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Top strategist warns solid earnings may not be enough to move stocks higher

Nicole Sinclair
Markets Correspondent
(AP Photo/Mark Lennihan)

Third quarter earnings season kick into high gear this week with 8% of the S&P 500 slated to report results. And while companies are forecast to reveal a healthy pace of earnings growth, expectations are already very high.

“A solid earnings season may not be enough to move the market higher—valuations are lofty, focus has increasingly shifted to policy,” according to Bank of America’s Savita Subramanian.

Market momentum in this “late cycle” period of the recovery may instead be predicated on company guidance, she added.

“Last quarter, for the first time since the peak of the Tech Bubble, beats were not rewarded,” Subramanian said. “Post-reported performance suggested the good news had already been priced in, as companies that beat on EPS and sales saw no reward over the next one or five days, while those that missed were punished more than usual.”

And “guidance better be great,” Subramanian said. She said this even as expectations for the fourth quarter and 2018 are already optimistic.

“We would again expect guidance—which has remained the strongest in nearly seven years—could once be the swing factor,” Subramanian said.

Lead-up expectations

Similar to the second quarter, analysts did not cut estimates as much as usual going into earnings season. A modest 3% downward revision in EPS over the past three months, which was below the post-crisis average of a 3.5% cut, was largely due to warnings from financials. The insurance industry is expected to be particularly hard hit because of losses from the recent hurricanes.

For the third quarter, analysts expect earnings to grow 4%, after two quarters of over 10% growth.  Analysts also see sales growth of 4% year-over-year, a slight deceleration for the second quarter’s 5% growth, with a weaker dollar helping multinationals in particular.

As investors and traders focus on guidance, any commentary related to the Trump administration’s agenda could be a critical driver of prices.

“We expect investors will ignore the EPS slowdown given one-time hurricane effects and the focus on benefits from corporate tax reform,” according to Goldman’s David Kostin.

Nicole Sinclair is markets correspondent at Yahoo Finance.

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