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Why the market is blowing off what has been a really good earnings season

  • Corporate profits are tracking at more than 18 percent higher, but stock market averages are little changed since the start of earnings season.
  • Net profit margins are tracking at 11.1 percent, which would be the highest level since the third quarter of 2008.
  • Companies that have beaten earnings have seen share price gains of just 0.1 percent in the two days after reporting, compared with an average 1.1 percent typical increase.

Corporate America is well on its way to what could be a record-breaking profit season, and investors don't really care.

First-quarter reports so far are turning one of the market's most time-honored truths on its head — that profits drive prices. Despite earnings growth of more than 18 percent and an 80 percent beat rate, the market is little changed since the season has accelerated.

That was true again Tuesday, when a slew of high-profile beats couldn't push the overall market much higher as traders hammered even some companies that beat expectations. In fact, as trading progressed, major averages turned decidedly negative, even as nearly three-quarters of the 23 companies that reported topped Wall Street estimates.

"It is pretty amazing when you look at it, an earnings season that's having an equal and opposite reaction to results," said Art Hogan, chief market strategist at B. Riley FBR. "It's a very difficult market to please right now."

People walk outside of the New York Stock Exchange on April 2, 2018 in New York City.
Getty Images
People walk outside of the New York Stock Exchange on April 2, 2018 in New York City.

Dow components Caterpillar and Verizon posted earnings beats and were rewarded with solid price gains at the open before their shares pulled back from their highs. 3M earning's were in line but saw its shares tumble the most in nine years after it reduced guidance, and Caterpillar tumbled on comments from its chief financial offer.

Google-parent Alphabet posted a strong earnings beat after the closing bell Monday, but saw its shares slide Tuesday as well.

Companies that have topped earnings estimates have seen share price gains of just 0.1 percent in the two days after reporting, well below the typical average increase of 1.1 percent as tracked over the past five years, according to FactSet. Earnings misses have resulted in two-day declines of 0.9 percent, which is actually well below the typical 2.4 percent decline.

Indeed, investors have been fickle, perhaps because they have more on their minds than just bottom-line profits.

Among the concerns are the looming possibility of a U.S. trade war with China, rising bond yields that briefly saw the benchmark 10-year Treasury note yield pass 3 percent Tuesday and a potentially more aggressive Federal Reserve, which could raise rates as much as four times in total before the year ends.

And there's more: Earnings reports are a look in the rearview mirror, which is showing companies getting a lift from tax cuts that will level off over time. The big boost in quarterly earnings likely to continue through 2018 will be tough to top in 2019.

That means investors are looking through the earnings reports and envisioning a potential deceleration ahead. Caterpillar, for instance, saw a sharp drop after its CFO said the company's outlook assumed that the first quarter was the "high water mark" for the year.

Morgan Stanley strategists say they see an "underlying deterioration" in the market that has been highlighted in the early part of 2018.

"We think the main drivers of this deterioration are lower quality earnings growth and tighter financial conditions, both of which are likely to be with us for the rest of the year," the firm said in a note.

A surface look at earnings doesn't show much weakness.

In addition to the solid bottom-line growth, sales are up 7.6 percent. The net profit margin for S&P 500 companies is tracking at 11.1 percent, which would be the highest level since FactSet began tracking the metric in the third quarter of 2008.

However, market reaction has been muted.

Hogan said investors probably are looking ahead at future earnings that won't be as spectacular as those seen so far in 2018, though the S&P 500 likely will post gains of about 11 percent in 2019, according to FactSet projections.

"That's still spectacular," Hogan said. "But this is not impressing this market."

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