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(Today’s musical accompaniment by “The Thamesmen”)
In an environment where 75-80% of major companies routinely beat their consensus EPS estimates, that metric loses its importance. It is clear that an EPS beat is a necessary condition for a post-earnings rally but is no longer a sufficient condition. Investors are looking through current EPS in favor of forward guidance. Considering that investors are pricing in double-digit earnings growth for 2025 while simultaneously believing that the economy is weak enough to justify six rate cuts in that time period, we need to hear companies tell us that they indeed believe this is possible. That point was hammered home yesterday by ASML.
The Dutch chipmaking equipment manufacturer accidentally released its earnings a day early. The company handily beat on EPS, €5.28 vs. €4.88, but the report showed a big shortfall in bookings, a key predictor of future revenue. Not only did it take ASML shares lower by -16%, it also put a damper on other semiconductor stocks and thus the market as a whole. For perspective, Nvidia (NVDA) shares were only modestly lower after yesterday’s open, resuming its flirtation not only with all-time highs, but with displacing Apple (AAPL) as the most valuable US company. This was despite news reports that the US Commerce Department was considering a ceiling for export licenses on AI chips. Instead, NVDA and its peers turned abruptly lower, with NVDA and SOX closing -4.7% and -5.3% lower, respectively. This morning, we see NVDA attracting dip buyers, but ASML is down another -5%.
2-Day Chart, ASML (red/green candles), NVDA (purple), SOX (yellow)
Source: Interactive Brokers
The focus on guidance is completely rational because equity markets are forward looking. While it is crucial to learn how a company performed in its most recent quarter, by definition, that data is at best current, if not backwards looking. When we find ourselves in an environment where the S&P 500 (SPX) sports a forward P/E of about 23, it implies that rosy expectations are already priced into stock prices. Persistent failures to deliver on those expectations could certainly have adverse consequences for stock prices. Indeed, while the current reading is not an all-time high for forward P/E, in the last 30 years it was exceeded only by 1999 and 2021. While both were followed by bear markets the next year, we are well short of the >30 readings that occurred in those years.
The Cboe Volatility Index (VIX) current readings in the 20 area somewhat reflect this concern. As we enter a period that includes a potentially consequential earnings season, not to mention a coin-flip election and an in-play FOMC meeting, it makes sense for investors to anticipate more volatility over the coming weeks. We’ve already seen some recently. Although SPX hasn’t finished its day with a close-to-close move of more than 1% in over a month (+1.7% on September 11th), we’ve had 7 moves of more than 0.6% over the last 11 sessions, with 4 of them more than 0.9%. That is not hardly a jittery market, but it is not a sign of complacency either.
Traders seem willing to price in some incremental volatility in the near-term. It is understandable why, especially if earnings guidance fails to meet lofty expectations.
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