Skepticism Reversal Is Buoying Stock Prices – Forbes

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The Wall Street Journal commits an error in “Big 6 Banks (*) Leave S&P Behind After Posting Strong Profits” (on page B-1 in July 19 print edition). The graph supporting this better-than-market interpretation focuses on too short a period – from July 12, the day before JP Morgan Chase, Citigroup and Wells Fargo led off the reporting, through July 18, when #6 Morgan Stanley reported. While that might seem a reasonable starting point for measuring the effect this quarter’s earnings reports have on stock prices, there is another factor at work: a reversal of the skittishness created by the surprisingly weak stock performance following last quarter’s “strong profits” reports, Below is the proper way to account for that added factor.

(*) The six banks (and their before-market reporting dates) are JP Morgan Chase (7/13), Citigroup (7/13), Wells Fargo (7/13), Bank of America (7/16), Goldman Sachs (7/17) and Morgan Stanley (7/18).

Disclosure: Author is fully invested in small company stocks and funds. None of the stocks mentioned here are held.

Include the previous quarter’s stock reactions to get an accurate picture

“Strong” is certainly the right adjective to place on this year’s earnings reports. Banks are enjoying a positive combination of higher rates, healthy lending and loan quality from a sound economy, robust Wall Street-corporate activities, volatile markets for trading, and significantly lower taxes.

Last quarter’s reports confirmed all the rosy expectations, but the stock reactions were generally poor. The stock market topped out in January, uncertainties about tariffs arose, and confidence and optimism heading into the EPS reporting period were maxed out. Thus, the reports’ anticipated good news provided no added boost. Moreover, that unexpected price inaction likely led to selling by those expecting a windfall.

(For last quarter’s view, see my April articles, “JPMorgan: Earnings Up, Stock Down – A Sign Of Stock Market Weakness?” and “Earnings Reports Don’t Support Hopes For A Bull Market Restart – Yet“)

The mental effect of surprisingly weak reactions to good news is skepticism and doubt – thoughts that perhaps something adverse is at work. The proof that something is amiss? We should see earnings estimates slip, and the next quarter’s results plus management’s outlook should contain some “strong, but…” cautionary issues. However,…

Earnings estimates show no weakness. For example, JP Morgan’s 2018 operating earnings estimate was $8.89 on March 31 and $9.03 on June 30 (source: Barron’s). The Goldman Sachs’ estimate went from $21.78 to $23.14.

This quarter’s earnings reports show no weakness. The stock price reactions? JP Morgan, Citigroup and Wells Fargo all closed down on the initial reporting day, Friday, 7/13. This action was likely the result of investor hesitation, remembering the previous quarter’s stock hits, and nit-picking the reports and managements’ comments. After a weekend of reflection, though, all three stocks reversed, climbing to reflect the good reports.

It was these latter gains that The Wall Street Journal focused on. However, to avoid overweighting and misinterpreting this week’s rises, we need to include the previous quarter’s reporting reactions. Here is the look at the two leading firms that are included in the DJIA: JP Morgan Chase and Goldman Sachs. (The remaining four banking firms’ graphs are included at the end of this article.) These graphs show that, while the past week has these stocks outperforming the S&P 500, the underperformance gap created last quarter is still present.

EPS price effect – JPM GSJohn Tobey (StockCharts.com)

EPS price effect – JPMJohn Tobey (StockCharts.com)

EPS price effect – GSJohn Tobey (StockCharts.com)

The bottom line

The rises we are seeing following earnings reports this quarter are likely a reflection of good news and positive management comments – plus the added relief from the skepticism created by last quarter’s poor stock action.

Are these price gains a precursor of a new, bullish trend? Perhaps. However, to the extent they include an emotional relief bounce, the less meaningful the rises are in predicting a future trend.

The remaining four banking firms’ graphs

EPS price effect – CJohn Tobey (StockCharts.com)

EPS price effect – WFCJohn Tobey (StockCharts.com)

EPS price effect – BACJohn Tobey (StockCharts.com)

EPS price effect – MSJohn Tobey (StockCharts.com)