The stock market’s earnings problem

Yahoo Finance’s Myles Udland, Julie Hyman, and Brian Sozzi discuss the earnings results for JPMorgan, Goldman Sachs, and PepsiCo, and what it means for market returns.

Video Transcript

JULIE HYMAN: We begin with the Morning Brief [AUDIO OUT] you in the coming hour as we get into earnings season here in earnest and hear from the big banks, hear from Pepsi, et cetera. As I mentioned, on the bottom line, on the face of it things are beating estimate. But just because things are beating estimates doesn't mean that the stocks are always going to go that way. And that's what you wrote about, not necessarily for these specific instances, but writ large in the Morning Brief today, Myles.

MYLES UDLAND: Yeah, you know, I'm so glad that the team over at Bank of America resurfaced this data set because for years, I've had to go back and cite a post that I wrote about this data Bank of America has. They published this in 2018. The context was we are going to see huge earnings beats because taxes were cut in 2017, but it may not necessarily lead to stock gains.

And the stat here is since 1996, in 75% of the quarters, excluding the financial crisis, in which the S&P 500 has gone down, earnings per share for the S&P have actually gone up by 10%. If you include the financial crisis, it's 60%. So still more than half of the time that the S&P is down earnings are up double digits.

And so I think that it's a reminder that strong earnings that we are going to get here is what has been driving the market's price until now. The question for where the market goes in the future, whether stocks continue to go up or not, is about if investors believe this earnings growth, this pricing power, this operating leverage, however you want to frame it that corporate America is enjoying, if they can carry that forward, right.

So again, it is just kind of this-- I mean, we say it so often just because I feel like I'm-- I say it because I'm learning it, right, so I'm reiterating it for myself, but this framework of how you think about what reflects stock prices today. Earnings are backward-looking. Earnings are in today's stock prices. And yes, beats may help elevate stock price today, but that earnings beat is really saying something about the future potential for the company, and what the stock is reflecting today is that future growth.

All of which is to say, as we expect S&P 500 earnings to rise likely 70% over last year in the second quarter, that data alone is not going to necessarily justify higher stock prices. You are going to also need investors to feel confident that continued earnings growth will happen into next year to power the markets higher, especially given that this has not been a multiple expansion environment for, really, six to nine months.

It has been about what we are expecting to see on the bottom line for S&P companies. And if we can see that going forward, then it is likely stocks may grind higher. But you know, that's kind of the relevant framework here, right. What we're seeing here is what would have been reflected over the last couple of quarters, today's stock prices about what happens next.

BRIAN SOZZI: Myles, I'm curious to get your take on this. So JP Morgan, they beat big, stock is down. Goldman Sachs, they beat pretty big, stock is down. PepsiCo smashes estimates this morning. They came out and materially raised their full-year outlook. Its stock is only up 2%. I thought it would have been up about 5%. What do you think these reactions are saying about the back half of this year in terms of the economy, in terms of profit?

JULIE HYMAN: You go first, Myles, then I'll weigh in on this.

MYLES UDLAND: Well, I mean, I think it's-- I mean, you know, I think your framing on the Pepsi should be up 5% or 2%, like, that actually is not relevant at all. The fact that it's up 2 and 1/2% answers exactly the scenario we outlined, I feel like. They raised guidance, so the stock is higher, because they're saying the future is going to be better.

The banks weren't able, with the same confidence, to project a better future than the environment they've been operating in. Goldman talks about their IB backlog, all that. But you're seeing FIC, for example, your trading revenues, already missing expectations. So to me-- Julie, I'm curious your thought on this, to me it's a perfect example of what we're talking about.

JULIE HYMAN: Yeah, I do agree. And I would add as well, Pepsi's a very straightforward business. They make stuff. They sell stuff, right. Yes, you have the headwinds of input costs, et cetera. When it comes to financials, it's a much more complex business, and it's not just as simple as more people are buying our stuff and we're able to charge more of it.

So even if they beat on the bottom line, it so doesn't even come close to telling the whole story with a company like JPMorgan or Goldman Sachs. And so I think that that nuance is more important when it comes to something like the financials, which are more complex.

But yes, in addition to that, we can definitely read it how Myles is reading it that the second half of the year you're not getting that same level of-- I mean, JP Morgan, in particular, is being explicitly cautious on some of this stuff. Loan loss reserves shrinking, that's not necessarily repeatable, right. Obviously, the M&A cadence and momentum is not necessarily repeatable. So that kind of stuff also is weighing on it.