Earning seasons is coming
This week’s second-quarter earnings season is about to start, and Goldman Sachs believes that many companies may make big movements following their reports.
The stock market has been relatively quiet in recent weeks, but the quarterly reports may cause some volatility and provide opportunities for options traders, according to the firm in a note.
“While solid economic growth justifies lower non-earnings-day volatility,” the note said, “our analysis of 25 years of earnings-day moves suggests earnings moves remain large when the economy is strong.”
Goldman’s derivatives research team compiled a list of potential options plays for the earnings season, focusing on companies where the firm’s analysts differed from Wall Street in one direction or another.
Morgan Stanley, which is set to report earnings on Thursday, is one of the names on the list that Goldman is bullish on. Goldman anticipates a significant earnings-per-share beat for its counterpart major bank.
The derivatives team recommended purchasing call options on Morgan Stanley with a strike price of $91 per share, which is slightly higher than the stock’s closing price on Friday.
Call options give traders the right to buy a stock at a predetermined price in the future, known as the strike price. The risk for traders is that the stock does not rise above the strike price, in which case the person holding the call option forfeits the fee paid for the derivative.
According to Goldman Sachs, investors should also look into call options for Starbucks and Caterpillar. The coffee chain’s stock has underperformed the broader market this year, while Caterpillar’s stock has fallen about 5% since its last earnings report in April.
These companies are expected to report near the end of July, so investors should consider call options expiring in August, according to Goldman.
On the other hand, Goldman is bearish on some stocks ahead of earnings reports.
Molson Coors, which is due to report on July 29, has a sell rating from the firm. Goldman analysts forecast a significant earnings miss for the beverage company and advise traders to consider the stock’s August put options.
Put options are the inverse of call options in that they function as a bet that a stock will fall in value. In 2021, Molson Coors stock outperformed the broader market, but it is still trading near pre-pandemic levels, making it a significant laggard over a longer time frame. According to FactSet, the stock has a sell rating from 23% of analysts, indicating that Goldman is not alone in having a negative outlook on the company.
The inflation debate
The hot inflation data cools down the trade in reflation more, raises the problem of tapering and tightening and flatters the yield curve – all of which increase market dependence another day on the largest, most growing firms on the board.
The unexpected rise in June CPI, both core and headline measures, does not resolve the debate over “transitory” vs. “permanent” above-trend inflation. It is mostly consistent with a temporary period of elevated inflation – once again, used-car prices and direct reopening effects, such as hotel and car-rental rates, account for the majority of the core gauge’s upside.
However, there has been some persistence in price increases elsewhere, and in any case, it is another month later. And the market is concerned that some Fed voters – primarily regional Fed bank presidents – will try to react to the data by pushing the taper/tighten plan forward. Whether correct or incorrect, this is how bonds are reacting, assuming an earlier first hike, which means more muted longer-term growth and inflation.
This week, Fed Chair Powell is likely to push back against the hawkish interpretation in Congress, so be prepared for whipsaws in bonds and style shifts in equities.
Equity-wise, it directs money to mega-cap growth – right or wrong, this is how the machines are programmed to play it. So far, there have been sharp divergences in intraday action among the S&P 500, Nasdaq 100, equal-weight S&P 500, and Russell 2000:
Today’s market breadth is at an all-time low. The NYSE and Nasdaq are down about 4,600 stocks and up about 2,000, with the S&P slightly positive. The small-to-large and median stock-to-headline index ratios are near YTD lows.
This demonstrates the rotational impulse’s ability to provide broad resilience to the tape while also implying a less generous, heavier market. Poor breadth does not always sabotage index rallies, and these splits can last for months, but it usually results in some tougher AAPL, MSFT, and AMZN kicking in a full percent of positive gross contribution to the S&P 500, while the other 497 stocks are down almost as much.
Yield-curve smush is overcoming good bank results, particularly from GS, though both are down about 1% this month. The positive trends underlying banks are fairly well understood, leaving the stock’s marginal move dependent on real-time net-interest margins and trading dynamics. According to a Bank of America fund manager survey, professionals are still overweight in financials.
The credit market is stable, with no signs of additional stress. The VIX is sleeping, and a major known catalyst has now passed in the CPI. There is no real signal. Sharp market divergences are currently suppressing index volatility, but if they become too tight, we may see an anxiety bid develop in downside protection. There isn’t much of one yet.
