Trade US stocks ahead of their Q1 results

Why’s this US reporting season important?

The S&P500 enters Q1 reporting season on-the-back-of one of the more contentious bull-runs in recent memory. US stocks sit poised only points below new all-time highs; however, the earnings picture is as murky as it has been for several years. Indeed, momentum still points to upside for the market, but the sustainability of this bull market rests in-large part on the earnings outlook produced by corporates this reporting season. In a rare case of when the micro-narratives lead the macro-narrative, not only will US earnings prove a powerful barometer for the Wall Street stocks, but also the global economic growth more broadly.

What are market participants expecting?

Following last years juiced-up growth, courtesy of US President Donald Trump’s tax-cuts, analysts are forecasting that earnings per-share across the S&P500 will have contracted last quarter from just shy of $40 to just over $38 – or by around 4-and-a-half percent. After a series of downgrades since Q4’s massive market meltdown, market participants have progressively lowered their expectations for forward earnings. This has come consequent to fears that a domestic and global economic slowdown, led primarily by the European and Chinese economies, will begin to manifest in the sales growth of US companies, and cause a material impact to their bottom line.

Can the current bull market keep running?

Despite this dour dynamic, from its December low, the S&P500 has been on a tear, rallying by over 15 per cent. The cause and solution to the major sell-off and rapid correction is one and the same: the US Federal Reserve. Some of this is certainly due to the positive impact on valuations from falling discount rates. But so much is the influence of the Fed, that although the global growth outlook has deteriorated in the last quarter, markets are expecting that US earnings will resume their growth trend in future quarters, as the benefit of looser financial conditions feeds into the “real” economy.

A new record high; or the next correction?

Coming into this quarter’s reporting season, the S&P500 is a paltry 47 points away from new all-time highs. It doesn’t take an elephant’s memory to recall what happened on the last two occasions the index traded at these levels: it was followed by a major spike in volatility, as stretched valuations and the exit of momentum chasing traders from the market brought about a rapid correction in share prices. With this and the uninterrupted rally in the S&P500 last quarter considered, the question for traders this US earnings season is: will this challenge of new highs come with another correction?

To which direction are the balance of risks skewed?

A downgrade to forward earnings across the S&P500 will probably hinder its run; while a beat on expectations will probably propel it to new highs. Primarily, it will be the guidance provided by corporates that determine whether the market has the vigour to register new record highs, or not. In the instance earnings do miss marginally, the bulls need not despair, necessarily. The last two corrections in US stocks were related to the pricing-in of rate hikes from the US Fed. With that central bank relegated to the sidelines, relative yields and valuations remain supportive of this bull market in the short term.