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Portfolio > ETFs > Broad Market

Stock Market Shrugs Off Strong Earnings

By Bernice Napach

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U.S. companies posted their strongest earnings in 13 years, with almost 75% of those in the S&P 500 topping earnings estimates, but the stock market was unimpressed.

After rising almost steadily in recent weeks, the major market indexes retreated, falling three sessions out of five last week, and the Dow Jones industrial average retreated below 22,000, the record it broke on Aug. 2. (It rebounded above that level in intraday trading Monday.)

(Related: 2 Key Times to Invest in Actively Managed Funds)

“Companies that beat on both earnings-per-share and sales expectations were met with muted price responses this quarter,” writes Richard Turnill, BlackRock’s global chief investment strategist, in his weekly market commentary.

(Related: ETF Bubble? Nope, Says Schwab’s Kleintop)

“The S&P 500 companies beating on EPS and sales have on average traded flat compared to the benchmark on the day after earnings release, versus nearly 1% outperformance last quarter … Companies that have missed on both earnings and sales were hit particularly hard, especially in Europe.”

(Related: Gundlach, Wary of Pricey Market, Sets Cap on DoubleLine’s Growth)

In other words, earnings still matter, but possibly more on the downside than the upside.

“The market is rewarding positive earnings surprises much less than average and punishing negative earnings surprises in line with recent averages,” according to FactSet.

There was a lot more upside in the latest earnings reports.

In its latest earnings analysis, FactSet reports that 73% of the 91% of S&P 500 companies that have already reported their Q2 earnings surprised on the upside while 69% reported positive surprises for sales. The blended earnings growth rate was 10.2%.

Q2 was the 22nd quarter in which earnings growth exceeded the end-of-quarter estimate, says Sam Stovall, chief investment strategist at CFRA. As a result, “EPS beats are becoming less of a surprise.”

That sentiment plus the fact that stocks are trading at “the upper edge of the fair-/overvalued range” is making investors “cautious about pushing up the multiple in a meaningful fashion,” says Stovall. “Maybe the market is like a drug addict and needs more and more to maintain its high.”

In its latest earnings analysis, FactSet noted that the blended earnings growth rate for S&P 500 companies generating more than 50% of their sales outside the U.S. was 14% while the rate for companies that generated more than half their sales in the U.S. was 8.5%.

The comparable numbers for sales growth was 6% growth for companies with more than half their sales outside the U.S. versus 4.7% for companies with more than half their sales in the U.S.

The weakening dollar is a key factor in that comparison. Morgan Stanley analysts last month said that every 1% drop in the dollar could add half a percentage point to S&P 500 earnings.

Looking ahead, FactSet says analysts are projecting earning growth of 5.2% for the third quarter and 11.2% for the fourth. Revenue estimates show 4.9% for the third quarter and 5.3% for the fourth.

“It will be more difficult for companies to achieve the same EPS growth in the second half, as the earnings recovery in the second half of 2016 is a higher hurdle,” writes BlackRock’s Turnill.

Valuations may also present a hurdle for the stock market. The forward 12-month P/E ratio for the S&P 500 is 17.4%, above the 15.4% five-year average and 14% 10-year average, according to FactSet.

But that doesn’t necessarily suggest a major decline in the market. Stovall, who says a 5% correction is overdue, says any decline “will probably be the kind that is refreshing, healthy, or even a bit scary, but not overly damaging to one’s portfolio in either time or magnitude.”

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