Houdini often used misdirection to help him become one of the most famous magicians in history. He would focus the audience’s attention on an illusion, so they wouldn’t notice what he did to complete his magic trick.
Today, the media and financial professionals use similar misdirection when trying to explain the stock market’s movements. They focus your attention on earnings and other illusions of today’s market when the real driver of price is completely different.
At the end of July, I wrote an article titled, “Why are Stocks Rallying? A Look Beneath the Hood” outlying what really was driving the market. In that article I raised the concern that making investment decisions based on earnings was likely to leave you disappointed as earnings were not driving stock prices.
In this update I take a look back at what was really driving share prices then and if that trend continues today. If so, then you should avoid getting sucked into the upcoming earnings season drama and focus on what really matters to the market.
During last quarter’s earnings season I gave the below examples of earnings announcements, misses, and stock price results. During the heart of 2Q earnings season, on Thursday, 7/26, the following S&P 500 (NYSEA:SPY) companies had negative surprises and/or guidance as reported by Reuters:
- 3M (NYSE:MMM)- Missed Revenues on 7/26, and up 1.2% on 7/26 & 7/27
- Amazon (NASDAQ:AMZN) – Missed Revenues on 7/26, and up 7.9% on 7/26 & 7/27
- International Paper (NYSE:IP) – Missed Revenues on 7/26, and up 2.8% on 7/26 & 7/27
- Waste Management (NYSE:WM) – Missed Earnings on 7/26, and up 5.7% on 7/26 & 7/27
Although all of these companies missed their numbers, they all have one peculiar thing in common. Their prices all rose – many drastically, even though many of the companies missed their earnings and lowered guidance.
Per Reuters, “this quarter is the first quarter in three years where earnings are expected to fall year over year”. CNBC also stresses the importance of this upcoming earnings season as the deciding factor in the “market’s next direction”.
So why did prices really rise through last earnings season? The answer has nothing to do with earnings or individual company performance as the media or conventional wisdom would lead us to believe; it is all about the macro-environment, specifically, the Euro, and I don’t expect that to change this earnings season either.
The Real Magic Trick
In the previous article I gave a detailed example of how the S&P 500 futures were already up in price before any of the above earnings announcements were reported and that is what really sent the markets higher on 7/26. The futures rose with the Euro and were up significantly before any earnings. That was a trend that washed, rinsed, repeated virtually every day. Of course the media led the public to believe it was all earnings induced rallies and didn’t mention the fact that the market was up already on the back of the Euro, well before the earnings announcements on most days.
Below I have an updated chart comparing the September prices of the S&P 500 and the CurrencyShares Euro Trust (NYSE:FXE). The extremely high correlation between the markets and the Euro continues still today. The Euro/USD relationship is the main driver behind US stock market prices, not earnings.
The chart shows how hard it is to even distinguish between the price history of the Euro and the S&P and the correlation analysis at the bottom confirms the extreme similarities between the two.
Following earnings is a misdirection, and trading the earnings likely wouldn’t have made you money during last quarter’s earnings season.
Factors well out of a company’s control have recently had more impact on share price than individual company performance or expectations. The Euro’s rise and fall over the past month continues to move the S&P, making next week’s kickoff to earnings season just another distraction.
A top down, more macro, approach is much more relevant in today’s market environment. Avoid misdirection by following what really matters.