Experience has led many traders to expect stock market volatility to roar to life only during earnings season. That means the lull between corporate quarterly updates has tended to provide low volatility. Yeah, well, notice anything different? The interim period between our latest Q2 and Q3 has been anything but calm. That adds to the pressure on an earnings-sensitive stock market to perform.
Many traders seemed to have hit their breaking point during what most market historians would typically have expected to be a slow August trade. Instead, beginning around August 21, markets erupted and volatile swings became a daily occurrence triggered by mounting concerns from overseas economic hiccups, exacerbated by Fed rate-hike timing uncertainty.
Case in point, the CBOE Volatility Index (VIX), traditionally used as a measure of investor fear or uncertainty, shot as high as 53.29 on August 24. This was even more remarkable if you consider that as recently as August 5 VIX hit a low for 2015 at 10.88. The VIX has slowly but surely drifted lower following those August highs but it has settled—so far—into a higher range (figure 1) than that seen earlier in 2015.
The question is: Will an already sensitive market handle a round of earnings data that some Wall Street analysts expect to show slowing revenue and profits?
According to estimates from Thomson Reuters, collective S&P 500 (SPX) profits as measured by earnings per share (EPS) are expected to fall 5.3% on a 3.4% drop in sales. At this time last year the same analysts were estimating Q3 EPS growth of 10% on the back of 3.2% sales growth.
Energy the Culprit?
Although expectations for growth have been dialed down across the board, it should come as little surprise that much of the negative sentiment for earnings this quarter grows out of the energy sector (broadly tracked by the Energy Select Sector Index (IXE)). Street analysts polled by Thomson Reuters are looking for a 65% drop in Q3 EPS for energy constituents in the SPX.
In October of 2014, the same set of analysts pegged the consensus energy sector EPS drop at 2% for this year’s Q3. This year’s Q3 energy sector revenue drop is pegged at 38%; last year’s comparable was for a 4.9% drop. If you strip out energy, SPX EPS are estimated to increase 2%, while sales are expected up 2.1%.
Who Will Grab the Baton?
To be fair, the energy sector only represents 7% of the S&P 500. The largest sector of the S&P 500 is the information technology sector (broadly tracked by the Technology Select Sector Index (IXT)). Thomson Reuters estimates call for information technology sector earnings and sales growth to be relatively flat at 0.14% and 0.42%, respectively.
If the largest component industry of the index is estimated to have a small increase in growth, the logical question might be where is the growth analysts are expecting going to coming from?
Thomson Reuters’ earnings estimates for the consumer discretionary sector are pegged for an increase of 10.6%. Telecomm EPS are estimated to be up 9.4%. The interesting difference in growth expectations for these two categories is in sales. Sales growth for consumer discretionary is estimated to be up 3.5%; telecom is pegged for a 12.8% increase.
Clues from Management: Listen Up
With so much negative sentiment tainting this earnings cycle, it may pay off for investors to pay closer attention to management discussion and analysis, plus any changes to guidance moving forward.
Not only will upper level managers typically provide an outlook for their own companies, they usually give insight into future economic conditions, an area of particular sensitivity to a market already stung by China’s ups and downs. Listen closely, should management change estimates for future revenues and profits in a significant way, markets could see large swings in either direction.
And then, yes, a volatile earnings period could live up to its reputation.
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