(This guest post previously appeared at the author’s blog)
Goldman Sachs says the recent surge in equity prices is fully discounting the positive earnings season that began two days ago. As can be seen in the accompanying chart, Goldman says investors have begun to catch onto the “better than expected” trend in earnings and have been front running the last few earnings seasons. Each earnings season has subsequently resulted in weaker equity performance as investors look to “sell the news”. When the market bottomed in March 2009 investor sentiment with regards to earnings was extremely negative (something our Expectation Ratio was way ahead of the curve on – see here).
The two quarters following this extreme negativity resulted in significant upside surprises. By Q3 ’09 the trend was well in place and it was clear that corporate profit margins were expanding and resulting in stronger than expected earnings. Each of the past two earnings season were front-run by investors who had noticed this trend and were hoping for performance that was similar to the prior earnings seasons. Neither Q3 nor Q4 resulted in significant gains and the Q4 earnings season coincided with the largest sell-off of 2010. The current rally into earnings is the largest since the quarter after the March 2009 bottom:
Source: Goldman Sachs
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