The market’s fear gauge suggests a calm environment, but the response of individual stocks to earnings announcements has been far from tranquil. Despite the temporary lull, it wouldn’t be surprising if we experience turbulence in the near future.
The Cboe Volatility Index (VIX), which measures expected S&P 500 volatility and signifies the level of uncertainty, has dropped to 14.9 from its peak of nearly 22 in October. This decline indicates that investors have moved past their initial panic and are once again embracing the market.
However, this tranquility starkly contrasts with the volatility experienced by individual stocks. Companies reporting earnings have witnessed significant fluctuations in their stock prices. After their reports, Roku (ROKU), Shopify (SHOP), and Palantir Technologies (PLTR) saw gains of more than 20%. On the other hand, Paycom Software (PAYC), ON Semiconductor (ON), and Estée Lauder (EL) suffered declines of 19% or more.
On average, the market has been more punishing than rewarding. According to data from Evercore ISI, companies that surpass earnings and sales estimates have only seen an average increase of 0.3% in stock price. Conversely, companies that miss both forecasts have experienced a drop of 4.8%. This 5.1-percentage-point gap is wider than the historical average of 4.1 points, and the gains are smaller while the losses are larger compared to typical market conditions.
The Numbers Haven’t Been Bad
Earnings per share for S&P 500 companies have surpassed expectations this reporting season, beating estimates by 6.9%, according to Evercore. Sales have slightly exceeded forecasts, and profit margins have been higher than anticipated. However, despite these positive results, stocks are facing challenges due to the S&P 500 already experiencing significant gains this year. Investors are always forward-looking, and the key concern is whether future growth can justify current valuations.
The Risk of Unmet Expectations
Spencer Hakimian, the founder of Tolou Capital Management, believes that the volatility in the market stems from the fact that investors have already priced in substantial earnings growth for the years 2024 and 2025. If this growth fails to materialize, equities would need to readjust their valuations accordingly. Hakimian warns that weakened forward guidance from companies can be an alarming signal for investors.
Pessimistic Outlook for the Fourth Quarter
Many companies, including ON Semi, have cited weakening demand for automotive chips as a reason for their disappointing fourth-quarter profit guidance. As a result, ON Semi’s stock dropped by 22%. Interestingly, between October 3rd and November 2nd, no company raised its fourth-quarter earnings-per-share guidance despite reporting earnings.
Bond Market Influence
Currently, the stock market is closely following cues from the bond market. The recent decline in the 10-year Treasury yield by 0.289 percentage points to 4.557%, the largest one-week decline since March, has temporarily eased investors’ panic. However, the concern remains that high interest rates could slow down the economy and jeopardize earnings projections for 2024 and 2025. Consequently, the market is likely to experience increased volatility.
A New Normal for Volatility
David Miller, co-founder of Catalyst Capital Advisors, suggests that a VIX level of 18 to 19 would be considered fairly normal in the current environment. With interest rates no longer being actively suppressed by governments, a high-teens VIX is to be expected. This indicates that market volatility is likely to persist in the foreseeable future.
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