The market has a problem: Many stocks are no longer rising on good earnings or guidance.
It’s been known for a long time that the markets reward companies that raise guidance (or at least imply their growth will be stronger than expected) and punish those that don’t. But something different is happening this quarter. Companies that are seeing a boost to their fourth-quarter earnings estimates (whether raised by the companies or by analysts) are not being rewarded with higher stock prices.
CSX, United Rentals, Citigroup, VF Corp, Autozone, Darden and Accenture, among others, all saw their fourth-quarter earnings estimates raised modestly by analysts, but all are trading down since their reports.
“The market is trying to figure out if the positives outweigh the negatives,” Nick Raich at Earnings Scout tells me. “Some of the positive momentum from the tax cuts is waning a bit.”
It’s simple, Raich insists. Stocks have risen on the strong economy, higher revenue, tax cuts and reduced regulation, but in the last few months a host of challenges have emerged. They include tariffs, rising interest rates and higher costs. Country-specific issues are weighing on large multinationals, including the slowdown in China, a populist government in Italy and the potential isolation of Saudi Arabia, important because the country is a major investor in technology funds.
As the boost from the tax cuts fades away, there’s concern about what will stimulate the economy if corporate revenue weakens, Raich noted.
Goldman Sachs, in a recent note to clients, noted that the 56 percent of companies that have beaten earnings expectations for the third quarter as of Friday’s close have lagged the S&P 500 by 0.24 percent, well below the historic outperformance of 1.03 percent.
Companies that miss expectations are punished even more. The 10 percent that have missed so far have underperformed the S&P by 2.98 percent, worse than the historic average of 2.11 percent.
What do we make of the market when those that do well underperform and those that don’t do well also underperform, though by a larger amount?
Maybe not much, at least not yet. These numbers were based on only about 20 percent of the market reporting.
“As long as we have above-trend revenue growth and revenues going up 7 percent with costs going up 2 or 3 percent, we should be fine,” Raich insists. “High single-digit revenue growth is a real positive.”
The rest of the market isn’t so sure. The fact that stocks are not rising on still-positive earnings is “Certainly worth keeping an eye on as we get into heart of earnings season this week,” Goldman noted.