Most religions celebrate annual festivals, but the cult of stocks celebrates an important one on a quarterly basis. Although I would never dare to comment on any religion’s rituals, as a self-ordained clergy in the cult of stocks, I feel qualified to pontificate about the quarterly ritual known as earnings season. If I had the power to reorganize earnings season, I would not have the major banks kick off the festivities.
I say this as someone who spent over 20 years as either the specialist or a market maker in the options of bank stocks large and small, domestic and foreign-based. It is human nature to try to extrapolate trends from limited data sets, and an early slew of bank earnings offer an unrepresentative small sample of data from which market commentators (present company included) try to divine a trend for the flood of reports that will follow. No other industry’s bottom line is nearly as dependent upon idiosyncratic items like the shape of the yield curve and trading results[i]. And as any trader will tell you, those are extraordinarily difficult to project. Sure, management might offer some insight into the bank’s loan demand from customers, but those insights rightfully lack specificity – they can’t discuss individual customers in a public forum.
Sports fans eagerly await opening day, and then sports radio is flooded with projections about how callers project their teams’ prospects from a tiny set of outcomes. This is the equivalent for financial media. They need to report the results, but drawing conclusions from the early outcomes is nearly impossible.
Quarterly earnings reports hold a rightfully important place in investors’ psyches. Federal securities regulations require public companies to disclose regularly disclose information. Domestic companies must file quarterly reports, known as 10-Q’s, and annual reports, known as 10-K’s, on an ongoing basis. The SEC mandates specific types of information in these reports, and all must include audited financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These form the crux of the data that investors focus upon. The financial statements give us a detailed look at last quarter’s activity, while the management’s discussion offers an explanation of those results and often a look ahead at current conditions and what management expects for the coming quarters.
For those of us who still cling to the fusty notion that equity prices reflect the present value of a company’s future cash flows and earnings, 10-Q’s offer crucial data toward updating those calculations. We get fixated upon whether a company beat or missed its estimates, but the initial response is usually pushed by reactive traders or news-reading algorithms. That can lead to overshooting. The longer lasting and often more meaningful post-earnings moves result from the qualitative guidance offered by management. We do get some initial reaction from headlines that might reflect updated quantitative guidance (e.g., XYZ sees revenues $5.2-$5.4 billion vs. $5.0 estimate), but the market usually requires some time to digest the full effects of management’s outlook. The myriad data points that are offered in the 10-Q’s and earnings calls become the basis for updated fundamental views, and properly digesting them can take time.
While the banks’ results themselves can offer little in the way of a solid basis for extrapolation, they can offer a useful view into all-important investor psychology. This year’s prior two earnings seasons (January and April) showed us that investors were all-too-willing to punish companies that missed expectations. The pain was particularly acute for growth companies that were no longer growing rapidly – think Meta (META), Netflix (NFLX), and Amazon (AMZN) for starters. While no one would mistake a major bank for a growth stock, it will be important to see if investors are in a relatively forgiving mood if the banks disappoint.
For many years, Motorola (MSI) and Alcoa (AA) signaled the start of earnings season. When they were more prominent, it could be argued that they were important harbingers of the results to come. As they faded, JP Morgan (JPM) took the reins, somehow ignoring PepsiCo (PEP), which reported today. Just as I wouldn’t advise reading too much into the market’s mildly positive reaction to PEP matching its estimate this morning, I would certainly avoid reading too much into whether a given bank’s trading results offered a clue to how the rest of earnings season will progress.
[i] As a long-time trader at a publicly traded financial company, I have plenty of first-hand experience with analysts’ ability to dismiss positive trading results as unsustainable, no matter how often they recur.
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