Investors are impatient, they want big earnings

It’s taking bumper corporate earnings and profit forecasts to impress investors this season, after a record first-quarter rally left stocks looking expensive.

S&P 500 firms are more than halfway through the reporting period and 79% of them have beaten profit expectations, according to data compiled by Bloomberg Intelligence. Yet, the median stock outperformed the index by less than 0.1% on results day — the smallest margin since late 2020.

And firms missing expectations are suffering the worst punishment in the data’s records going back to 2019, lagging the S&P 500 Index by a median of 3.7%. 

Examples abound. On Wednesday, shares in Norwegian Cruise Line Holdings Ltd. sank 15% despite a forecast-beating result and improved profit outlook. The reason? High expectations fueled by a rival cruise liner’s result. The same day, electricals firm Eaton Corp. dropped as investors gave a thumbs down to its forecast-topping earnings.

The malaise hasn’t spared Europe either. Novo Nordisk A/S, which makes the weight-loss drug Wegovy, slipped even as it raised its profit outlook.

The main reason, many reckon, is the S&P 500’s 28% rally from its October lows through end-March, which raised expectations of strong profits. Markets were also at the time betting on multiple interest-rate cuts from the Federal Reserve, a tailwind that’s now all but disappeared.

A price-to-earnings ratio of over 20 had left the index “nearly priced to perfection,” said Michael O’Rourke, chief market strategist at JonesTrading. “Therefore when a company disappoints, prices are likely to readjust sharply lower.” A resilient US economy also makes “it hard to have confidence in the outlook of a company that has stumbled.”

US stocks have faltered after hitting a record high in March, on signs the Fed will delay cutting rates amid sticky inflation. Stagflation concerns have resurfaced as US economic growth posted a surprise slowdown last quarter. Investors are therefore keen for clues on how management teams plan to navigate waning consumer confidence.

Here, too, there’s been some disappointment.

Data from Bespoke Investment Group shows that on average, 4.4% of US firms have raised guidance this quarter, the smallest proportion since the same period in 2020, when the Covid pandemic upended the economic outlook.

Many companies that came through with strong forecasts did reap rewards. Eli Lilly & Co., for instance, rallied by the most since August 2023 as its popular obesity drugs enabled it to boost full-year revenue guidance. NXP Semiconductors NV surged after issuing upbeat targets for the second quarter. Social-media company Snap Inc., industrial equipment firm Trane Technologies Plc and chipmaker Amkor Technology Inc. were also among the beneficiaries of robust outlooks.

But even before the earnings season, options markets were pricing smaller profit-driven moves on average compared with the previous quarter, according to data from JPMorgan Chase & Co. At the same time, investors were bracing for the highest earnings-related volatility in a year and a half, the figures showed.

Strategists at the bank, including Mislav Matejka, had warned in mid-April that a solid season wouldn’t translate into stock market gains as investor positioning was already “very stretched.” Morgan Stanley’s Michael Wilson has also blamed the jump in Treasury yields for taking the shine off earnings.

AI BURDEN

Another sensitive area for investors is artificial intelligence. After almost a year-long equity rally fueled by the AI frenzy, they want to see evidence of how companies are adopting the technology, said RBC Capital Markets strategist Lori Calvasina. 

“I’m seeing an intolerance for the ‘we need to be patient” conversation,” Calvasina said in an interview on Bloomberg Television. “The ‘wait and see, this is going to take time’ — investors don’t seem to have a lot of patience for that.”

 Not everyone is pessimistic on the season.

Deutsche Bank AG strategists said a strong scorecard from S&P 500 firms was already prompting analysts to raise targets for the second quarter, in contrast to a 1% reduction that’s typical at this stage of a season.

For Scott Chronert, head of US equity strategy at Citigroup Inc., the burden for further stock gains is squarely on earnings, given higher valuations and a more hawkish outlook on interest rates. 

“Thus far, the earnings season has been mostly a beat-and-hold event,” Chronert said.