10/25/2018 0 Comments Earnings are great, markets don't careAbout a quarter into earnings season and the data is showing a very strong 3rd quarter. The markets took the news and dropped the S&P almost 9% this month. A lot of analysts are scratching their heads over this conundrum and why the data isn't raising as rosy of a picture as in the past. There are three major thoughts on why earnings don't matter, two of them justify the correction, while one of them leaves a lot more to worry about in the coming months. Overestimated earnings: The estimate cycle usually goes in its downward revising fashion as the estimate date comes near. This is a classic example of people overestimating near term future conditions. This year something different has happened, estimates went up as a result of the tax cuts that came into effect. This caused the markets to rally on the news and the optimistic estimates before the actual results came out. Therefore no stock prices are shocked or unprepared for these higher numbers. Outlook:
In relation to the earnings story, a lot of companies forward guidance was a cause for concern. Admitting to the one time boost from these tax cuts and concerns over the tightening of the rate cycle, the markets could be pricing in modest earnings growth in the future. Companies have come out in their earnings calls mentioning the tougher climate that is ahead and headwinds to their industries, or the economy as a whole. While this is not good for companies' stock prices it is a factor that can be measured, as a result, so will the market correction. Macro factors: This is the big question mark in terms of how much the market has to drop. Earnings and outlook stories will understandably see an adjustment in the markets to take into account the new realities. The big "if" factor is whether the trade wars with China escalate, sanctions on the middle east de-stabilize the region and the oil market, or Italy and the Euro countries come to a budget resolution. These issues are more frightening to the markets because there is no estimate to how bad they can get. As escalation in the trade war deepens, you can see earnings consistently erode beyond even the lowest estimates. Sharp spikes in oil prices can negate any wage growth Americans have seen, and curb spending. These are the concerns to watch in terms of how much the market may still have to go. As time goes on you will see these negative factors start to fade, or be priced into earnings forecasts. It will be in a couple quarters that the macro factors start to become an earnings story.
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