On Friday, Oct. 14, the stock market’s third-quarter earnings season shifts into high gear as several of the country’s largest financial companies are set to unveil their quarterly earnings. 

On the morning of the 14th, Citigroup (C), JPMorgan (JPM) and Wells Fargo (WFC) are all scheduled to announce their quarterly results before the market opens. 

Quarterly earnings season is a critical period for the stock market because profits and revenues play a big role in stock market valuations. When corporate profitability is robust, stock prices usually move higher. The reverse is true when earnings growth stagnates, or even worse, moves into negative territory.

Q3 earnings season is especially important in 2022 because growth in the U.S. economy has been minimal, and that pessimism has bled into the stock market. Year-to-date, the S&P 500 is down nearly 25%. 

Earnings estimates for the third quarter have also been deteriorating. Back in June of this year, most forecasts suggested that earnings would grow at a rate of roughly 7% in Q3. Today, most estimates suggest that earnings growth in the S&P 500 will be less than 1%.

When excluding the energy sector, Q3 projections get even worse. Minus the energy sector, Q3 earnings growth is expected to move into negative territory—negative 6%, to be exact. 

Some of the sectors seeing the biggest downward revisions to their earnings estimates in Q3 include basic materials (-14.9%), communications services (-13.1%) and consumer discretionary (-11.9%).

Looking at the full-year picture, total S&P 500 earnings are still expected to be up +7.0% in 2022. But on an ex-Energy basis, total 2022 earnings are only forecasted to be up +0.4% in 2022.

Downward revisions to Q3 (and full-year) earnings expectations are no doubt linked to several negative pre-announcements that have hit the market in recent weeks. 

For example, on Sept. 16, FedEx (FDX) warned that customer demand was weakening, and that the company’s Q3 (and full-year) earnings would be worse than expected. In the wake of that news, shares in FedEx corrected by 21%—the biggest one-day percentage drop in FDX trading history. 

In response to slowing demand, FedEx is planning a hiring freeze, closing some FedEx Office locations, and reducing operations in some markets to help save on costs. And FedEx is by no means the only company experiencing headwinds.

Over the last several weeks, corporate leaders from General Electric (GE), Nike (NKE) and Verizon (VZ) have issued similar profit warnings. Based on those reports, current headwinds appear to be rooted in several common themes: Falling customer demand, higher financing costs (higher interest rates), supply chain complications and rising costs (inflation). 

Against this negative corporate earnings backdrop, it’s a little easier to understand why the stock market has struggled in 2022. However, all may not be lost. 

Traditionally, when the stock market bottoms out, it’s usually a two-step process. First, there’s an adjustment to valuation multiples (i.e. stock prices fall), and then there’s a downgrade to earnings—the latter of which appears to be underway at this time. 

Q3 earnings season could be ugly, but it could also pave the way for a rebound in the stock market. The stock market has historically served as an indicator or predictor of the economy. As such, large decreases in the stock market are often thought to be reflective of declining confidence in the economy.

However, the reverse is also true—meaning that a shift in expectations for the economy (from pessimistic to optimistic) can also catalyze a strong rally in the stock market. 

For these reasons, investors and traders should not only track current earnings reports, but also any future guidance issued by companies that they trade/follow. Guidance on earnings for future quarters is at least as valuable—if not more valuable—than the current quarter’s earnings report.

To learn more about trading quarterly earnings, check out this installment of Best Practices on the tastytrade financial network. For more on how implied volatility tends to get “crushed” after earnings, watch this episode of From Theory to Practice.

For daily updates on everything moving the markets—including in the solar sector—tune into TASTYTRADE LIVE—weekdays from 7 a.m. to 4 p.m. CDT. 

Sage Anderson is a pseudonym. He’s an experienced trader of equity derivatives and has managed volatility-based portfolios as a former prop trading firm employee. He’s not an employee of Luckbox, tastytrade or any affiliated companies. Readers can direct questions about this blog or other trading-related subjects, to support@luckboxmagazine.com.