Earnings Surprises Are Foretelling a Stock Market Crash
If you own stocks, you might want to read this: the stock market could disappoint in 2018. Don’t get too complacent just yet. There are developments suggesting that a stock market crash is still a possibility this year.
Go back to late 2016 and 2017…
Advertisement
No matter what companies did, their stock prices increased; earnings didn’t really matter to investors. This was mainly because investors were optimistic about the U.S. economy and believed that everything would be just fine.
We are now seeing investor sentiment change. Remember, sentiment is one of the key things that drive the stock market higher or lower. If investors are optimistic, they buy and the stock market soars. If they are pessimistic, we face a stock market crash.
How do we see investor sentiment changing?
Usually, Wall Street analysts provide earnings estimates. If companies beat those estimates, their stock prices rise. The difference between what the analysts were expecting and what the company actually report is called a surprise. A positive surprise is when a company reports earnings higher than analysts were expecting, and a negative surprise is when a company reports lower than what was expected. In normal markets, the bigger the surprise, the bigger that the swing in a stock price could be.
Companies posting positive surprises are getting punished by investors. It tells us that investors are anything but optimistic and that the stock market could face a lot of headwinds.
Fourth-Quarter Earnings: Investors Selling Companies With Solid Earnings
To get some perspective, consider this: during the fourth-quarter 2017 earnings season, S&P 500 companies that reported positive earnings surprises actually witnessed a decline of 0.2% on average in the four-day period (two days before and two days after earnings date). (Source: “Earnings Insight,” FactSet Research Systems Inc, March 9, 2018.)
Over the last five years, S&P 500 companies that reported positive earnings surprises increased by 1.2% on average in the four-day period.
Digging a little deeper…
For the fourth quarter, 366 companies of the S&P 500 reported positive earnings surprise. Of those 366 companies, 57% of them (207) recorded a decline. Those 207 companies reported an average decline of four percent in the four-day period. Of those 207 companies, 13 saw double-digit declines.
Stock Market Outlook for 2018: Don’t Rule Out a Massive Sell-Off
Dear reader, in early February, we saw a mini stock market crash. Key stock indices like the Dow Jones Industrial Average and the S&P 500 declined 10% in a matter of a few days.
That may just be an episode of what’s ahead: a bigger stock market crash.
The phenomenon of investors not rewarding companies by buying their stocks, even when the companies are reporting stellar financial performance, is worth watching closely. I believe that when investor sentiment is turning, it may be a good idea to focus on capital preservation.
What is capital preservation? It could be as simple as setting stop-losses on positions in a portfolio. Remember, the declines are usually much faster than the rises in the stock market. So, stop-losses could protect investors’ portfolios from deep losses.
