Broken Records: Earnings Strong, but Sentiment Weak

Consecutive quarters of record-breaking earnings strength haven’t improved the mood among Wall Street analysts. That negative sentiment spoiled an otherwise healthy backdrop for active managers in the third quarter.

Each quarter, we assess the market conditions for active managers in our Wall Street Mood Monitor, a model that gauges the active management climate based on three factors: correlations, analyst sentiment and earnings trends.

Two of those factors—correlations and earnings—have been quite supportive. At the end of the third quarter (before October’s sell-off) stock correlations were near 15-year lows established in late 2017.

Earnings trends, meanwhile, have never been stronger. A record 60% of Russell 1000 companies beat consensus earnings expectations by at least one standard deviation in the third quarter, marking the second straight quarter the rate of significant earnings beats reached record highs.

Conversely, only 11% of companies reported earnings that missed expectations by at least a standard deviation, near the low-water mark of the past eight years. Put together, the gap between companies reporting significant earnings beats and significant earnings misses is close to its widest level in 15 years.

No Lift for Sentiment

Despite earnings strength, Wall Street sentiment cooled this quarter. We gauge analyst sentiment by comparing the total number of upward and downward revisions with all sell-side analysts’ corporate earnings estimates. The number of upward revisions dropped significantly in the third quarter, but still outnumbered downward revisions. In September, however, the total percentage of upward revisions fell below 50% for the first time in 11 months.

The change in sentiment has been fast and significant. In January, an overwhelming 74% of all analyst earnings estimate changes were upgrades, a record level for the last 15 years. Upgrades continued in February and March, as analysts continued to factor in the benefits of corporate tax reform, but the level of upward revisions dropped substantially over the next three months.

With corporations already beating earnings expectations at record rates for two straight quarters, it’s hard to envision what it would take for that sentiment to improve.

To read more on Wall Street sentiment, or the other factors we use to assess the backdrop for active management, read our full Wall Street Mood Monitor >