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A month ago, stocks appeared destined for a serious correction. This morning, they opened at new all-time highs.
What changed?
Earnings season started.
Third-quarter earnings have been a rousing success thus far. With nearly four-fifths of S&P 500 companies’ results in, 78% of companies have beaten consensus earnings expectations. If it holds, that would mark the highest percentage of S&P 500 companies to beat earnings expectations since the second quarter of 2010.
The effect on the market has been profound.
When Alcoa (NYSE: AA) unofficially kicked off Q3 earnings season on Oct. 9, the S&P 500 was at 1,928. Today it’s up to 2,020 (see chart below).
That doesn’t mean earnings were entirely responsible for the turnaround. But the timing isn’t a coincidence. Just look at how some of the largest companies in the S&P 500 have performed since reporting third-quarter earnings:
- Apple (NASDAQ: AAPL): +9.2% since reporting earnings on Oct. 20
- Google (NASDAQ: GOOG): +6.7% since Oct. 16
- Microsoft (NASDAQ: MSFT): +6.3% since Oct. 24
- Wells Fargo (NYSE: WFC): +9.6% since Oct. 14
- General Electric (NYSE: GE): +6.5% since Oct. 17
The list goes on. But you get the gist.
Basically, nearly every major company has seen its shares rise substantially since reporting earnings in the last three weeks. When blue chips are soaring, other stocks tend to follow – especially when many of those other stocks are getting earnings boosts of their own.
I’ve written in the past about how earnings season can be overrated. At times, that’s true. Often investor momentum – bullish or bearish – has swung so far in one direction that no amount of earnings beats (or misses) can alter it.
That wasn’t the case this time. Apparently investors were looking for a reason – any reason – to start buying stocks again after a rough month. Despite the swift pullback that looked like a much deeper correction, investor sentiment hadn’t changed. And why should it?
Unemployment has dipped to its lowest level in six years. U.S. gross domestic product has expanded in 11 of the last 12 quarters. Corporate earnings are healthier than they’ve been at any time since the recession.
True, despite all the domestic growth, there are plenty of major concerns overseas. For months, however, Wall Street had turned a blind eye to things like ISIS, Ebola, the Russia-Ukraine conflict, and talks of Europe headed for an unprecedented triple-dip recession.
Those things didn’t suddenly start mattering to U.S. markets overnight. The 9% pullback was more a reflection of investor concerns that the market had become too overbought. Eventually, those concerns will boil to the surface again. But with earnings improving at the pace they did last quarter, stocks don’t look quite as overbought now as they did a couple months ago.
The current 12-month forward P/E ratio for the S&P 500 is 15.7. That’s higher than the five-year average of 13.5 and the 10-year average of 14.1, but lower than the long-term average and lower than it was for much of the summer.
A real correction is still on the horizon. For now, however, Q3 earnings have injected new life into this three-and-a-half year rally without a 10% correction. If the holiday quarter brings more earnings surprises, then this rally might be far from over.
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