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This Earnings Season Might Catch Wall Street Off Guard

This Earnings Season Might Catch Wall Street Off Guard

Dave Gilbert here, Editor of Smart Money.

I’ve been thinking back to a little plaque that hung on the wall of my parents’ house for years. It was a picture of a rather forlorn-looking Cocker Spaniel, and underneath it said:

Blessed are those who expect nothing; for they shall not be disappointed.

It always got a reaction out of folks, usually a chuckle and a nod in agreement. I see you can buy it today on Etsy for $16, which is probably a lot more than my parents paid for it.

A photo of a forlorn-looking Cocker Spaniel with the caption “Blessed are those who expect nothing; for they shall not be disappointed.”

I mention this because it seems to be a fitting description of Wall Street’s attitude to earnings reporting season, which is now underway in full force.

Earnings are measured in expectations. Companies either beat, meet, or fall short of analysts’ estimates, and those results often have a significant impact on the stock.

What’s interesting is that low expectations can be a good thing, for exactly the reason stated on the plaque: They shall not be disappointed.

“They” might even be pleasantly surprised…

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Finding Balance

There is no official beginning to quarterly earnings season, no starter gun fired into the air or no announcer saying, “And they’re off!”

But everyone agrees that the reporting season started last Friday when four major banks released their results. Now come a flurry of reports and daily headlines from some of the most influential companies in the world.

Case in point: Everyone will be watching after today’s close for the latest results from Netflix Inc. (NFLX), the first major technology company to report and an indicator of advertising and subscriber trends, which in turn inform us about consumer spending.

Earnings results by definition look backward at the last quarter, but as you well know, the market looks forward to where things are going. This brings us back to expectations. Most companies provide “guidance” for the current quarter – and sometimes beyond – and investors want to know this as companies operate in this environment of inflation, rising interest rates, and increasing talk of a recession.

So what exactly are those expectations for last quarter’s results? Low. And they’ve been getting even lower. According to financial data company FactSet:

The start of the third quarter earnings season for the S&P 500 has been weaker than normal, as the number and magnitude of positive earnings and revenue surprises have been smaller than recent averages. In addition, analysts have continued to lower earnings estimates for companies since the end of the quarter. As a result, the earnings and revenue growth rates for the S&P 500 for the third quarter are lower today compared to September 30.

The current overall estimate for the quarter is for S&P 500 earnings to grow 1.6%, also according to FactSet. Expectations are down from 2.2% last week and 2.8% at the end of September.

That’s barely growth at all. In fact, earnings are expected to contract in seven of the 11 S&P 500 sectors.

A chart depicting the S&P 500 Earnings Growth for Q3 2022 (source: FactSet)

When estimates are this low and the outlook this bleak, it actually increases the chances that companies will beat expectations. As Eric Fry told us in a recent meeting…

Wall Street is braced for the worst. And while the worst is always a possibility, it is rarely the most likely one. Expectations are so low that I expect more positive earnings surprises this quarter than last.

I will be interested to hear what companies have to say about their earnings outlooks for next year because I think the on-the-ground realities aren’t as bad as what the media paints.

Certainly, economic conditions are tricky right now, and very few companies are delivering strong growth at the moment. But I wouldn’t be surprised if investors cheer results that are “not as bad as we thought.” The results don’t have to be great, just less bad. You can see some of your best rallies that way.

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Kicking Off with Early Beats

We have already seen this play out in the early returns. Notice in the table above that financials have the lowest expectations of all sectors with earnings expected to fall 16%. They were first out of the gate, and most companies exceeded expectations.

Of those four companies reporting last Friday…

  • JPMorgan Chase & Co. (JPM) beat expectations for both sales and earnings. The company earned $3.12 a share, ahead of Wall Street’s estimate for $2.88.
  • Wells Fargo & Co. (WFC) also easily beat on both the top and bottom lines, earning $1.30 per share versus estimates for $1.09.
  • Citigroup Inc. (C) saw its third-quarter earnings fall 25% over last year, but in a good illustration of low expectations, earnings of $1.50 per share still exceeding the consensus estimate for $1.42.
  • Morgan Stanley (MS) was the only one of the first four to fall short of expectations for both revenue and earnings.

The stocks have reacted accordingly. JPM, WFC, and C are all ahead of the S&P 500 over the last five days of trading, while MS dropped and now trails the index.

A chart showing JPM’s total return (+11.82%), WFC’s total return (+8.52%), C’s total return (+6.73%), and MS’s total return (+0.70%) against the S&P 500’s total return (+2.84%) from Oct. 12, 2022 to Oct. 17, 2022 (source: YCharts)

The trend has continued this week, as Bank of America Corp. (BAC) and Bank of New York Mellon Corp. (BK) both beat expectations yesterday and gained 6% and 5%, respectively. They were followed this morning by Goldman Sachs Group Inc. (GS), which is up more than 4% today as I write this.

A bounce in the overall market certainly helped these stocks rally, but their individual bounces have exceeded that of the market, so investors at least so far are rewarding the upside surprises. I know Eric is watching this trend closely and will continue to over the coming weeks as more and more reports come out.

You may also have noticed on the chart above that energy sector earnings are projected to grow an incredible 120%. This is also in keeping with Eric’s bullishness on the entire energy spectrum, from the growth in alternative energy to the ongoing supply/demand imbalance in oil and gas.

The burden is higher for these companies to meet expectations, but valuations remain low enough that rallies are still very possible. For example, Eric’s latest energy recommendation, which is up more than 15% in the three weeks since he alerted his Fry’s Investment Report subscribers, is an oil company trading at under 7X the last 12 month’s earnings and less than 5X expected 2022 earnings. That’s less than half its long-term average PE valuation.

We’re still in the early stages of corporate earnings reports, but so far, those low expectations are producing more pleasant surprises than bitter disappointments. And no matter what the coming reports show, a stock’s performance over time always comes back to how much money the company makes.



P.S. Eric just released his latest monthly issue of Investment Report, where he dives into the newest French “fashion,” a lesson in patience for a cybersecurity ETF, battery metals, and one major megatrend that the media isn’t paying nearly enough attention to. Learn how you can gain access to this issue (and much more) here.

On the date of publication, Eric Fry did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Article printed from InvestorPlace Media, https://investorplace.com/smartmoney/2022/10/this-earnings-season-might-catch-wall-street-off-guard/.

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