With the focus investors have had on what the Fed will do at the end of July, very little attention has been given to the start of the second quarter earnings season. There have been a few earnings announcements this week, but when the banks and some tech firms start reporting next week, it will really mark the start of the earnings season.
With the trade war lingering over global businesses and economic slowing around much of the globe, the overall aggregate earnings for S&P 500 companies is expected to decline by 1% for the second quarter.
So far there have been 113 S&P members that have issued guidance for the quarter and of those 87 have guided lower. That guidance leads me to believe that analysts have pretty low expectations for the quarter as a whole.
The predicted earnings decline in aggregate earnings is a little misleading as it reflects big declines from tech earnings. The median earnings expectation for S&P 500 companies is plus 4% while the average tech firm is expected to see a decline of 10%. The heavy weighting from tech is what causes the aggregate to show a decline.
While analysts seem to be prepared for lower earnings growth, I’m not sure investors are—at least not based on the fact that the S&P eclipsed 3,000 for the first time ever this week and the Dow crossed 27,000 for the first time. Indices hitting all-time highs is not what you see when investors are preparing for bad news.
After the G20 meeting and the progress in the trade war, investors pushed stocks higher. When Fed Chairman Powell indicated that the Fed would in all likelihood cut rates at the end of the month, investors pushed stocks higher. Investors seem to be throwing caution to the wind a little as the tariff truce doesn’t mean the trade war is over and the reason the Fed is cutting rates is that they see economic conditions weakening.
I did an interview on Cheddar TV earlier this week and the earnings season was the focus of the conversation. I cautioned investors that you need to look at the sentiment on a company by company basis to see if it is too bullish or not.
Personally, I haven’t had a chance to break down the sentiment readings on too many companies at this point, but I have looked at the big banks and healthcare. The sentiment on big banks seems to be slightly more bearish ahead of earnings after Morgan Stanley downgraded the industry earlier this week.
Banks could be looking at shrinking margins with a rate-cutting cycle on the horizon. When the Fed is going through a rate-hiking cycle, banks benefit as the spread between what they pay on deposit products and what they charge on loan products increases. The opposite is true as well – the spread between deposit rates and loan rates shrinks during rate-cutting cycles.
Expectations for the healthcare sector seem to be pretty low as the sector has lagged the others so far in 2019. The industry has been in the political spotlight for a great deal of the year with political figures from both sides of the aisle looking to get drug costs under control. President Trump’s proposal that drug manufacturers be forced to include prices in their advertisements was shot down by a Federal judge earlier this week, but that hasn’t taken the political pressure off of the industry.
As for overall market sentiment, the Investors Intelligence bull/bear ratio just moved back above the 3.0 mark. The ratio has been rising since December and it moved above the 3.0 level earlier in the year, but it fell back below that level during the May pullback.
Over the years the 3.0 level has been used as a demarcation point to signify excessive optimism, but the ratio has been much higher. The ratio was above 5.0 back in late 2017 and early 2018, but the rough first quarter and the terrible fourth quarter caused the ratio to fall below 1.0 in December.
My suggestion to Bull Market Rodeo readers is you need to look at the sentiment readings on individual stocks that you own to see if the sentiment is extremely bullish or not. If analysts’ ratings are almost all “buy” ratings, if the short interest ratio is below 2.0, if the put/call ratio is below 0.75—these are all signs that sentiment is too bullish. When this happens, it becomes very difficult for the company to clear the expectations hurdle.