Investors treating bad news like good news—and vice versa—is the narrative shorthand of the moment when it comes to explaining daily stock-market moves, but the looming second-quarter U.S. earnings reporting season could soon change the equation, one analyst warned Tuesday.
The good-news-is-bad-news version of the phenomenon was on display last Friday after a stronger-than-expected U.S. June jobs report triggered a modest stock-market pullback as investors scaled back the scope of expected interest-rate cuts by the Federal Reserve.
Ahead of the data, investors had pushed all three major U.S. stock indexes — the S&P 500 SPX, -0.02%[1] the Dow Jones Industrial DJIA, -0.25%[2] and the Nasdaq Composite COMP, +0.40%[3] — to record finishes last Wednesday, with buying enthusiasm attributed to enthusiasm for aggressive Fed monetary easing after recent weak economic data.
The counter-intuitive dynamic, which has investors expressing disappointment over strong economic data and joy over weak numbers, has exasperated some market observers, but it’s hardly a new phenomenon, noted François Trahan, a strategist at UBS, in a note to clients.
“The excitement investors are currently showing over impending Fed easing is fairly typical,” Trahan wrote. “Indeed, there were similar short-lived periods of enthusiasm in both 2001 and 2007 as investors began to focus on coming rate cuts.”
But, as investors might recall, neither of those episodes panned out like market bulls had anticipated, Trahan observed. While extended “rate-cut rallies” were a feature of the 1990s, they’ve proven to be short-lived over the last 20 years as market valuation measures, like the price-to-earnings ratio, expanded temporarily but then began to compress in the face of weaker leading indicators, he said.
That puts the second quarter earnings reporting season, which gets under way early next week with results from some banking heavyweights, in the spotlight. Trahan noted that unlike the 1990s, the so-called “Fed put” was of little use in 2001 and 2007 when S&P 500 index earnings growth fell to 0%.
A put option gives the holder the right but not the obligation to sell an underlying asset at a set price by a certain time, providing insurance against loss. The metaphorical Fed put is a reference to the belief that the central bank will take action to bolster asset prices in the event of an economic downturn.
Moreover, earnings growth has been slowing more rapidly than economic data suggests, Trahan said. That’s due in part to import tariffs imposed by President Trump, but is explained largely by the 2018 corporate tax cuts...