How Earnings Season Is Setting Up Stocks for a ‘Bear Market Trap’

Text size Earnings reports for the most part have been upbeat, but stocks have had a muted reaction. That could just set the stage for another market drop soon. Angela Weiss/AFP/Getty Images Stock performance has been “ho-hum” after earnings reports, and that’s not great news for a market that was set up for easy beats. Investors really haven’t been expecting great earnings news. Expectations had already dropped leading into reporting season, with fourth-quarter earnings-per-share estimates for the index falling about 7% from September through the end of the year, according to Credit Suisse. The main driver has been that economic demand is softening as the Federal Reserve lifts interest rates, a move designed to lower the rate of inflation. That inflation, though, is still pressing profit margins as companies lose the power to raise prices even as wages rise. Overall, “fear mongering lowered the [earnings] bar,” wrote Chris Harvey, chief US equity strategist at Wells Fargo. With 95 S&P 500 companies having reported, aggregate earnings per share for them are 1.7% higher than analyst expectations, according to Refinitv, with 67% of the companies topping estimates. Those stats aren’t stellar. Companies have, on average, reported earnings 4.1% above those expectations since 1994, with 66% beating forecasts. Newsletter Sign-up The Barron’s Daily A morning briefing on what you need to know in the day ahead, including exclusive commentary from Barron’s and MarketWatch writers. Still, the resulting earnings beats have been good enough. The average stock has gained 0.5% after reporting, according to Evercore ISI data, while shares of companies that surpassed both sales and earnings-per-share estimates have gained 0.8%. That’s below the five-year average of a 1% gain, but double misses haven’t been punished as much as they usually are—they’ve dropped 1.6% on average, below the 2.9% average over the past five years. That’s a reflection of the uncertainty investors are forced to confront right now. The Federal Reserve remains in rate-hiking mode, and the market is unsure of whether the economy is headed for a recession or a soft landing. That makes the current numbers—and the guidance companies are providing—even harder to read. The stock market’s new year’s rally, too, means that valuations are higher than they were three months ago, raising the bar even as declining expectations lowered it. It’s a setup that could be leading to more declines, according to Martin Roberge, portfolio strategist and quantitative analyst at Canaccord Genuity. He notes that the market’s recent run after a down 2022 recalls a surge seen two decades ago, just before more declines took hold. Following a terrible 2000, the S&P 500 rose 4% during the January 2001 earnings season, as results convinced some investors that the worst of the tech wreck was over. Analysts, though, kept cutting their earnings forecasts, setting the market up for a larger decline over the rest of that year. “The risk in switching to a more bullish mode without earnings visibility is a replay of the January 2001 bear-market trap,” Roberge explains. Let’s hope history doesn’t repeat. Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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