Earnings Season: A Potential Paradise for Stock Pickers, According to BofA

The upcoming earnings season is shaping up to be highly favorable for stock selection, according to a recent note from Bank of America.

BofA’s strategists have noted that while market returns were primarily driven by valuation multiples during the 2022-23 period, earnings are now gaining traction and are expected to account for 45% of the S&P 500’s 12-month returns as of September. With a shift toward an easing cycle, the firm anticipates that earnings will increasingly contribute to future market returns.

Interestingly, the options market is indicating a heightened level of post-earnings implied volatility for individual stocks this season, in contrast to the relatively subdued implied volatility at the S&P 500 level. The analysts suggest this points to a focus on individual stock performance rather than the broader index during the upcoming earnings announcements.

Expectations are that options for individual stocks will be more expensive this quarter due to a higher average implied move. However, actual market movements have recently outpaced these implied moves, as evidenced by the realized-to-implied move ratio from the last quarter. This mismatch may explain why implied moves have increased recently.

The strategists note that if earnings results continue to exceed the options market’s expectations, this could lead to earnings straddles finishing in the money. Despite only a few companies having reported results thus far, some stocks have already shown movements that exceed what was implied.

Furthermore, as long as inflation remains manageable, strong economic data is expected to provide continued support for stock performance. Following a robust jobs report last Friday, attention is now turning to the upcoming Consumer Price Index (CPI) data, which is viewed as critical.

Anticipated market movement due to the CPI has climbed to 109 basis points for the S&P 500 on Thursday, up from 91 basis points last week, potentially marking the largest market shift driven by CPI data since May. While the market may accommodate a slight rise in inflation given the improving macroeconomic conditions, a significant surprise could prompt doubts about the easing cycle and lead to increased volatility.