Wall Street has once again engineered the perfect scenario to push stocks higher.
Third-quarter earnings season unofficially starts on Thursday when aluminium giant Alcoa reports results, and strategists including Goldman Sachs’ David Kostin have warned that given the macroeconomic turbulence during the quarter, this reporting season is likely to be rocky for the stock market.
But once again, analyst expectations for corporate earnings have been lowered, leaving companies a prime opportunity to see their stocks rally after beating (already lowered) expectations.
Morgan Stanley’s chief US equity strategist Adam Parker wrote in a note to clients on Monday(emphasis added):
“Q3 2015 earnings expectations have once again been lowered to the point where we would be quite surprised to not ultimately see aggregate earnings upside for the 27th consecutive quarter. With this decline in estimates, we expect reported results to show modest upside. Earnings for the group of companies reporting prior to Alcoa have been above estimates. The sample size is small, but beats included Nike, Oracle, and Carnival Corporation among others. The market is following the typical pattern of
rewarding companies that beat consensus revenue and earnings while harshly
punishing revenue and earnings misses.“
Before second quarter earnings season, Deutsche Bank’s David Bianco described this pattern of lowered expectations followed by big beats as a “charade.”
Bianco advised clients not to judge a company by whether it beats or misses, but on year-on-year earnings-per-share growth.
But in addition to rewarding companies that top earnings expectations, investors could also simply look at lower stock prices and want to buy.
In the third quarter, the S&P 500 saw a 7% drop, making it the worst since the third quarter of 2011. Year-to-date, the S&P 500 is down about 4%. In recent weeks, we’ve seen top strategists at Goldman Sachs, Deutsche Bank, RBC Capital, and others slash their year-end targets.
But we’re still a ways off of where Wall Street expects stock to end the year, with the median year-end S&P target among top strategists sitting at 2,150 on Monday, according to data Bloomberg.
This implies that the S&P 500 will rally 11% from Monday’s opening level of 1,941.75.