After Wall Street equities came under pressure in October, the onus has fallen on companies to soothe investors’ frayed nerves and extend a remarkable run of growth since late-2017 corporate tax cuts.
That is why strategists at Société Générale say it might merit watching measures of uncertainty in earnings estimates, according to a Friday note. Uncertainty over U.S. profit growth in relation to stock-market volatility can yield useful clues to investors who want to know if price swings have more fundamental underpinnings than shifts in sentiment, and if the sharp selloff of the past few months can subside.
“A continued deterioration in [earnings uncertainty] should help us differentiate between a garden-variety spike in equity volatility and the big one,” wrote Jitesh Kumar, an equity derivatives strategist at Société Générale.
Calculated by the ratio of the standard deviation of estimates of the S&P 500’s earnings per share, or EPS, to the average EPS estimate, earnings uncertainty generally rises and falls in line with gauges of equity volatility. The chart below shows how the one-month implied volatility gauge for the S&P 500
or the Cboe Volatility Index, also known as the VIX
moves in tandem to uncertainty over corporate earnings.
It isn’t surprising that equity volatility would eventually catch up with a lack of confidence in corporate earnings. After all, if strategists are unsure about continued profit growth, it’s only natural that they’ll also be unsure whether to retain their equities, with investors split between the fear of missing a strong earnings season and avoiding an earnings implosion.
But it’s often when the two deviate sharply that investors should watch out.
In late 2017, legislative efforts in U.S. Congress to pass President Donald Trump’s trillion-dollar tax bill were making headway, driving up earnings uncertainty even as stocks notched fresh highs. But this growing dislocation appeared to presage the sharp spike in the VIX at Feb. 2018.
Though, most analysts point to the blowup of VIX-related exchange-traded products for the flare-up in equity volatility, the chart shows that when measures of earnings uncertainty briefly break away from the VIX, it has led to a violent re-coupling of the two indicators.
Yet sometimes earnings uncertainty can lag behind spikes in market volatility. In such episodes, it can indicate analysts at Wall Street are waking up to deeper concerns over the health of U.S. companies.
With the most recent equity selloff, stock-market volatility led the way even as analysts were mostly confident of strong earnings growth. The S&P 500
and the Dow Jones Industrial Average
falling from their all-time highs in October to send both benchmark indexes off more than 5% in 2018.
“It seems that analysts have been somewhat complacent and late to change earnings estimates,” said Kumar.
Back in October, Wall Street was still rosy on the earnings outlook, citing the strong U.S. growth environment for driving corporate profits to double-digit growth. Equity strategists were predicting 16.4% increase in earnings for the S&P 500 at the start of the fourth quarter of 2018, according to FactSet data.
Yet investors shrugged off strong-third quarter earnings amid concerns corporate profits had peaked as the impact of the tax cuts faded. And after Federal Reserve Chairman Jerome Powell made comments supporting its steady pace of rate increases, trepidation over the economy’s momentum took hold.
Once companies like Apple Inc. lowered their guidance at the start of the year, it solidified the view among equity analysts that the earnings outlook had deteriorated. Analysts now expect EPS for the S&P 500 in the fourth quarter to grow 11.4%, still considered a healthy pace but a disappointment from previous lofty expectations.
delivered its fourth-quarter results early Monday, with JPMorgan Chase & Co.
and Wells Fargo & Co.
releasing their results on Tuesday.
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