Analyst sentiment heading into earnings season is exceedingly grim for the sixth straight quarter. However, one expert says negative calls from analysts can actually mean good things for stocks.
“What we’ve seen, is that the expectations bar is set low,” Bespoke Investment Group’s Paul Hickey told the “Fast Money” traders last week. “And normally when you have this kind of situation during earnings season you at least get a short term bounce in the market.”
The spread this season, meaning the difference between positive and negative revisions for companies in the S&P 1500 in the four weeks before the start of earnings, skews 24.5 percent negative.
In the last twelve quarters, the second quarter of 2014 was the only time that analysts posted more earnings revisions to the upside heading into earnings season. As it turns out, that is the only quarter in the last twelve quarters when the S&P 500’s return in the six week encompassing ‘earnings season’ was negative.
“More often than not, when the expectations bar is set low for earnings season (negative spread), the S&P 500 sees a positive performance during earnings season,” Hickey said. “Conversely, when the bar is set high heading into earnings season (positive spread), the market has struggled during the reporting period.”
Among stocks, the best bets include energy, materials and industrial sector names.
The revisions spread for the energy sector (XLE) this quarter is -68.1 percent. And based off of the five prior quarters when the revisions spread was below 60 percent, the sector was up the following weeks with an average gain of 3.55 percent.
Jumping over a lower bar
The returns are even larger in materials and industrials. The revisions spread for materials (XLB) this quarter is -53.8 percent. In the six prior quarters where revisions spread was by down at least 40 percent, the sector was positive every time in earnings season for a median gain of 6.8 percent.
Industrials (XLI) tells a very similar story. The revisions spread this quarter is -35.6 percent. And in the five prior quarters where revisions spread was below -30 percent, the sector was positive every time in earnings season for a median gain of 6.8 percent.
“So when the bar is set low, you get companies exceeding that lowered guidance and stocks react positively,” Hickey said.
While we might see a small jump in stocks this season, Hickey says that overall investor sentiment is less enthusiastic as well, given all of the market volatility so far in 2016.
“These results are not going to be good, especially in the energy sector, he said. “Investors are not anticipating really good news here.”
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