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Cheating…in a Helpful Way

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·3 min read
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Wall Street analysis are trying to help us out this earning season … a free report for you, courtesy of our technical experts … the S&P sits at a key level that could break either way

We need earnings to meet or beat estimates. If not, we’re likely in for another leg lower in the market.

An illustrative example of this can be seen by looking at what’s happening to Snapchat today.

(The company issued earnings that missed both top- and bottom-line forecasts. Its stock is down 38% as I write Friday afternoon.)

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

Fortunately, we have an ace up our sleeve…

Professional sandbaggers who are lowering earnings expectations for us.

To explain, let’s turn to our technical experts, John Jagerson and Wade Hansen of Strategic Trader:

How do you set the stage for stock prices to continue moving higher even as the United States continues to battle 40-year-high levels of inflation and the looming potential of a recession?

It’s simple. You lower earnings expectations… and then watch Corporate America beat them.

You see, Wall Street analysts are professional “sandbaggers.”

To make sure we’re all on the same page, we’re talking about an intentional lowering of expectations to produce relatively greater-than-anticipated results.

Let’s see how this works.

***Having trouble making it over the bar? Well, just lower the bar

Before we jump in, for newer Digest readers, John and Wade helm Strategic Trader, InvestorPlace’s premier trading service. It combines options, insightful technical and fundamental analysis, and market history to trade the markets, whether they’re up, down, or sideways.

As John and Wade explain in their latest update, analysts are doing their best today to make sure that the markets trade “up” through these sandbagged earnings estimates.

But the thing is, this happens nearly every earnings season, not just this one.

Here’s John and Wade explaining how the game works:

It’s all about incentives.

Analysts get paid to provide information; if the information they provide makes their clients happy, they will continue to get paid. If it doesn’t, they won’t.

Buy-side analysts know that clients who pay for, and act on, their insights are going to be much more forgiving of a recommendation with a sandbagged earnings estimate that overperforms than they are of a recommendation that was too rosy and underperforms – or worse yet, costs the client money.

So, quarter after quarter, analysts lower expectations on Wall Street by cutting their estimates in the run up to earnings season, setting everyone up to be pleasantly surprised when the numbers come in “better than expected.”

After all, it’s much easier to clear a lowered hurdle.

The amazing thing is that everybody knows this is happening, yet it continues to work a surprising amount of the time.

***How much sandbagging is happening right now?

Using data from FactSet, John and Wade tell us that analysts dropped their Q2 2022 bottom-up earnings estimates for the S&P 500 by 1.1% in the run-up to this earnings season.

Chart showing the change in bottom-up EPS for the S&P
Chart showing the change in bottom-up EPS for the S&P

Source: FactSet

(For any readers less familiar, a “bottom-up” approach means analysts look at the EPS estimates for each of the 500 companies in the index individually and then combine them to generate an overall forecast for the index.)

Here’s John and Wade with some context for this 1.1%-earnings reduction:

That’s the most sandbagging analysts have done since the COVID-19 pandemic first shocked the globe.

Now, we’re not saying it’s not justified; we know the global economy has been hit hard and corporate margins are getting squeezed.

But this means that even if companies fail to report stellar numbers, they still have an excellent chance of beating expectations, which could push stock prices even higher than they already are.

We’re still early in this earnings season, but thanks in large part to the sandbagging, we’re already seeing more positive earnings surprises than negative earnings surprises.

Chart showing the sector level earnings surprises in the S&P
Chart showing the sector level earnings surprises in the S&P

Source: FactSet

Here’s the bottom line from John and Wade:

Not all sectors have been able to clear their incredibly low hurdles, but those that have should continue to lift and provide some stability the S&P 500…

If companies continue to surprise to the upside, look for the S&P 500 to remain in bull-market territory.

***By the way, don’t miss this free special report all about options

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To help take the mystery and misconceptions out of options, InvestorPlace has created a fantastic, free report that pulls back the curtain on all the important details.

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That’s understandable.

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This new report clearly explains what options are, the various types of options available to investors, the pros and the cons of using them, examples to drive everything home, even how to open an options account so you can start trading.

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It’s part of our goal to help make our InvestorPlace readers wealthier and wiser investors.

***Let’s end today’s Digest by coming full circle to John and Wade

Yesterday, these technical experts sent out an alert, updating subscribers on today’s important level in the S&P:

The S&P 500 is at a key inflection point.

The index bounced up from its down-trending support level in mid-June, broke out of a bullish continuation pattern in mid-July and is now testing down-trending resistance just below 4,000.

We know it may seem like we’re stating the obvious here, but at this inflection point, the S&P 500 could either break up through resistance or bounce back down.

Which direction the S&P breaks will be heavily influenced by how earnings come in.

As I write Friday afternoon, the S&P is down 1.2%. Let’s cross fingers for more sandbagging.

Have a good evening,

Jeff Remsburg

The post Cheating…in a Helpful Way appeared first on InvestorPlace.