Stock prices are swinging as high valuations and uncertain outlooks leave investors on edge.
U.S. stocks have been more volatile than usual in response to recent corporate earnings reports, as high valuations and uncertain outlooks have heightened investor caution.
The Standard & Poor's 500 Index, Wall Street's benchmark, has been relatively stable in recent weeks, going more than a month without a daily move of more than 1% in either direction, but many individual stocks have seen sharp swings.
Among the major companies that posted daily gains of more than 10% after reporting third-quarter earnings this month were Tesla, Philip Morris International and Netflix, while companies such as Lockheed Martin and HCA Healthcare suffered their steepest losses in years, according to the Financial Times.
“The amount of bonuses and penalties on earnings results is very high right now,” said Heather Brilliant, CEO of Diamond Hill Asset Management, which specializes in value investing. “You see moves of 10% to 20% or more.” She added that “high valuations make investors nervous. If there’s a small dip, some people think, ‘I don’t need this stock in my portfolio.’”
According to a Bank of America analysis based on data through Thursday’s market close, this season’s worst performers underperformed the S&P 500 by about 3.3 percentage points the day after reports, while historically, worst performers tend to underperform by only about 2.4 percentage points.
According to the newspaper report, disappointing results usually lead to stronger reactions in stock prices than results that exceed expectations, because most large companies make an effort to prepare the market in advance so that analysts’ estimates are realistic, but subject to being exceeded.
However, stocks that beat expectations also rose at a faster-than-usual pace, outperforming the broader market by 2.7 percentage points compared with an average of 1.5 percentage points.
“The reaction was very strong in sectors like financials… which investors don’t have a lot of ownership in,” Savita Subramanian, equity and quantity strategist at Bank of America, was quoted as saying by the newspaper. “The positive surprises have led investors to buy stocks almost compulsorily.”
Investors and analysts have pointed to several reasons for the strength of the recent market moves.
Reasons for recent market movements
Some of these reasons are due to simple seasonal factors. David Giroux, chief investment strategist at T Rowe Price, which manages the $65 billion Capital Appreciation Fund, said third-quarter earnings often elicit stronger reactions because that’s when companies give clearer guidance on their medium-term outlook for the year ahead.
“There are a lot of companies that have made forecasts out to 2025, and those forecasts have been a bit disappointing, and the market has reacted strongly to them,” Giroux said.
But the unusual market environment has also weighed on investors, with stocks trading at record highs despite geopolitical tensions, an uncertain outlook for interest rates and the looming US election. The S&P 500 is trading at 21.7 times 12-month forecast earnings, compared with a five-year average of 19.6 times, according to FactSet data.
“There are so many big catalysts happening in the market at the same time,” said Pinky Chadha, chief global strategist at Deutsche Bank. “There’s earnings, there’s elections, there’s geopolitical risks… Given the multitude of catalysts, you have a nervous market, and a nervous market will react strongly in both directions.”
Chadha warned that the current pattern could change in the second half of the earnings season, especially as election uncertainty eases.
Meanwhile, investors look for opportunities during periods of volatility.
“All of this points to a market that is more stock-picking in the traditional way,” Subramanian said. “We are in an environment that is no longer about buying big tech stocks, but looking for companies that are going to surprise the market with their positive performance.”
“On the one hand, it can be frustrating when stocks fall too much because of a short-term rather than a long-term problem,” T Rowe’s Giroux added. “But on the other hand, excess market volatility presents an opportunity for vigilant investors to capitalize on. If you believe in the stock over the next three to five years (and buy on the dip), your expected return has gone up.”
