If bullish price movement in the April stock market has taught us anything, it is that Wall Street has an amazing capacity to maintain a longer-term bullish outlook — especially when stock prices are cheap.
We know this sounds crazy as we head into what promises to be a wild earnings season. After all, didn’t JPMorgan Chase (NYSE:JPM) announce on Tuesday that its profits fell by 69% from the previous year during the first quarter? And didn’t Bank of America (NYSE:BAC) announce this morning that its profits fell by 45%?
Yes, both of those things are true. But those numbers are in the past. That’s the thing with earnings announcements. The metrics are by their nature backward-looking.
Wall Street likes to think about the future.
Traders spend their days trying to anticipate what’s going to happen next so they can buy stocks before the good news hits or sell their stocks before the bad news hits.
This tendency to look to the future typically causes the stock market to lead the business cycle through both contractions and expansions. Take this business cycle chart:
Fig. 1 — Stocks’ Relationship to the Business Cycle
Stocks tend to fall before the economy contracts, and they tend to rise before the economy expands.
This is exactly the pattern we’re watching play out now.
The stock market fell by more than 20% in late February and early March in anticipation of the looming recession in the U.S.
Now that recession is being confirmed. Millions of workers have filed for unemployment and the Census Bureau announced that retail sales dropped by a record 8.7% in March.
Why is the market starting to bounce now? If traders were so concerned about the U.S. economy last month that they sent the S&P 500 into bear market territory, what on earth could they be seeing that would make them start buying stocks this month?
It appears traders believe the economic contraction is going to be relatively short lived. Although it’s likely to get a bit worse before it gets better.
According to FactSet, traders are anticipating a 10% decline in earnings for the S&P 500 for the first quarter of 2020. These are the numbers we’re beginning to see.
As bad as that may seem, traders are think it’s going to get even worse. They are expecting an earnings decline of 20% for the S&P 500 in the second quarter.
After that, however, the outlook starts to brighten. Traders are expecting a smaller 8.5% earnings decline in the third quarter and a miniscule decline of 0.9% in the fourth quarter.
If that’s the case — if traders believe the economy is going to rebound and earnings declines are going to stabilize — it’s not hard to see why traders are buying stocks right now. They’re just doing what they’ve always done: looking ahead and trying to buy stocks before the good news hits.
The Bottom Line
While all of this is encouraging, there is no guarantee corporate earnings announcements will unfold as expected or that this bullish bounce will last.
There’s a lot that could happen between now and the end of 2020. The earnings decline for first quarter may end up being worse than expected. The gradual reopening of the global economy may be slower and bumpier than anticipated. Covid-19 could have a resurgence later this year.
Of course, the opposite is also true. The earnings decline for the first quarter may end up being better than expected. The gradual reopening of the global economy may be faster and smoother than anticipated. We may develop enough tests, vaccines, etc. and maintain social distancing long enough to prevent a resurgence of Covid-19 this year.
What we do know is there’s a case to be made for buying stocks after the recent selloff, and Wall Street has bought in so far.
Are we likely to see the S&P 500 challenging its all-time high of 3,393.52 points this spring? Probably not. But if the first quarter earnings season doesn’t deliver any devastating surprises and the economy starts to reopen, we’re likely to see some sustained optimism and buying.
John Jagerson & Wade Hansen are just two guys with a passion for helping investors gain confidence — and make bigger profits with options. In just 15 months, John & Wade achieved an amazing feat: 100 straight winners — making money on every single trade. If that sounds like a good strategy, go here to find out how they did it. John & Wade do not own the aforementioned securities.