How earnings season affects your 401(k)
Performances of U.S. corporations drive stocks up or down
“Earnings results matter because these companies ... make up trillions of investment dollars that are held directly or indirectly by Main Street investors.” Dan Suzuki, senior market strategist, Bank of America Merrill Lynch
It’s time again for Corporate America to show Wall Street the money.
U.S. companies are starting to report their business results for the April-June quarter. And how profits or losses come in could affect whether your 401(k) or favorite stock goes up or down.
Earnings season is important because it is the financial version of a scorecard, a benchmark investors can use to gauge if things are good or bad for a specific company, industry or broader economy. The official start to the earnings season is Friday, with results from major banks, including Citigroup and Wells Fargo.
“It gives us the latest update on the health of U.S. corporations,” says Dan Suzuki, senior market strategist at Bank of America Merrill Lynch. “Earnings results matter because these companies employ tens of millions of people. And the stocks of these companies make up trillions of investment dollars that are held directly (via individual stocks) or indirectly (through funds) by Main Street investors.”
The second-quarter earnings season is particularly important as the Dow Jones industrial average hit another record high Wednesday and is up 9% for the year. And with stock prices relative to earnings now overvalued vs. history, investors want to see evidence that corporations are making enough money to “justify current prices,” says Brad McMillan, chief investment officer at Commonwealth Financial Network.
The April-June quarter also follows a great first quarter, when companies in the Standard & Poor’s 500 stock index collective- ly posted earnings growth of 15.3% — the best pace since 2011. Analysts are forecasting slower growth of 7.8% in the second quarter, according to earnings-tracker Thomson Reuters I/B/ E/S. But few Wall Street pros had expected companies to keep up their strong first-quarter pace and view the estimated profit growth for the latest quarter as solid.
The strongest profit growth (+602%) is expected from energy, a sector that continues to benefit from easy comparisons with earlier quarters when earnings were depressed by last year’s plunge in oil prices. Other big earnings gainers are tech, which is seen growing 11.2%, and financials (+7%).
The profit-reporting season is all about expectations. If results top them — which Wall Street dubs an earnings “beat” — it often acts as a tailwind for stocks and the market. But profit “misses” are viewed as a sign of weakness and often cause share prices to fall.
Key sectors to watch, Suzuki says, include tech, as popular stocks such as Facebook, Apple and Amazon.com have been market leaders this year. Industrial and manufacturing companies are also key as they are tied to the global economy and will be among the first to alert the market to “signs of a slowdown,” he says. Companies that sell discretionary products to consumers will also be closely watched as they provide a “broad view of how the consumer is doing.” Here’s how corporate profit results can affect your bottom line: Broad market impact. Earnings drive stock prices, McMillan says. And no matter where the market is trading, “faster-than-expected earnings growth is often taken as a sign that stock prices should be higher — which often becomes a self-fulfilling prophecy.” Individual stock impact. If you own an individual stock, the price can gyrate wildly following a sizable earnings beat or miss. The effect tends to be more severe for shortfalls. For example, in the final quarter of 2016, stocks in the S&P 500 that reported profits below expectations fell 0.9%, on average, in the first day of trading after the report, Thomson Reuters data show. Companies that topped forecasts saw average gains of 0.2%. Provide glimpse of the future. The earnings reports, coupled with what CEOs say about the outlook for their businesses, provide investors with key insights into the future, which they can’t get elsewhere, Suzuki says.