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Stocks are being weird

Sam Ro
·Managing Editor
·4 min read
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Monday, February 8, 2021

A version of this article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Companies are smashing expectations, but investors are selling the news

“Buy the rumor, sell the news,” is an old saying in the markets. Simply put, you make a trade assuming some future outcome, and when that outcome is confirmed you close out your trade.

According to the numbers during this earnings season, it looks like the “rumor” was that companies would smash expectations.

When earnings season kicked off, analysts were estimating that S&P 500 (^GSPC) earnings fell by about 9% year-over-year in Q4 2020. However, actual earnings so far have been beating estimates by such a wide margin that it looks like these companies may have actually delivered earnings growth during the period.

“As of [Friday], the S&P 500 is reporting year-over-year growth in earnings of 1.7% for the fourth quarter, compared to a year-over-year decline in earnings of -2.4% last week and a year-over-year decline in earnings of -9.3% at the end of the fourth quarter (December 31),” FactSet’s John Butters wrote. “If 1.7% is the actual growth rate for the fourth quarter, it will mark the first time the index has reported year-over-year growth in earnings since Q4 2019 (0.8%).”

According to FactSet, 81% of companies that have announced so far have beaten expectations, which is the second highest percentage since the firm began tracking the numbers in 2008. And those reported earnings, on average, have been 15.2% above estimates; this is the third largest beat margin since 2008.

With earnings beating so broadly across companies and by such a wide margin, you’d think stocks would respond to the news well. But, that hasn’t been the case.

“To date, the market is not rewarding positive earnings surprises and punishing negative earnings surprises less than average,” Butters observed. “Companies that have reported positive earnings surprises for Q4 2020 have seen an average price decrease of -0.5% two days before the earnings release through two days after the earnings release. This percentage decrease is well below the 5-year average price increase of +0.9% during this same window for companies reporting positive earnings surprises.” (Emphasis ours.)

Investors are punishing companies for positive earnings surprises. (FactSet)
Investors are punishing companies for positive earnings surprises. (FactSet)

Three months ago during Q3 earnings season, it seemed beating expectations was actually meeting expectations. Today it seems that beating expectations is... missing expectations? Maybe the market has been expecting more than the analysts.

But if we go back to that old rule, it seems to be the case that investors are selling the news.

‘Perverse’ price moves an ominous sign?

It’s worth nothing that the S&P 500 is nevertheless at a record high (Just because stocks usually go up, doesn’t mean that can’t act strangely sometimes). So, maybe investors came back and bid up prices on a lag.

Bank of America’s Savita Subramanian, however, cautions that this behavior could be a sign of something far more ominous.

“Perverse reactions remain a big theme this earnings season,” Subramanian wrote last week. “The perverse reactions point to euphoric sentiment and rich valuations, similar to the last time this happened: right at the peak of the Tech Bubble.”

We’re not gonna get into the whole bubble debate here. That’s for another time. But we will note that there are also many reasons why today is not a repeat of 2000.

Still, prices are nevertheless being a bit weird.

In another note last week, Goldman Sachs’ Spencer Hill and Ronnie Walker observed that stocks weren’t reacting to economic data like they used to.

“Financial markets have been far less sensitive than usual to economic data releases during the pandemic,” they wrote. “The sensitivity of Treasury yields to growth indicators has plummeted to 16% of its post-2000 average, and equity market sensitivity to growth data has similarly fallen to 50% of its usual level.”

The Goldman analysts believe market participants have their eyes on non-business, non-economic variables.

“Historically, recessions are periods of heightened data sensitivity, and the simplest explanation for the muted environment in the 2020 recession is that investors instead focused on the public health variables that would ultimately determine its length and severity,” they said.

To be sure, public health variables are having a massive impact on the economy, the businesses underlying the economy, and ultimately the earnings produced by those businesses. With vaccines now being distributed, things are looking up in the economy, which is a good sign for earnings. When you think of it that way, despite the weird short-term behavior, it starts to make sense that stocks are at record highs.

By Sam Ro, managing editor. Follow him at @SamRo

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