When people ask me what’s the one thing to know about investing, I say, out of all the things to consider, there are actually three of equal importance to me. 

1. Direction of interest rates

2. Earnings expectations

3. Sentiment

Each of them are important to understand anytime, but particularly during earnings season. 

Interest rates are important because they can act like a return hurdle for investors to check whether taking a risk in buying a stock is worth it or not. 

TL;DR: Interest rates 📈, stock values 📉

Like today, if you can earn 5% in a savings-type account, investors will look to earn more than that when taking the extra risk that comes with stock investing. This means, if interest rates are trending higher, particularly the 10-year treasury yield, which forms the basis for stock valuation analysis, it can drag returns down across the stock market. Inflation expectations are a component of interest rates. So if those go up from hotter inflation data, like we’ve had, interest rates then rise with it—which tends to lead to lower stock values.

As an example, this chart shows how as the 10-year treasury rate started to rise this month, the S&P started to fall:

Expectations are everything when it comes to earnings. Markets don’t react to earnings in an absolute sense, but instead to the earnings report relative to what was already expected to happen. For example, if a company is expected to earn about $1.50 a share for a quarter, but they end up earning $2 per share, that might garner a positive response since they did better than expected and vice versa. 

BUT recently the importance has been around “guidance.” Guidance is the projections some companies put out on what they expect to earn in the future quarter or year. Some have lowered their guidance and the markets have reacted negatively, despite a good quarter. Some companies have even increased their guidance for the next quarter, but not changed it for the full year. This can negatively affect a stock because the markets can interpret this to mean further out quarters are expected to have slower growth.

Finally, sentiment is key, and seems to be most important this quarter.

Sentiment is the feeling or vibe investors have about a company. Generally, it works similarly to the way other things in life work. Say you watch a movie everyone you know raved about. By the time you see it though, you don’t think it was as good as everyone said it was. That’s because the sentiment you had going into it was amped up to a level that couldn’t be reached. Particularly this quarter, investors seem to have had positive sentiment about many stocks such that actual earnings reports were disappointing, despite being good.

On the flip side, several earnings reports were not good on most data points, but sentiment was already so low heading into it that the stocks still rallied. The reports were bad but that was expected, while some positive info was mixed in that gave investors hope.

One place to look for sentiment is analyst ratings. When there are a high number of analysts with a buy rating, sentiment might be high. 

Keep this in mind as the 2nd half of earnings season continues.