Q2 Earnings: 1% Drop — 2 Ways to Play the Dip
A sense of normalcy isn’t something we usually strive for.
Most of the time, we want excitement and adventure.
That’s why my son and I ventured onto a submarine, and dove down 1,000 feet below the ocean’s surface last month in Curaçao.
At just nine years old, he may be the youngest person to ever venture that deep into the ocean. Recreational scuba divers can go a maximum of 130 feet below.
Before we plunged to the depths of the ocean, the guides told us not to expect much once we headed below 500 feet — it’s nearly pitch-black, and there’s hardly any wildlife down there.
But we still wanted the rush of diving into the abyss and hitting that 1,000-foot mark.
If I wanted normalcy, I would stay above the ocean’s surface and wouldn’t dare to explore.
But my philosophy on deep-sea diving contrasts with my conviction about the stock market.
When it comes to the market, normalcy is exactly what I want to see.
Since last week, the market has not been in a normal period. The sharp whipsaws in the Dow Jones Industrial Average are anomalies that we can take advantage of.
We just have to embrace the excitement some investors find during a volatile market.
As things return to normal, investors will push the market to new highs.
And one indicator shows we are getting back to normal just as this volatility picks up. That gives us an excellent opportunity to buy the dip. Let me explain…
Q2 Earnings Are Back to Normal
Over the last six months, the market has been anything but normal.
In December, stocks plunged nearly 10%. That led into the worst year for the S&P 500 Index in a decade. Then stocks rallied against a calmer backdrop, and investors worried along the way.
The two were diverging sharply, and the uncertainty was weighing on the market.
The obvious takeaway would be that stocks were set to fall during earnings season as investors’ expectations didn’t match reality.
This wasn’t the case.
Stocks continued to climb through earnings season as corporations achieved better than the already beaten-down expectations.
With that fear out of the way, investors are back to a normal view for the second quarter.
In the first quarter, analysts expected a 4.6% decline. The five-year average decline is just 1.7%. The first-quarter decline was an anomaly. It kept investors on edge throughout the quarter.
The second quarter is back to normal as expectations are at a more reasonable 1% decline.
The chart below shows the change in quarterly earnings per share (EPS) for the past five years. Take a look at the expected change for the second quarter:
With investors’ expectations for earnings getting back to a normal level — closer to the five-year average — it gives investors a sense of calm amidst the latest market noise of trade wars.
And jumping in right now will pay off big-time as stocks keep climbing higher.
At this point, over 80% of the companies in the S&P 500 have reported earnings for the first quarter. It gives us a clear picture that analysts are taking guidance for the second quarter much better than the previous quarter.
Buy the Dip
As earnings expectations are getting back to a sense of normalcy, it brings a sigh of relief to the stock market.
It’s a break from plunging 1,000 feet into complete darkness. When my son and I got back on dry land, we both breathed a big sigh of relief — we were back in a normal environment.
And as investors look ahead to the second-quarter earnings reports, they will help push stocks to new all-time highs as they rush back into the market.
During the first quarter, investors lowered expectations for earnings, but remained bullish on stocks, as the future looked more promising:
- No more interest rate hikes.
- Trade talks resumed.
- The economy continued to grow at a healthy pace.
The stock market has seen more adventure recently. Investors are worried about another rate hike due to a strong economy and trade talks breaking down, at least from what President Trump’s Twitter feed shows between the U.S. and China.
This snagged headlines and helped spark the current sell-off.
The worries will always be there, but they’re only beneficial if you embrace them and look for the opportunities they represent.
And right now, it’s time for investors to breathe that sigh of relief as earnings expectations get back to normal and overcome the attention-grabbing headlines.
To take advantage of it, just buy the dip.
Buying the SPDR S&P 500 ETF (NYSE: SPY) is an easy way to benefit. This exchange-traded fund (ETF) holds common stocks in the S&P 500, such as Microsoft, Apple and Amazon. It will rise as the market rebounds.
But if you are looking for greater returns, you can buy a call option on that ETF.
You can grab the September 20, 2019 $280 SPDR S&P 500 ETF calls (SPY190920C00250000) for $12 a share, or $1,200 per contract.
Chad Shoop, CMT
Editor, Automatic Profits Alert