Earnings Season: Why Investors Are Too Bearish

As earnings season approaches, bearish investors remain pretty skeptical about the market’s recent rally

By Steven Russolillo

 Right now the bears are in charge, but stock bulls may have the last laugh.

Right now the bears are in charge, but stock bulls may have the last laugh. Photo: Mike Roy/Zuma Press

This equity rally has few believers. That might actually bode well ahead of what is expected to be another poor earnings season.
The S&P 500 has surged about 12% since bottoming in February and is roughly flat for the year. Yet a funny thing has happened throughout the market’s rebound: The skeptics are still pretty pessimistic.

Short interest, or bearish bets, on the average S&P 500 stock jumped to as much as 3.5% of available shares by mid-February, according to data provider Markit. That is the highest since November 2009, capping an upswing that began last August during the summer selloff. While short interest has since edged lower from the February high, it remains at a still-elevated 3.1%.
So why haven’t the bears lost much conviction? One reason is the looming earnings season, unofficially kicking off with Alcoa Inc. AA -0.13 % ’s quarterly report on Monday.

In short, earnings aren’t expected to be good.

By FactSet’s count, first-quarter earnings are forecast to log a contraction of 8.5%, with energy companies garnering much of the blame. As recently as December, the S&P 500’s earnings-growth rate was projected to be slightly positive during the first quarter.

Furthermore, if earnings fall again, it will mark the fourth consecutive quarterly decline. The last time that happened was during the financial crisis.

What’s more, these projections are based on so-called pro forma figures, results provided by companies that exclude certain items such as restructuring charges or stock-based compensation. As Heard on the Street has reported, results under generally accepted accounting principles have fared much worse, a trend that is expected to continue.

Of course, earnings estimates have a propensity for falling too far just before the reporting period begins. Companies often hurdle the lowered bar. The S&P 500 has risen during three of the previous four earnings seasons, according to John Butters at FactSet.

While such positive “surprises” are nothing new, the market’s reaction to a better-than-expected round of earnings might not be typical. With pessimism, and short interest, so high, earnings surprising to the upside could prolong the recent rally.

The bears may be growling, but the bulls might have the last laugh.

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