Looking at the year-to-date chart for the S&P 500, it is hard not to conclude that stocks are at a critical time right now. After a big drop to start the year, the S&P 500 hit its low in early February, then started to bounce around a month ago. By the end of March, the index had recovered around three quarters of its losses and, in the process, looked to have broken the downtrend. April, however, has been a disappointment so far, with the S&P dropping back to a low of 4% below the March close.
Based on the look of the chart, it really could go either way from here. A retest of the February lows that would take us back to correction territory is possible, as is a jump back to challenge the all-time record high of 4818.62. This week sees the start of earnings season, with most companies reporting their results for the first three months of the year. Under normal circumstances, those earnings would be the most likely catalyst for the next move in the market, so would be absolutely critical.
These, however, are not normal circumstances.
The main thing impacting the market right now is that the Fed in the process of executing a shift in policy, a shift that is designed to put the brakes on the economy quite sharply. That means that traders and investors are looking forward, not backward. What happened over the last three months is interesting, but even a great quarter from a company will be in danger of being overshadowed by any hint of pessimism in forward guidance, or suggestion by an FOMC member that they will push hard down their chosen path.
So, will beats matter?
Typically, over 70% of S&P 500 companies beat the average Wall Street estimates for their earnings, which raises questions about why analysts don’t learn from a mistake that they have made consistently over the last twenty years or so. But those are questions for another time. What matters here is that, given that fact and the fear about how the Fed’s actions will impact the future, it would seem that individual earnings beats are less important this time around than they have been in the past.
But does that mean that Q1 earnings don’t really matter? No, of course not. Ultimately, even though the average multiple of earnings changes based on fundamental macro factors like rate hikes and the progress of the Russian invasion and war in Ukraine, those earnings themselves are important. There are two ways for multiples to fall if that is what the market thinks should happen: lower stock prices or higher trailing earnings. Good Q1 results, therefore, could at least slow the drop in prices, even if pessimism about the rest of the year remains, and would accelerate a recovery should that come.
Still, while earnings may affect the pace of a drop or jump, they are unlikely this quarter to determine which will happen over the next few months of trading. So investors should be wary of drawing big, broad conclusions about the market based on the numbers. Stock investing, however, is about relative performance. Ideally you want to own stocks that not only do well in good times, but that also perform less poorly on drops. This quarter may well give investors some clues as to which will fit that bill for the rest of this year.
Over the last few years, there been an interesting shift in the way the market perceives one particular class of stocks: big tech. We have shifted from a situation where the market’s focus is on the word “tech” in that phrase for companies like Apple (AAPL), Microsoft (MSFT) and Alphabet (GOOG, GOOGL) to one where “big” is becoming more important. Those stocks are now seen as defensive, rather than as a proxy for risk appetite. If they perform well in an otherwise challenging quarter, that perception will be reinforced.
That matters for investors, who must shift their understanding of what “defensive” stocks are. Sectors like communications and utilities still have their place in a portfolio, but it could be that the most important “defensive” investments over the next few years will be these big tech companies. That transition could be hastened over the next few weeks if those companies outperform relative to more traditional defensive sectors, so that is something that investors should be watching closely this earnings season.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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