Every three months, corporate America gives investors a look at its books — offering updates on how sales and profits fared in the latest quarter, and usually providing a sense of what to expect from the rest of the year.
It can be an important period for the stock market, as traders learn how well their expectations matched up with reality. With the pandemic raging and the recovery floundering, earnings seasons gives investors another bead on the state of the economy.
(Earlier this month, for example, several big banks said they were cutting down reserves meant to protect against a downturn — a clear sign that they’re feeling better about things — and the news helped bolster stocks.)
But the latest earnings season also comes at a time when investors are starting to wonder if the stock market’s rally has gone too far, and whether stocks are in a bubble as prices become increasingly detached from a company’s profits and growth prospects.
How Wall Street reacts to the incoming results could help show how important (or unimportant) earnings, sales and growth are to share prices.
This week is the busiest of the fourth-quarter earnings season, with results expected from a third of the companies in the SP 500 — including technology giants Microsoft, Apple, Facebook and Tesla. Overall, Wall Street analysts expect that profits at SP 500 companies will be down 7 percent compared with the fourth quarter of 2019, according to FactSet data.
So far, results from the first 66 companies in the SP 500 that reported earnings have been slightly stronger than usual. About 88 percent of those companies did better than analysts expected. Wall Street is notorious for underestimating how companies will do, but that share of companies that “beat” is higher than what’s typical.
Strangely, however, investors have seemed downright dismissive of better-than-expected earnings results, and that could be a bad omen for the market.
Usually, when a company does better than expected, its shares rise. But, through Friday, companies that beat expectations have actually underperformed the broader market, according to Bank of America analysts.
Such a reaction is yet another indication that stock prices are becoming increasingly untethered from fundamentals. In fact, Bank of America analysts noted that they haven’t seen this sort of reaction to earnings results since the dot-com bubble was beginning to deflate.
“The last time we saw such a perverse market reaction to earnings was during 2Q 2000 earnings season, after which the SP 500 fell by 13 percent over the next three months,” they wrote.