned by some of the most highly valued companies, including JPMorgan Chase & Co. JPM, -0.80% Apple Inc. AAPL, +4.42% Facebook Inc. FB, +1.27% and Amazon.com Inc. AMZN, -0.74%
Bell said recent quarterly results have seen outperformance of about 3 to 4 percentage points better than analysts’ consensus estimates on average, compared with the 5.7 percentage points earnings are currently running ahead.
Bell said what’s really impressive is that expectations were already lofty and this quarter represented the first in which the bar was raised to factor in fiscal stimulus measures such as corporate tax cuts, which took effect in late 2017.
“It’s significant because we haven’t seen a change like this from the very beginning to (the) start of reporting season,” Bell said. She said the numbers have been cut for each quarter going back to the second quarter of 2006.
So why has the stock market not snapped out of its doldrums? The Dow Jones Industrial DJIA, -0.73% has shed about 1.8% since April 12, just as first-quarter earnings season was about to get under way. The S&P 500 index SPX, -0.72% has lost 0.8%, while the technology-centric Nasdaq Composite Index COMP, -0.42% has fallen by 0.3%, through midday Wednesday.
Although it is isn’t easy to pinpoint exactly what’s troubling investors, here are a few theories as to why this dynamic may be playing out:
“What concerns me the most is that we’ve had spectacular earnings and the market is just shrugging it off,” said Randy Frederick, managing director of trading and derivatives at Schwab Center for Financial Research.
The Cboe Volatility Index VIX, +0.71% or VIX, surged to an eye-popping intraday level of 50.30 on Feb. 6, abruptly ending a period of quiet that reigned in 2017 and ushering in a new era of sometimes vicious market swings. The VIX, which is calculated using options on the S&P, is a measure of expected, or implied, volatility over the following 30 days.
Frederick believes the new regime of volatility, which resulted in the first correction for the Dow and S&P 500 in about two years, has pushed investors to the sidelines, which has resulted in prices hovering lower due to a lack of buyers.
Indeed, the number of 1% moves for the S&P 500 has already tripled that of 2017.
Although the VIX is currently trading below its historical average of around 19, Frederick believes that the mode—a statistical average representing the most frequently occurring levels over time—is a better gauge of the normal level for so-called fear index. Based on the mode, the VIX should be around 12.5, compared with its current level around 15.
“That kind of shows you that we are in the period of short -term exhaustion and I think people are just tired of being whipsawed,” he said.
A strengthening dollar and rising yields
According to Morgan Stanley’s Chris Metli, a strengthening dollar—the greenback put in its best monthly rise since President Donald Trump’s election in April—and a rising 10-year Treasury note yield TMUBMUSD10Y, +0.19% —the 10-year yield touched its highest level in more than four years above 3% late last month—are also factors weighing on stocks. That 3% round-number level has caused angst on Wall Street, because it translates to higher corporate borrowing costs.
A weaker dollar tends to be beneficial for multinational companies, because it can support sales of goods and services abroad, with a stronger dollar having the opposite effect.
Morgan Stanley wrote last week that stocks are likely to move cautiously higher in such an environment because investors need to determine if economic growth will offset higher real rates: “A grind higher is consistent with what last week’s price action tells us: the dollar has begun to move higher alongside yields which suggests rates are getting to a point where they could limit further upside, and stocks didn’t rally much on good earnings, suggesting expectations are already high.”
A lack of enthusiasm could wear on the psyche of investors, Metli wrote.
Lack of leadership
MarketWatch’s Ryan Vlastelica wrote that estimates for the percentage of S&P 500 sectors outperforming for two months in a row recently hit multiyear lows, and traded near multidecade lows, citing research from Michael Wilson, chief U.S. equity strategist for Morgan Stanley.
“Rarely have we experienced such low leadership,” Wilson wrote.
“Our experience tells us that these leaderless periods typically occur during important transitions in the market,” he wrote. The next stage, if history is any indication, could favor what he called “late-cycle sectors,” including energy, industrial, and health-care stocks.
Although the energy sector XLE, +0.41% has climbed 11.6%, outperforming other sectors in the past month, financials XLF, -1.15% which were expected to benefit from rising rates, have lagged, producing the fifth weakest performance among the S&P 500’s 11 sectors, according to FactSet data.
There are signs that harmonized global growth is starting to unwind and that has hurt investor confidence. “The problem is that there have been macro forces that have been clouding the outlook, so it’s preventing the investor from taking the good earnings news and running with it,” Alec Young managing director of global markets research at FTSE Russell told MarketWatch last week.
Concerns about global trade tensions between China and the U.S. and the fear that the stellar earnings could be as good as it gets for stocks are all combining to undermine the sort of confidence that was in abundance during last year’s run of repeated records for equity benchmarks, as the U.S. economy enters it ninth year of expansion and as the Federal Reserve moves to normalize monetary policy from crisis-era levels.