This Friday when Bank of America, Citigroup, and Wells Fargo report earnings results, it will kick off the next round of earnings season. Stocks have bounced back nicely from the lows in April and the earnings reports could help the rally continue or they could derail the rally. Which scenario is more likely?
For the most part, earnings estimates are showing that analysts and investors expect the bulk of companies to grow earnings modestly from one year ago. Modest expectations are almost always good as it doesn’t create too high a hurdle for companies to clear. One area where expectations seem to be a little higher than the rest of the market is with tech stocks. Investors seem to have raised the bar for the bulk of tech companies and therefore it becomes a little more difficult for the companies to beat estimates.
As a whole, sentiment toward the overall market has been declining in recent weeks. The Investors Intelligence report for June 26 showed a ratio of bulls to bears of 2.59. That same ratio was over 5.0 in late December and it was at 3.12 on June 12.
The AAII Sentiment Survey fluctuates more than the Investors Intelligence ratio, but it also showed a decline in recent weeks as well as a big drop since its peak at the beginning of the year. The ratio came in at 0.71 and that is the lowest reading since April. The ratio was approaching 4.0 back at the beginning of the year, and now more investors are bearish than bullish.
From a contrarian perspective, this is a good sign as it means that the overall sentiment toward the market is tempered. When investor sentiment is too high, that’s when we tend to see peaks in the market. While these sentiment readings aren’t necessarily a reflection on the earnings expectations, seeing them decline ahead of earnings is good in my opinion. It should also be noted that the sentiment toward individual stocks can vary greatly from the overall market sentiment. Before you go buying a stock ahead of the company’s earnings report, check the short interest ratio, the analysts’ ratings, and the option activity. If these indicators reflect extreme bullish sentiment, it becomes much harder for a stock to rise after the report.
One concern I have regarding this earnings season, in particular, is the impact the trade disputes might have. The ongoing tariff battles shouldn’t have had an impact on the earnings results for the second quarter, but they could have an effect on the outlooks companies give after the release of the report. This scenario could mean that the earnings calls and outlooks mean even more than usual during this earnings cycle.
Obviously, any tariffs that are enacted can impact all sectors of the market, but two, in particular, that will see the most significant impact are the consumer staples sector and the industrial sector. Pay close attention to companies in these industries as they release earnings and then what happens after the earnings call.
For the most part, the sentiment and the expectations are reflecting lower enthusiasm than we have seen over the past few years. That leads me to believe that market as a whole will likely move higher through this earnings season. The trade disputes and resulting tariffs shouldn’t reflect on the current earnings, but they could result in lower estimates for the upcoming quarters. The longer these disputes go on and the more tariffs that get enacted, the greater the negative impact will be going forward.