Welcome to earnings season – in which companies around the world report their financial performance for the previous three months. It’s an important time for investors because company performance directly impacts share prices, and therefore stock markets.

The good news is the numbers coming through for the third quarter of the year – July to September – look great. At the time of writing, 79% of US companies had beat analyst expectations, according to Bloomberg at the end of October, compared to a long-term average of 65%.

But this didn’t translate to a stock market boost, quite the opposite. Although the experts at Coutts, the bank behind the NatWest Invest funds, see signs of markets improving between now and the end of the year.

According to research by Bloomberg at the end of October, companies that failed to meet analysts’ published sales and earnings expectations saw their share price drop by an average of 5% on the day after their results. In a normal earnings season, such companies would only fall by about 3% on average. So it seems investors are punishing disappointing results particularly harshly this quarter. 

Past performance should not be taken as a guide to future performance. The value of investments can fall as well as rise, and you may not get back what you put in.

So what’s going on?

It appears to be down to demanding expectations due to some over-confidence among investors earlier in the year, which has transformed into some general nervousness now.  Howard Sparks, US equity expert at Coutts, explains, “Expectations among analysts and investors were overly high going into earnings season, which meant any signs of weakness were severely punished.”

This has perhaps been best shown by the so-called ‘Magnificent Seven’ – the group of leading US technology firms that includes Meta, Alphabet and Tesla.

These tech giants led positive US stock market performance earlier this year, partly because of the rising popularity of artificial intelligence. So they came under intense scrutiny this earnings season, and two of them saw their share price fall 10% following disappointing results, despite beating their earnings estimates. 

But there’s more behind the negative reaction we’ve seen to positive news.

“The continued resilience of the US economy means there’s uncertainty around the future path of interest rates – when we’ll see them peak and how long they’ll need to remain high,” Howard says.

“This can hit company performance as high interest rates affect their borrowing costs and the amount people spend. We have indeed seen a lot of mentions of ‘weak demand’ in many of the company earnings reports.”

He adds, “This backdrop means we’ve had an earnings season where investors just haven’t been in the mood to reward winners, and have been more inclined to punish those that have disappointed.”

Despite the more than muted market response to this latest round of company announcements, Howard’s view is that things should still improve over the coming weeks and months.

“My base case is that a continuing improvement in company earnings growth will support stock markets over the coming months and into 2024,” he says.

“November and December seasonally have been good months for stock performance over time, so my best guess is that this pullback in markets will be temporary.”