Traders have not been this unresponsive to earnings announcements in nearly two decades.
The rate of earnings beats in the second quarter is above its five-year average, at 73% of S&P 500 companies that reported through Friday according to FactSet. Corporate America is also giving less negative guidance about the third quarter than usual.
But this kind of topline earnings performance is not impressing Wall Street and moving the market like it used to. For the first time in 17 years, there are no short-term rewards for topping earnings forecasts, according to Bank of America Merrill Lynch.
Companies that beat on earnings per share and sales have traded in line with the market the next day and over the following five, BAML said in a note on Monday. However, those that miss have been punished. They have underperformed the market by three percentage points over the next day, and five percentage points over the next five.
“Investors may be honing in on other sources of guidance like net interest income, subscribers, volumes, etc,” said a BAML team of equity and quant strategists led by Savita Subramanian in a note on Monday.
“Reactions based on earnings guidance have also been muted: companies with positive 2017 EPS revisions (in excess of the 2Q beat) performed in-line with the S&P over the next one and five days vs.underperformance of ~1p pt for those with estimate cuts, though spreads were wider on revisions to 2018 EPS.” The S&P 500 is up 1.8% since July 11, when PepsiCo kicked off earnings season for the largest companies.
Buy the rumour, sell the news
The rally in stocks this year, despite gridlock in Washington over healthcare and tax reform, suggests that investors were already expecting a second-straight quarter of profits growth.
One sign of this expectation is that as earnings season approached, analysts made fewer and smaller cuts to their estimates than they usually do, according to Deutsche Bank.
And so, earnings surprises are not that surprising. Combined with low inflation and sluggish changes to interest rates, earnings growth was a pillar of the bullish thesis for stocks that drove the market to new highs.
Chris Harvey, a senior analyst at Wells Fargo, found that large caps are bearing the brunt of Wall Street’s muted reaction to earnings outperformance. Post-earnings release, large-cap companies that beat on EPS have underperformed the S&P 500 by -0.32%. But similar companies on the small-cap Russell 2000 index have outperformed the market by 1.77%.
“We believe the relative outperformance by large caps has raised the bar too high and is likely contributing to the ‘sell the news’ dynamic as compared to smaller caps,” Harvey wrote in a note on Monday.