Traders work on the floor of the New York Stock Exchange (NYSE) in New York. (Photographer: Michael Nagle/Bloomberg)

Earnings Season Is Denying Bulls Who Sought All-Clear on Stocks

(Bloomberg) -- An April that many investors hoped would end two months of indecision in the stock market is not quite living up to billing.

While benchmark indexes eked out another week of gains, below the surface, frustration was the rule. Reactions to earnings results are muted -- the average stock is flat the day after reporting. Megacap tech companies are soaring, but makers of semiconductors and household goods have stumbled.

It’s not that companies aren’t beating estimates. Most are, by the widest margins in years. It’s that the market has been slow to reward them -- and quick to punish those that fall short.

“As we get further into the bull market cycle, U.S. companies have to try harder and harder to make investors happy, and that’s tough,” said Frank Ingarra, the head trader at NorthCoast Asset Management LLC. “Investors set their bars really high.”

Earnings season was supposed to clear the decks, be a respite from concerns that drove stocks down in February and March. But now investors are noticing interest rates again, with the 10-year Treasury yield again approaching 3 percent. Surging prices in metals are reviving inflation anxiety.

For the week, the S&P 500 rose the first three days then fell the last two, erasing its advance for the year on Friday. It climbed 0.5 percent wire-to-wire, turning lower after closing above 2,700 on Tuesday and Wednesday. The Dow Jones Industrial Average gained 0.4 percent over the week while the Nasdaq 100 Index advanced 0.6 percent.

At first glance, it’s been one of the best earnings quarters of the bull market. Combined profits have exceeded Wall Street estimates by 7 percent, a rate that if sustained would be the highest since at least 2016.

The results aren’t being rewarded. Stocks have risen less than 0.1 percent on average on the day after results. Companies that missed estimates trailed the market by 1.7 percent. In other words, those that miss are being punished almost three times as much as those that beat are being rewarded.

Why haven’t stocks done better? The reason could have more to do with the estimates than the results. Maybe companies are beating forecasts that simply failed to model the impact of the president’s tax overhaul.

The lackluster returns can’t help but buttress concern that much of the good news about tax cuts and economic growth is already reflected in stock prices. Heading into this earnings season, strategists from Goldman Sachs and Leuthold Group had warned that counting on a big lift from earnings might not be realistic. At 17 times forecast profit, the S&P 500 trades at a valuation that’s about 10 percent higher than the 10-year average.

“Valuation is not going to save you,” said Chris Harvey, head of U.S. equity strategy at Wells Fargo. “This late in the cycle, the broader environment is not going to help you out.”

Companies representing 41 percent of the S&P 500’s market capitalization are scheduled to report next week. A lot of them are makers of technology, an industry whose next-day returns have been some of the worst in the S&P 500 during this reporting season. While companies from Lam Research to Accenture exceeded earnings estimates, their shares fell by 3.7 percent on average in first-day reactions.

Computer and software stocks remain among the most “crowded” in the market. The industry has been favored in Bank of America’s monthly survey of money managers for more than a decade. In the last one, 64 percent of respondents said they’d reduce holdings to less than benchmarks suggest should antitrust, privacy regulations get ratcheted up.

Pain from earnings can be particularly pronounced for crowded stocks, according to Savita Subramanian, an equity strategist at Bank of America. She studied the fourth-quarter reporting season and found that companies with more mutual fund ownership saw their stocks suffering much bigger underperformance than those that are less popular: 2.4 percentage points versus 0.2 point.

“It’s a more uncertain economic policy environment coming out of Washington,” Lori Calvasina, RBC’s head of equity strategy, said in an interview on Bloomberg Television. She cut her 2018 target earlier this month for the S&P 500 to 2,890 from 3,000. “Investors need to curb their enthusiasm because of some of these clouds.”

©2018 Bloomberg L.P.

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