Q2 Earnings Season Preview: What to Watch and How to Trade

Earnings season is already underway. Two companies, Grupo Televisa S.A. (TV) and Bank of South Carolina (BKSC) have already reported calendar Q2 2021 earnings, with two more, Hingham Institution for Savings (HIFS) and Aslan Pharma (ASLN), reporting today. Obviously, none of those are exactly household names, so you can be forgiven for missing their earnings releases, but that all changes tomorrow when the first of the big names report.

That will include two big banks, JP Morgan Chase (JPM), and Goldman Sachs (GS), as well as a personal favorite indicator of the health of the construction industry, Fastenal (FAST). By the end of this week, we will have heard from all the big banks, along with a few other industry bellwethers such as Alcoa (AA) and United Healthcare (UNH) and then next week, the trickle of earnings becomes a flood.

Before the chaos starts, it is worth taking a minute to think about what you should be looking for in this earnings season and devising a trading strategy for trading if you are someone who can take the risk involved.

Normally, earnings are evaluated against two things: analysts’ forecasts for EPS and revenue, and how the results compare to the same quarter last year. This year, however, there is a problem. Q2 2020 results were a mess, as lockdowns around the world left some companies with little or no revenue streams, while others saw sales artificially boosted by the forced rise of the stay-at-home economy. That obviously makes direct comparisons to last year’s numbers unreliable, but it also means that the analysts, who rely heavily on past performance when calculating their estimates, are in the dark too.

Because of that this season, the actual, objective numbers will matter less than the subjective opinions of the management teams who compile the reports and, in most cases, host investor conference calls after them. A huge beat of expectations means nothing if management tell us that the last three months were about meeting the pent-up demand for their products or services. Nor does an unexpected loss mean anything when they say that recovery in an industry has been delayed.

Therefore, good things will come to those who wait this quarter. The numbers may look great or awful compared to the consensus forecast but now more than ever, they mean nothing without context. As a result, conference calls will be more important than releases. We will also see a lot of those situations where an initial move on the release is followed by a sharp turnaround, with the end result seemingly illogical based on the numbers themselves.

Therein lies the key to trading earnings over the next few weeks. The first thing to say to most people when talking about trading any earnings season is "don't!"

Trading in anticipation of earnings involves a huge amount of risk and all of your attention. Releases come outside of market hours when markets are extremely thin, so simply setting stop-loss orders on positions taken is not a good idea. The thin markets lead to wild swings on any surprise, swings that often take you out of your position before the real trend gets underway, even if that trend is in your favor. And in a market with big gaps, fills on stops can be far enough away from your level to do real damage to your account.

That means not only that you have to be paying attention when the numbers come out, but also that you have to be prepared to make some hard decisions when they do, and to make them quickly. But even when you do that, you will always be a step behind the market professionals; the odds are stacked against you.

Far better, then, to attempt to use their speed of action and execution work in your favor.

That means waiting for the initial move on the release of numbers, then fading (trading in the opposite direction to) that move. Not every initial move will reverse when context is applied in an investor call but enough will to make it a viable treading strategy, especially given the risk/reward profile of a trade like that. If things continue in the same vein as the initial reaction, there will be limited movement as a lot of the move will have already taken place. If, on the other hand, things reverse, and there is a rush to exit the initial trades, the move will be exaggerated.

Circumstances make it so that this earnings season will be of little value in making long-term investing decisions. Whatever numbers we hear will be distorted and unrepresentative, and therefore basically meaningless. That, however, will mean that everything is open to interpretation, and that is a situation that creates the kind of two-way volatility that benefits traders, or at least those who know how to trade it.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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