How earnings season sets stocks up for 'bear market trap'

Text size Earnings reports were mostly upbeat, but stocks had a muted reaction. That might just set the stage for another market drop soon. Angela Weiss/AFP/Getty Images Stocks performed ho-hum after the earnings report, and that's not great news for a market that was tuned for easy rhythms. Investors really weren't expecting big earnings news. Expectations had already fallen by the start of the reporting season, with fourth-quarter earnings per share estimates for the index falling about 7% from September to the end of the year, according to Credit Suisse. The main driver has been economic demand softening as the Federal Reserve raises interest rates, a move designed to lower the rate of inflation. That inflation, however, continues to squeeze profit margins as companies lose the power to raise prices even as wages rise. Overall, “fear mongering reduced [earnings] at least," wrote Chris Harvey, chief U.S. equity strategist at Wells Fargo. With 95 S&P 500 companies that reported total earnings per share for them were 1.7% higher than analysts' expectations, according to Refinitv, and 67% of companies beat estimates. Those stats aren't great. Companies have, on average, reported earnings 4.1% above expectations since 1994, with 66% beating forecasts. Subscribe to the newsletter Barron's Daily A morning briefing on what you need to know for the day ahead, including exclusive commentary from Barron's and MarketWatch writers. Still, the resulting earnings are good enough. The average stock rose 0.5% after the report, according to Evercore ISI data, while stocks of companies that beat both sales and earnings per share rose 0.8%. That's below the five-year average of a 1% gain, but double misses haven't been punished as much as they usually are - they've fallen 1.6% on average, below the 2.9% average over the past five years. It is a reflection of the uncertainty that investors are now forced to face. The Federal Reserve remains in rate hike mode, and the market is uncertain whether the economy is headed for a recession or a soft landing. That makes the current numbers — and the companies that provide the guides — even harder to read. The New Year's rally in the stock market also means values are higher than they were three months ago, raising the bar even as falling expectations lowered it. According to Martin Roberg, portfolio strategist and quantitative analyst at Canaccord Genuity, that's a setup that could lead to more downside. He notes that the market's recent rally after the 2022 crash is reminiscent of the rally seen two decades ago, just before further declines occurred. After a terrible year in 2000, the S&P 500 rose 4% during the January 2001 earnings season, as the results convinced some investors that the worst of the tech wreck was over. Analysts, however, continued to cut their earnings forecasts, setting the market up for more declines over the rest of that year. "The risk of moving into a more bullish mode without earnings visibility is a repeat of the January 2001 bear market trap," explains Roberg. Let's hope history doesn't repeat itself. Email Jacob Sonenshine at jacob.sonenshine@barrons.com Source link