The market doesn’t care about bad news as long as it knows it’s coming. It hates nasty surprises and loves the pleasant ones. Everything — everything — is relative to expectations, at least in the daily scrum of trading.
Case in point: JPMorgan Chase‘s (NYSE:JPM) second-quarter results. JPM’s London Whale trading loss was more than twice as large as first disclosed, and more far-reaching than initially thought. As a result, the nation’s biggest bank is restating first-quarter results. It’s also looking to grab back two years’ worth of compensation from the people involved, all of whom have been kicked to the curb.
And yet JPM’s stock rallied sharply on the news.
Why? Because the loss, the restatements, the black eye CEO Jamie Dimon and the bank’s vaunted reputation for risk management suffered — none of it was nearly as ugly as traders feared.
Yes, the bungled trade loss ballooned to more than $4 billion from $2 billion when JPM first disclosed it — but it still was far short of the $9 billion loss media reports said the bank projected in a worst-case scenario.
And as for the restatement of the prior quarter’s earnings, that’s ugly, too. But it’s not something the market cares about, because stocks are forward-looking. Traders only care about the profits JPM can make in the future. So what if the bank’s trailing price-to-earnings ratio jumps?
The past is the past, the thinking goes. It might be of consequence to value investors with long horizons, but certainly not to traders on a Friday morning in July.
And lo and behold, the present and immediate future suddenly looks a lot brighter for JPM after it disclosed the loss, the restatement and all the other damage control its doing in wake of the debacle. The bank, a component of the Dow Jones Industrial Average, said second-quarter profit fell 9%, but it still booked $5 billion in profit.
That’s right: The bank lost $4.4 billion on the bungled trade during the quarter — and $5.8 billion on it so far this year — and still earned $5 billion over three months.
Oh, and earnings beat Street estimates by 51 cents a share.
No wonder the stock jumped more than 4% after the opening bell and helped propel the Dow to an early triple-digit gain.
It’s all about expectations — and JPM blew them away with much better-than-expected news across the board. The trading loss in the bank’s Chief Investment Office slashed the bank’s second-quarter profit by 69 cents a share, after-tax. And it still crushed analysts’ average estimates.
True, the bad trade still is poisoning the bank’s books, but it’s a cold — not the pneumonia the market feared. It cut the bank’s first-quarter profit by less than $500 million (JPM made about $3.5 billion in the period), and could cost another $1.6 billion in the current quarter, Dimon said.
JPM is rallying sharply — at least for a session — on relief. Traders were bracing for a report that was far uglier than what ultimately transpired. When it comes to the market, bad news is good news when it’s better than expectations.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.