World Events Overshadow Earnings, Sidelining Stock Pickers

This earnings season, which is typically when investors shift their focus from macroeconomic factors to company-specific news, has proven to be quite atypical. While individual stocks have reacted to earnings reports over the past week or so, the spotlight has been taken by the turmoil in the Middle East and the surging Treasury yields, causing S&P 500 Index constituents to move together as global events have a broad impact on markets.

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In four out of the six trading sessions since the earnings season began on October 13, over 400 members of the S&P 500 moved in the same direction. This level of synchronized movement hasn't been seen in the last three earnings periods. These collective market movements, both upward and downward, are adding complexity to the lives of stock pickers, who have faced a challenging year, with only 37% of large-cap active managers outperforming their benchmarks by the end of September, as reported by Bank of America Corp.

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"Macro factors are once again dominating the narrative," remarked Quincy Krosby, the chief global strategist at LPL Financial, noting that the situation in the Middle East is affecting market sentiment. Coupled with 10-year yields reaching their highest levels since 2007 and the looming threat of a U.S. government shutdown next month, these factors are collectively making the job of active stock pickers more difficult.

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The third-quarter earnings season has had a mixed start, with most banks performing well, but some major players like Tesla Inc., which has been a top gainer in the S&P 500 this year, delivering disappointing results.

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Distinguishing between winners and losers, especially in the immediate aftermath of earnings reports, has proven challenging. For instance, 92% of S&P 500 members rose on Monday, and several other days since October 13 saw at least 82% of stocks moving in the same direction.

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Investors are eagerly awaiting earnings reports from several major tech companies next week, looking for signs of whether Wall Street's projections are overly optimistic, as the market has been punishing companies that fall short of expectations.

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Overall, companies in the S&P 500 that beat earnings and sales projections have underperformed the benchmark by an average of 0.1% within a day of reporting, which is significantly lower than the norm of the past six years. Conversely, those that missed expectations trailed by 6.2%, marking the most substantial negative reaction in a year.

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This suggests that while company-specific negative news may not have been fully priced into individual stocks, macroeconomic factors have had a more substantial influence on the direction of U.S. equities, given the relatively muted market reaction to earnings beats.

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These "all-or-nothing" days, which were prominent during the stock market downturn in 2022, have become more pronounced since the outbreak of conflict in the Middle East and have been making a resurgence since mid-September. As various headwinds, from the possibility of additional Federal Reserve interest rate hikes to the political uncertainty in the U.S. House of Representatives, are looming, it's understandable why measures of market co-movements are on the rise again after reaching multi-year lows in July.

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