A Punishing Season for Earnings Misses
In a famous scene in the satirical film Network (1976), a corporate CEO tries to explain immutable financial laws to a television news anchor who has been crusading against big business. At one point the CEO shouts: “You have meddled with the primal forces of nature and you…will…atone!”
My financial sermon for today is about atonement, for the sin of earnings misses. This earnings season, companies that report negative quarterly surprises are suffering harsh retribution, as investors reward positive earnings surprises near average levels but punish negative earnings surprises more than average. Below, I’ll point you toward a trading system that can profit from this dynamic.
As Q3 earnings come in mixed, stocks are losing momentum. On Monday, The Dow Jones Industrial Average fell 410.89 points (-1.44%), the S&P 500 dropped 56.89 points (-1.63%), and the tech-intensive NASDAQ shed 192.67 points (-1.65%). Stock futures in pre-market trading Tuesday were in the green, as investors put aside their concerns about earnings to place improbable hopes on a last-minute stimulus deal.
Companies that have reported positive earnings surprises for the third quarter of 2020 have experienced an average price increase of +0.8% two days before the earnings release through two days after the earnings release, according to research firm FactSet. This percentage increase is slightly below the five-year average price increase of +0.9% during this same window for companies reporting positive earnings surprises.
But Wall Street is getting tougher on companies whose earnings come in below consensus expectations. Companies that have reported negative earnings surprises for Q3 have seen an average share price decrease of -5.0% two days before the earnings release through two days after the earnings. This percentage decrease is considerably larger than the five-year average price decrease of -2.6% during this same window for companies reporting negative earnings surprises (see chart).
Basing investment decisions on the earnings expectations game can be a risky proposition. To justify significant future appreciation of stock prices, we’ll need to see a big improvement in corporate earnings. We probably won’t get it.
The blended year-over-year earnings decline for Q3 2020 is -18.4%, which is far below the five-year average earnings growth rate of 4.0%. For Q4 2020, analysts are projecting an earnings decline of -11.8%. For calendar year 2020, analysts are projecting an earnings decline of -17.1%.
Brutal economic realities are showing up on bottom lines, undermining the bullish case. Even if the economy were completely thrown open tomorrow, millions of consumers would be reluctant to pursue their customary behaviors. I probably speak for many people when I declare that I’m in no hurry to start taking the kids in my family to restaurants or theme parks.
Yes, the economy will bounce back in early 2021, but it probably won’t be robust enough to sustain frothy equity valuations. The forward 12-month price-to-earnings ratio for the S&P 500 is about 22, above the 10-year average of 15.5. Another market swoon probably awaits.
In a sign of future trouble, six sectors are reporting (or are projected to report) net profit margins that are below their five-year averages, led by the industrials (4.7% versus 8.6%) sector. COVID-19 is raising costs for companies across the board.
The pandemic looms large. As of this writing Tuesday, the U.S. is home to approximately 220,000 deaths and 8.2 million cases of the coronavirus. The country is seeing more than 50,000 new cases per day. Don’t get conned by politicians who are trying to put an optimistic spin on the numbers. You may be tired of the virus, but it’s not tired of you.
The following chart tells the grim global story. You’ll notice that the trend lines are moving up, not down (compiled with World Health Organization data as of October 18):
To put it coldly and bluntly, mass death is bad for the economy. The dichotomy between a prosperous Wall Street (led by a handful of tech stocks) and a devastated Main Street will eventually face a reckoning.
As I’ve just explained, jittery investors have been unforgiving to the shares of earnings underperformers. But there’s a way to make money from the trends I’ve just described. My colleague Jim Pearce has developed a system that takes advantage of stock market disequilibrium.
A veteran trader with decades of profitable trades under his belt, Jim is ready to reveal his trading system that makes money from the market’s mayhem. He knows how to pinpoint overvalued stocks and harvest a windfall from their fall to earth.
Jim is poised to execute his next trades. It takes just minutes to get in…and you could reap up to $124,160 when you cash out. Click here for details.