Bad Earnings Aren’t Really “Bad”

Unraveling a mega-cap earnings mystery… [Morning Reckoning] August 20, 2024 [WEBSITE]( | [UNSUBSCRIBE]( Bad Earnings Aren’t Really “Bad” Baltimore, Maryland August 20, 2024 [Greg Guenthner] GREG GUENTHNER Good Morning Reader, It’s once again that magical time of the quarter when investors become confused, angry (or both!) when stocks don’t react as they expect after filing their quarterly updates. Why are earnings so tough on armchair investors? It might have something to do with all the confusing numbers and analyst estimates floating around. Or maybe it’s because the financial media stirs the pot by quick-calling after-hours reactions, only to update their coverage when a stock abruptly changes direction following the conference call Q&A. But the most frustrating part about earnings season is that stocks don’t react appropriately once the numbers hit the wire – at least, not in the minds of most investors. More often than not, a stock will behave differently than one might logically expect, even when earnings perfectly adhere to analyst expectations. Unfortunately, there’s no quick fix that will make earnings season more palatable for the average investor. Companies will continue to dish out fresh reports every three months, and investors and traders will simply have to do their best to navigate the uncertainty. As long as you’re involved in markets, you’ll have to deal with the occasional earnings shenanigans. So it’s best if you learn to embrace the madness… Today, I’ll show you that it is possible to ride the earnings wave without losing your mind. The secret to earnings zen doesn’t involve scouring estimates, analyst reports, or insider transactions. You simply need to learn how to put the earnings announcements into context with the forces affecting a stock’s price and trend. Let’s check out a couple of recent high-profile earnings reactions that have frustrated the investing masses… [Elon Musk’s Final Masterpiece: X-9840]( After revolutionizing the payment processing industry with Paypal…The space exploration industry with SpaceX…And the auto industry with self-driving Teslas… Elon Musk is now set to revolutionize MONEY with his [“Project X-9840...”]( A project he said could change “Your entire financial life.” [Click here to see the details because there’s not much time to prepare](. Elon has said he could flip the switch “as early as mid 2024.” [LEARN MORE]( A Tale of Two Mega-caps… Earnings are hard to predict… We can see stocks like Tesla Inc. (TSLA) rally off 52-week lows after reporting an earnings miss. On the flip side, a stock like Meta Platforms Inc. (META) can crater after beating both top and bottom-line estimates. Moves like these are why so many people are distrustful of the stock market. They have no idea what to make of price action not matching up with top and bottom-line numbers parroted on the financial news. The Tesla news alone unleashed more than its fair share of angry comments across social media… Demand for EVs is falling off a cliff! Tesla’s free cash flow flipped negative! Profits are hitting 3-year lows! But none of these facts prevented Tesla shares from rocketing off their lows as traders appeared blissfully unaware that anything could be wrong with the company’s business prospects. Meanwhile, Meta has been a Wall Street darling since it bottomed in early 2023. Shares were up 450% from their 2022 lows ahead of its earnings announcement last week. The stock was also up 40% year-to-date ahead of earnings — the opposite action we had seen from Tesla during the first quarter. While Tesla’s financials were a mess, Meta actually posted some impressive numbers. The company beat earnings and revenue expectations for the quarter, extending its fiscal comeback from the dark days of its metaverse pivot in late 2021 - early 2022. But slightly lower second-quarter expectations stuck out to investors despite the strong Q1 showing. After a perfect start to the year, sellers came out in full force and sent the stock lower by double-digits to its worst showing in 18 months. What Did You Expect? To truly understand why the market reacted as it did, we have to zoom out and place the earnings into the context of the bigger price trends shaping these two popular stocks. On one hand, we have sputtering TSLA shares. TSLA broke from its Magnificent Seven brethren in late December and spent most of the first quarter digging itself into a deep hole. Most investors expected the worst. In fact, sentiment couldn’t have been more bearish heading into last week’s announcement. Combine that with the strong downtrend and breakdown to fresh lows, and you have a recipe for a big bounce on mediocre results. Tesla only needed a report that was slightly better than apocalyptic to spark a short covering rally. And that’s exactly what happened! The opposite was true for Meta. The stock was on a historic run, posting one of the best-looking charts amongst the mega-caps extending back to the 2022 bear market lows. This strong uptrend plus the fact that Meta shares extended to new all-time highs following its previous earnings beat left little room for error. Anything less than a “perfect” earnings report would of course entice investors to take profits — which is exactly what happened. Tesla just needed to prove the wheels weren’t falling off their cars to attract buyers, while Meta needed to dazzle analysts and investors to maintain its Heck, even if this premarket drop holds, META shares won’t completely fill the earnings gap higher from early February (the stock jumped 20%-plus following its quarterly earnings release). Bottom line: earnings reactions are all about expectations — just not the expectations everyone talks about. You have to separate the financials from how the herd feels about a stock. The best way to do that is to analyze prices and trends. Best, [Greg Guenthner] Greg Guenthner Contributing Editor, Morning Reckoning feedback@dailyreckoning.com [Congrats, you earned this…]( As one of my readers, you qualify for [this special deal.]( Only a small fraction of our readers will have the chance to see this. Fortunately, you’re one of them. All you have to do is [click here now to see how to claim your special deal.]( [LEARN MORE]( In Case You Missed It… Waiting for Godot’s Crash Sean Ring, Editor [Sean Ring] SEAN RING Good morning Reader, In Beckett’s play Waiting for Godot, two tramps, Vladimir and Estragon, spend their time waiting for the titular character. He never arrives. It feels like that with this recession. But according to my friend and colleague Jim Rickards, we’re already in one. There’s compelling evidence that Jim’s correct. But where’s the market crash we ordered? That looks like it’s never coming. And that’s a good thing. In this edition of the Morning Reckoning, I’m going to argue in favor of Jim’s thesis that we’re in a recession, damn the GDP numbers. I’ll also explain why the market hasn’t tanked yet. We have two of three ingredients for it, but the third one will prove elusive. The Receding Economy Are we, or aren’t we, in a recession? I’ll answer, “Yes, since March.” Here’s why. Sahm, McKelvey, and Unemployment Claudia Sahm, an old Fed economist, takes credit for a recession indicator she didn’t invent. From [Mish Shedlock]( Edward McKelvey, a senior economist at Goldman Sachs, created the indicator. Take the current value of the 3-month unemployment rate average, subtract the 12-month low, and if the difference is 0.30 percentage point or more, then a recession has started. Claudia Sahm, a former Federal Reserve and White House Economist, modified the indicator from 0.3 to 0.5. Please consider The Sahm Rule: Step by Step, written December 7, 2023, by Claudia Sahm. I created the Sahm rule, and it’s on me to communicate it well. I try. If you have any questions, please add them to the comments. Sahm claims to have invented the rule. However, credit should go to Edward McKelvey, at Goldman Sachs. The Lag Effect Sahm modified the McKelvey rule to eliminate false positives. But that was at the expense of being far less timely. In the 2008 recession, the Sahm rule triggered three months late. In the 1973 recession, Sahm triggered 7 months late. Here’s the Sahm Rule Recession Indicator: It hit McKelvey’s 0.30 threshold in March 2024 and has only climbed higher since. Right now, it’s above Sahm’s 0.50 threshold. Either way, the indicator says we’re in a recession. The Market Crash That Isn’t Happening Generally, we need three things to happen for the market to crash. - Initial jobless claims are rising over time. - The inverted yield curve (short rates > long rates) is steepening to normal (short rates < long rates). - Oil prices are rising over time. Only two of those three are happening right now. Initial Jobless Claims Even though we had a respite last week, the numbers are trending up. An unemployed individual files an initial claimafter a separation from an employer. The claim requests a determination of basic eligibility for the Unemployment Insurance program. That means more people are losing their jobs and claiming unemployment insurance. However, what compounds the issue is that continued claims are starting to increase after a sideways trend. Continued claims, also referred to as insured unemployment, are the number of people who have already filed an initial claim and have experienced a week of unemployment and then filed a continued claim to receive benefits for that week of unemployment. Yield Curve Steepening (Un-inversion) Most people start panicking when the yield curve inverts. Since that happened in late 2022, they’ve been biting their nails for nearly two years. But the real danger of recession is when the curve steepens or “un-inverts” to become normal again. It’s normal for short-term interest rates to be lower than long-term interest rates. After all, if you were going to lend someone money for a decade, you’d demand a higher premium because of all the missed investment opportunities over that period. But you'd probably charge less if you loan money for a few months. The yield curve often inverts when the Fed aggressively hikes short-term interest rates to combat inflation. We had this for most of 2022. The inversion reflects expectations that these high rates will slow economic growth. When the curve begins to steepen, the Fed has either paused or is about to lower rates in response to weakening economic conditions, which is where we are in the cycle. The market sees this as a sign that the central bank is concerned about economic growth, reinforcing the recessionary outlook. The steepening process signals a shift from the market expecting economic stagnation to actively preparing for a downturn, mainly as the economic data reflects weaker growth, declining consumer spending, and rising unemployment. Unemployment unexpectedly rose in the U.S. to 4.3% two Fridays ago. Historically, recessions often follow a period when the yield curve first inverts and then steepens. The inversion signals economic stress, and the steepening tends to occur when that stress transitions into actual economic contraction, leading to a big market sell-off. Oil Prices Everything you’re wearing, eating, or sitting on was either made with or transported to you by oil. Never mind those green idiots; oil is the most important commodity on earth. When oil gets expensive, we’ve got big problems. If we have increasing initial claims, a yield curve “un-inversion,” and an oil price rally, we will be smacked in the head with a market crash. But here’s where the crash theory fails. Despite the war in Ukraine, a war in Israel, saber-rattling over Taiwan, and the Houthis effectively closing the Suez Canal, oil prices are languishing. We’ve been sitting around $80 forever. It’s a big yawnfest. So, no market crash… for now. Wrap Up The recession has already begun. Most people can feel it. Some ignore it. Kamala Harris mustn’t acknowledge it. But if I were Trump, I’d be hammering her over it. As for the market crash, it’s not imminent, and we may never get it. Unless and until oil prices start to rise, we should be reasonably fine in equities for the time being. All the best, [Sean Ring] Sean Ring Contributing Editor, The Morning Reckoning feedback@dailyreckoning.com X (formerly Twitter): [@seaniechaos]( Thank you for reading The Morning Reckoning! We greatly value your questions and comments. Please send all feedback to [feedback@dailyreckoning.com.](mailto:dr@dailyreckoning.com) [Greg Guenthner] [Greg Guenthner, CMT,]( is chief strategist at Forge Research Group. He has spent the better part of the past two decades developing long-term and short-term strategies with a single goal in mind: to help everyday investors generate outstanding returns and control their financial futures. Greg’s charts, analysis, and insights have appeared in Marketwatch, Forbes, Yahoo Finance, and many other financial publications. 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