Stocktake: Investors expect bumper earnings season

Yes, the news looks good, but there are two caveats worth keeping in mind

Good earnings don’t necessarily mean good market returns. Photograph: Stan Honda/AFP/Getty Images

Good earnings don’t necessarily mean good market returns. Photograph: Stan Honda/AFP/Getty Images

 

US earnings season is in full swing, with Microsoft, Tesla, Netflix, Intel, and Johnson & Johnson just some of the big names reporting this week.

After exceeding expectations by one of the highest margins ever in the first quarter, it’s safe to assume this will be another bumper earnings season. Analyst estimates have increased more than 7 per cent over the last three months – the biggest quarterly increase since FactSet began tracking that metric in 2002. The number of companies raising estimates is also at record levels. All 11 S&P 500 sectors are expected to report higher earnings.

That’s good, but there are two caveats. Firstly, the second quarter will “almost certainly end up being the peak in earnings growth for this cycle”, notes LPL Research.

Secondly, everyone knows earnings will be good, so the question is whether this optimism is already priced in. Companies have delivered “not just good, but great news” in recent quarters, says LPL, so investors are “rightly asking” if positive surprises will dry up, as firms “may no longer be holding anything back”.

The same point is stressed by Bank of America (BofA), which notes the S&P 500 has already returned 16 per cent this year in anticipation of soaring earnings.

Good earnings don’t necessarily mean good market returns. BofA notes that 60 per cent of down quarters since 1996 have occurred in periods with earnings beats.

Consequently, it’s hard to tell how stocks will respond to strong earnings. The one certainty is that companies that fall short of expectations will be punished by disappointed investors.

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