While news about the upcoming election and rumors about future federal stimulus packages get much of the recent credit or blame for the stock market's ups and downs, a less provocative market mover officially begins this week: quarterly corporate earnings season. Ultimately, a company has to at least promise investors future earnings and revenue streams for its stock to find value in the public marketplace. And the third quarter (Q3 2020) earnings season officially begins when the four largest banks by assets - Citigroup, JPMorgan Chase, Bank of America, and Wells Fargo - release their financial reports this Tuesday and Wednesday. With the market's emphasis on year-over-year statistics and 2020's sharp economic slump brought about by the coronavirus and subsequent government lockdowns, the numbers are expected to be historically bad, but what matters is if the businesses beat forecasts. Through the years, companies have gotten very good at reducing expectations amongst analysts, so that missing estimates is a much bigger surprise than beating them, as shown in the chart below:
So to move share prices upward, usually companies have to beat expectations by more than the anticipated amount. We can get some idea about how much the market expects companies to beat expectations this quarter from the market reaction to the few companies that reported before the official "season" begins. According to UBS strategist Keith Parker, "The bar is high. Thus far, a 10% sales beat seems to be a cut-off for positive stock returns."
If enough companies can clear this bar, then there might be some momentum to keep the recent broad-based stock advance pushing forward. A sign that more stocks have begun to drive the current rally can be seen in the chart below that compares the total return over the last three months of the S & P Equal Weight Index versus the conventional market-cap-weighted S & P 500 Index. The traditional S & P 500 Index contains the largest 500 domestic companies, with bigger companies receiving bigger allocations in the index. For example, as of 10/9/2020, Apple Inc. was about 6.5% of the S&P 500 Index, but only 0.2% of the S&P 500 Equal Weight Index, an index where every company receives the same allocation. If the stocks of the biggest companies are outperforming, then the S&P 500 index will surpass the S&P 500 Equal Weight Index, which occurred during the spring of 2020. However, if there is a wide range of advancing stocks, then the S&P 500 Equal Weight Index will usually outstrip the standard S&P 500 Index, which has happened over the last three months.