The stock market is becoming a victim of its own success.
Even when companies turn in impressive earnings reports, that strength isn’t translating to higher stock prices.
In the second quarter, a company beating expectations only saw a 0.3% share-price gain over the following three days, according to data compiled by Morgan Stanley. The picture was even worse for companies that beat sales forecasts. Their stocks remained flat over that period.
It’s only when companies missed on earnings that investors seemed to snap to attention. Those falling short of profit estimates slipped 2.1% over the subsequent three days, while missing on revenue cost them a 0.9% decline, Morgan Stanley data show.
“Investors appear to be taking the recent earnings success of stocks for granted,” Brian Hayes, head of equity quantitative research at Morgan Stanley, wrote in a client note.
It’s possible that investors have simply been spoiled by the stock market’s recent run of earnings success, with the S&P 500 expanding profits for five straight quarters, the longest such streak in more than two years. Another explanation is that investors are getting worried about valuations that are the highest since the dotcom bubble, making them reluctant to add to positions as they look for a reason to sell.
Either way, it’s bad news for the stock market, which has historically used earnings growth as its primary source of share gains.
Here’s a visual representation of the dynamic:
Another interesting wrinkle to the earnings picture, as seen in the chart above, is that stock prices have reacted more to earnings results than they have to sales figures. Morgan Stanley said it best: “The reward for beating on EPS was greater than for revenue and the penalty for missing was worse.”
As such, traders betting on earnings moves would be well-served to recognise and prepare for the outsized influence of bottom-line profits.
Over the longer-term, the earnings picture may be due for a shake-up, at least according to Strategas Research Partners, which argues that profit growth has nowhere to go but down. Adjusting for historical factors, the firm sees earnings growth declining over the next two quarters before being cut almost in half by the first quarter of 2018.
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