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Why the market is not rewarding positive earnings surprises

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In Monday’s Morning Brief, Yahoo Finance Managing Editor Sam Ro writes about why companies are smashing expectations, but investors are selling the news. Julie Hyman, Brian Sozzi and Myles Udland discuss.

Video Transcript

[MUSIC PLAYING]

MYLES UDLAND: All right, welcome back to Yahoo Finance Live on this Monday morning. We're about an hour and 20 minutes into the trading session. We see all three majors are higher. And we are, of course, remain in the teeth of earnings season. Now most of the market cap of the S&P has already reported their results. But big companies like Disney, Twitter are set to report later this week.

And in the morning brief this morning, Sam Rowe took a look at the reaction that stocks are having to these results. Data from FactSet's John Butters shows that most companies, companies on average rather, are beating earnings expectations by some 15 percentage points. And yet, the average stock reaction is a decline of one-half of 1% in the share price for these businesses in the two days before and after earnings results.

Now, in a typical earnings period, you see stocks go up about 1% after reporting a positive earnings surprise. And so, we continue to see a very interesting dynamic, where good results are not being rewarded, though perhaps, Brian Sozzi, we shouldn't be surprised because this was allegedly what the market was pricing in all of 2020. We spent the whole year pulling forward expectations that the markets-- that the E in the PE equation would eventually catch up. That's why the price went up so much.

And so, I guess on that basis, it's not a huge surprise to see investors not thrilled with huge beats because that's what had been expected. That was the minimum expectation, I guess we should say, for how this corporate earnings season was going to go.

BRIAN SOZZI: Yeah, I really enjoyed this newsletter. This was really a cool read. And to your point, yes, this was priced in six months ago. But there's another little-- there's another aspect here. You know, you hop in these earnings calls for these companies, and two years ago, you go onto an earnings call, you would be able to get some sense on what will happen the next month, two months, three months, six months, and then 12 months. And that is not happening right now.

And even if an executive goes onto an earnings call, and they say, you know what? Our January sales were really good. Well, sales might fall off a map in February and March if a lot of these-- what these companies are selling are impacted by some way with regards to the COVID-19 pandemic. So it's just, I think, a lack of belief, Julie, that companies can live up to any guidance or any commentary they put up right now. And I think that's why you're seeing some of the cautious responses here.

JULIE HYMAN: Well, and I hate to bring it back to GameStop, but I'm going to, because you have to think also that part of the typical reaction you see post-earnings, A, it has to do with options, and B, it has to do with retail investors. And if retail investors' attention is diverted right now to Bitcoin and Tesla and GameStop and AMC and all of the other companies that we've been talking about, and they're trading those, rather than trading the things they normally would be buying in the wake of earnings, that could potentially also be having a diminishing effect, a muting effect, if you will, on some of the earnings reactions, potentially.

MYLES UDLAND: Yeah, and I think it also comes back to something that I've referenced many, many times on this show. And it's kind of one of those stories you write and then you forget about it, but then you remember it again, which is the story from Bank of America back in 2018 that found that in years where earnings are up better than double digits, more than half the time, the S&P is down. And the S&P doesn't go down that much in most years. It usually goes up, as we know here.

And so, just, that dynamic is something I've kind of kept in the back of my mind, that really good earnings results, as they come in, aren't necessarily accompanied by great stock performance. And so, one wonders how this pattern plays out for the rest of the year, which a year that we expect to be a stellar one for corporate earnings results.