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What to Watch This Earnings Season

What to Watch This Earnings Season

TheLooking at the year-to-date chart of the S&P 500, it’s hard not to conclude that stocks are at a critical time right now. After a big drop at the start of the year, the S&P 500 hit its lowest level in early February, and then started rebounding about a month ago. By the end of March, the index had recovered nearly three-quarters of its losses, and in the process it appeared to have broken the downtrend. However, April has been disappointing so far, with the S&P slipping to as low as 4% below the March close.

Standard & Poor's 500

Depending on what the chart looks like, it can go either way from here. It is possible to retest the February lows that would bring us back into the correction territory, as well as jump again to challenge the all-time high at 4818.62. This week sees the start of earnings season, as most companies announce their results for the first three months of the year. Under normal circumstances, these profits would be the most likely catalyst for the next move in the market, so they would be critical.

These, however, are not normal conditions.

The main thing affecting the market right now is that the Fed is in the process of implementing a policy shift, a shift designed to put the brakes on the economy very sharply. This means that traders and investors are looking forward, not backward. What has happened over the past three months is interesting, but even a large quarter of the company will be in danger of being overshadowed by any hint of pessimism in future guidance, or a suggestion by a member of the Federal Open Market Committee that they will push hard down their chosen path.

So, do strikes matter?

Typically, more than 70% of S&P 500 companies have beaten the average Wall Street estimate for their earnings, which raises questions about why analysts haven’t learned from a mistake they’ve consistently made over the past 20 years or so. But these are questions for another time. What matters here is that, given this fact and the fear of how the Fed’s actions will affect the future, individual earnings beats appear to be less important this time around than in the past.

But does that mean that first-quarter earnings aren’t really important? No, of course not. In the end, although the average earnings multiplier varies based on underlying macro factors such as price hikes, progress in the Russian invasion, and the war in Ukraine, these same earnings are important. There are two ways for multiples to fall if this is what the market thinks should happen: lower stock prices or higher subsequent earnings. Thus, good results in the first quarter of the year could at least slow the price decline, even if pessimism about the rest of the year persists, and will speed up the recovery if it does.

However, while earnings may influence the pace of decline or jump, this quarter is unlikely to say which ones will happen over the next few months of trading. So investors should be careful not to draw big and wide conclusions about the market based on numbers. However, investing in stocks is all about relative performance. Ideally, you want to own stocks that not only perform well in the good times, but also do less badly on the dips. This quarter could give investors some clues as to which will be a good fit for this bill for the rest of this year.

Over the past few years, there has been an interesting shift in the way the market views a particular class of stock: big tech. We’ve gone from a situation where the market focus is on the word “technology” in that phrase for companies like Apple (AAPL), Microsoft (MSFT), and Alphabet (GOOG, GOOGL) to one where the word “big” has become more relevant. These stocks are now seen as defensive, not as a proxy for risk appetite. If they do well in a challenging quarter, this perception will be reinforced.

This is important for investors, who must change their understanding of what “defensive” stocks are. Sectors like telecommunications and utilities still have their place in the portfolio, but the most important “defensive” investments over the next few years may be these big tech companies. This transition could be accelerated over the next few weeks if those companies outperform traditional defensive sectors, so investors should watch this earnings season closely.

The opinions and opinions expressed here are those of the author and do not necessarily reflect the views and opinions of Nasdaq, Inc.

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