We're entering the most important earnings season in recent memory - and the fate of the stock market hangs in the balance
- Quarterly earnings season is getting underway, and it could go a long way towards dictating the future of the stock market.
- A recent uptick in equity volatility has created an uncertain and unstable earnings environment, which could result in sharper share moves than usual.
- We outline why this is the most important earnings season in recent memory, and discuss what's at stake.
Earnings season is always a crucial time for stock investors. It gives them a rare peek inside the companies whose shares they own. And, perhaps most importantly, it's a chance for them to take advantage of bigger-than-usual price swings.
But the reporting period getting underway this week is carrying extra importance. In fact - given what's transpired in recent months, and what's at stake - it's not an exaggeration to say this is the most critical earnings season in years.A big part of that stems from the profit growth slowdown being signaled by Wall Street and corporations alike. For evidence of that, just take a look at the corporate preannouncements that have taken the market by storm over the past few weeks - and the drastic effect they've had on stock prices.
In early January, Apple foreshadowed what's looking like a rough quarter by cutting its sales forecast. American Airlines got in on the action recently, making similar downward adjustments to both revenue and earnings on a quarterly and full-year basis.
And then you've had retailers like Macy's and Kohl's, who both warned recently that a weak holiday season will weigh on fourth-quarter profits.
All of these developments are telling investors that these companies - and the indexes over which they exert such heavy influence - are in a vulnerable position right now. And sure enough, each piece of guidance outlined above took a big bite out of the whole market, particularly the Apple news.
As such, how earnings season unfolds could have major implications for the broader market. Sure, many firms are getting out ahead of their dismal reports and absorbing the share losses that result from weak guidance. But what if their earnings are even worse than expected? What if that weakness is more widespread than originally assumed?Read more: Wall Street experts are ignoring major warning signs being flashed by the market - and their negligence could speed up the next stock crash
Those are both questions stock traders will be asking themselves as reports start to roll in. And their answers will go a long way towards dictating how equities will trade going forward.
With all of that established, here are three main reasons why the current earnings season is taking on abnormally large importance:
1) We just had a bear market scare
On Christmas Eve, the S&P 500 closed a fraction of a percent away from a bear market. The severity of the decline surprised even the biggest bears on Wall Street, whose models hadn't prepared them for so much selling in such a short period.
And while the market has rebounded in the weeks since, the psychological overhang remains. Investors got a quick taste of what a sharp market crash looks like, and the memory is sure to linger as companies report earnings.
If a series of key numbers come in weaker than expected, there's no guarantee the market will react in any less severe fashion. It's entirely possible that scarred investors will sell first, then ask questions later. Especially since their beloved "buy the dip" strategy has gone by the wayside.
2) Some experts are expecting an earnings growth recession
The unfortunate reality of profit growth surging so much in 2018 was that it came largely on the heels of tax reform. Since that positive effect provided only a temporary boost to corporate bottom lines, the risk now is that investors will see slowing earnings and sell shares of affected companies.
To complicate matters further, the market is pricing in a far bigger drop in profit growth than experts across Wall Street expect. This is notable because any capitulation on the behalf of analysts could cause traders to de-rate stocks even further.After all, if the market is so negative on earnings at a time when Wall Street is still largely optimistic, it's impossible to know how deep the selling could go if those analyst forecasts roll over.
The chart below shows how Wall Street experts are still relatively optimistic about earnings growth.
3) The trade war remains a wild card
If you thought President Donald Trump's trade battle with China would be over by the time first-quarter earnings season kicked off, you've been proven sorely wrong. That's bad news not just for companies that will report soft overseas numbers for this period, but also for the future earnings prospects of internationally exposed firms.
For instance, as part of its slashed revenue forecast, Apple cited the trade war as a headwind for its overseas business. It's a concern that's certain to keep popping up for companies particularly tied to China.
So investors must ask themselves: Is it worth continuing to own shares of China-exposed companies when a trade war resolution is nowhere in sight? Ultimately, the way they answer that question will have a major impact on how the whole market trades.