Q2 Mood Monitor:
Earnings Hold Strong, but Pessimism Lingers

Wall Street Mood Monitor 2Q19 bubble chartBusinesses delivered another quarter of strong earnings results but the mood on Wall Street remains glum; In June, analysts revised earnings estimates downward at the highest rate in more than three years.

The divergent path between what corporations have been delivering on the earnings front – and what analysts think they will do next – create a mixed environment for active managers in the second quarter.

Each quarter, the 361 Capital Mood Monitor assesses the climate for active management based on three factors: earnings trends, sentiment and correlations. The data behind those factors points to a mixed bag for active managers.

Earnings Strength is Near Historical Highs

We gauge the earnings environment by comparing the percentage of companies reporting earnings at least a standard deviation above consensus estimates (an “earnings surprise”) to those reporting earnings a standard deviation below expectations (an “earnings disappointment”).

A constructive way to assess the environment is to look at the gap between the percentage of companies reporting an earnings surprise and the percentage reporting an earnings disappointment. That gap narrowed slightly in the first quarter, and then widened again this quarter.

The bigger picture beyond those short-term movements is one of historical earnings strength. For the better part of the last four years, the gap between the portion of companies reporting earnings surprises and disappointments has grown consistently wider and hovers near 15-year highs established in September 2018.

Pessimism Persists on Wall Street

Businesses continue to deliver impressive earnings results, but another trend also continues: Wall Street analysts don’t believe the hot streak can continue. On a monthly basis, we compare the cumulative upward and downward revisions sell-side analysts make to corporate earnings estimates. Only once in the past 10 months have positive revisions outpaced negative revisions.

Worse yet, in June, the negative revision rate exceeded the positive revision rate by 31%. That’s the worst mark since January 2016. The highest negative revision rates were in some of the most cyclical sectors: Materials, Energy and Industrials.

Correlations Returned to Normal Levels

Intra-market correlations now hover near their long-term averages, but for active managers, that’s a reprieve from the prior quarter. As market volatility ebbed and the prospects of accommodative Fed policy improved, correlations came down from 0.60 at the end of March to 0.51 at the end of June. That level is slightly lower than the long-term average of 0.55.

Normalized correlations, combined with strong earnings trends and pessimistic sentiment have created a passable, though not perfect, environment for active managers to navigate.

To read more about the backdrop for active management, including the view at the individual sector level, read our full Wall Street Mood Monitor report >