The Glass Half Full Market: Revenue Losses Are Getting Harder


Even as stocks rebounded from bear market lows, there was a nagging worry: would second-quarter earnings derail the upward move?

The concern was inflation and a slowing economy would lead to weak earnings reports that would pull the market down.

And in fact, the companies aren’t beating analysts’ earnings expectations by a record margin like they did in 2021.

Even so, investors are rewarding companies that have simply met expectations or beaten by a wider margin than in any other earnings season in the past two years.

“We entered earnings season with a glass-half-empty mindset,” says Steve Sosnick, chief strategist at Interactive Brokers. “We were probably a bit predisposed to think negatively, there was concern about a kitchen sink quarter,” he says, meaning investors were expecting second-quarter earnings be the time when companies would throw out all their bad news at once.

Instead, as of Aug. 3, with about 51% of the 854 U.S.-listed companies covered by Morningstar analysts reporting second-quarter results, investors have not punished stocks to the same degree as they did in the first quarter results. The average one-day return following the release of positive results is 1.89%, compared to an average of 0.75% over the past four quarters. For a full explanation of how we calculated the data, see the explanation at the end of this article.

Other key takeaways from Q2 earnings so far

  • Companies that missed earnings estimates actually saw their shares rise an average of 0.72%, compared to an average loss of 1.77% the previous year for this same group.
  • Executives proved more confident in their guidance and commentary, leading investors to also send stocks that missed earnings estimates higher.
  • Of the stocks covered by Morningstar analysts who reported, only eight fell more than 10% after their results, compared to 32 during the first-quarter earnings season. The reinsurance company Scor was the hardest hit. (SCRYY)which fell by 15%.
  • None of the companies that have reported so far have seen their stock fall more than 20%. Seven companies fell that much in the previous quarter, including Under Armor (UA)whose shares plunged 25.88%.
  • The stocks that had the worst earnings reaction to first-quarter results, large retailers, have yet to report, leaving the risk that investor sentiment will quickly deteriorate.

So far, fewer companies are beating their second-quarter earnings estimates, with only 47% of those saying they have done so. That’s down from the 56% seen in the first quarter and below the 60% average of the past four earnings seasons. There was also an increase in the number of companies that fell short of expectations, with around 19% of estimates missing in the second quarter. This compares to an average of 15% over the past year and is slightly worse than the 18% in the first quarter.

So why are investors cheering the second quarter news when there are fewer earnings beats and more misses?

“Better than expected was key this quarter,” says Sosnick, who points to the changing psychology of the market. When market psychology is good, investors expect companies to beat earnings and generally reward them and vice versa, he says. But when market psychology “stinks” as Sosnick sees it now, “the market just hopes companies will hit their targets. You don’t need an earnings beat for the results to be good news,” he says.

This follows an increase in the number of companies that met expectations for the second quarter, to 33% of those that have reported so far. Companies that met expectations saw an average earnings reaction return of a decline of 0.57%, which is slightly higher than the average decline of 0.74% from the previous year.

A bar chart showing the average returns of stocks that reported higher, missed, and in-line earnings results.

When it comes to companies that fell short of expectations and still saw a positive average earnings reaction, this implies that investors were paying attention to more than beats or fails. Sosnick found a greater level of confidence in how companies talked about their targets when commenting on second quarter results.

“The companies lacked clarity, and that showed in the first quarter, and that’s why investors walked into the glass half empty in the second quarter,” he says. “Instead, companies seemed more, if not optimistic, a bit more confident in their direction. Markets like certainty.

A combination of companies generally meeting or even beating expectations at an accelerated pace this quarter and greater confidence in guidance ranges was enough to turn market sentiment around.

“Investors were much more willing to reward positive news than punish negative,” Sosnick says. He cited investor reactions to bank earnings, which many see as good weather for the rest of earnings.

And after?

The broader market rebounded 13.9% from its 52-week low on June 16, supported by strong earnings news, leading some to believe the market has passed its bear market low. . But Sosnick is hesitant to say recent results indicate the market is up.

“We’ve been through most of earnings season, but the next few weeks are going to be eye-opening as we hear from retailers, and I suspect they may be telling a different story,” he says.

A large wave of retailers typically reports towards the end of earnings season, many of which were among the companies with the worst earnings reactions in the first quarter, including Target (TGT)whose shares fell 24.93%, and Bed Bath and Beyond (BBBY)which fell 23.58%.

Sosnick is also concerned that the psychology of the market could reverse again, saying there are still factors that can alter sentiment.

“I’m hesitant to say we’ve bottomed out in the bear market because I’m a big fan of ‘Don’t Fight The Fed,’ and they haven’t eased off yet,” he says, referring expectations that the Federal Reserve will continue to raise interest rates.

“We’re also going to have the other issue of the Fed shrinking its balance sheet, the Fed has pumped a lot of money into the markets, and they’ve just started to pull back,” Sosnick said. While the Fed will shrink its balance sheet at a very slow pace, Sosnick still sees this as a major headwind going forward.

“They [the Fed] are unlikely to change their stance unless we face a recession, and the bond market is shouting to our face that we’re probably going to face it. But stock market investors kind of view this as something to ignore or do well as they expect the Fed to cut rates [in the event of a recession]says Sosnick. “It’s really a case of being careful what you wish for.”

A line chart highlighting previous declines in the Morningstar US Market Index from its latest highs since 2012.

Methodological remarks:

The analysis was conducted on the 854 U.S.-listed stocks covered by Morningstar analysts as of August 3, 2022. Earnings release dates were drawn for each stock during each earnings period between April 1, 2020 (the start of the second quarter 2020 earnings season) to August 3, 2022.

Earnings reactions are the one-day stock returns of companies on the available trading day following their earnings release date. If a company published earnings before market or while the market was open, then the return was calculated for the same day. If a company released its results after market close or on a weekend, the next trading day was used to pull the one-day return as the earnings reaction.

The data was aggregated based on a company’s earnings per share surprise percentage. If companies reported actual EPS 5% or more above FactSet consensus average estimates, that was considered a beat. If companies reported actual EPS 5% below or below estimates, it was called a dud. If the actual EPS was within 5% of the estimate, the results were considered to be in line.

About Dwayne Wakefield

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