- Julian Emanuel at Evercore says stocks performed very well over the last two quarters.
- He says that won’t happen again in a slowing economy where investors are less bearish.
- However, he says oversold, steady-earning stocks could still trade higher after earnings.
Investors won’t walk away from 2022 with a lot of happy memories, but Julian Emanuel of Evercore ISI says there were two surprisingly positive periods for stocks in an otherwise difficult year.
“The cumulative advance of the S&P 500 during July’s and October’s Earnings Reporting Seasons was 22%!” he wrote in a recent note to clients.
Emanuel, who is in charge of the firm’s equity, derivatives and quantitative strategy and portfolio strategy research teams, says that stocks performed very well during those two earnings periods even though companies (and analysts tracking stocks) were cutting their profit and revenue projections as the economy slowed down. The reason, he wrote, is because investors thought things might get even worse, and stocks and bonds were both oversold as a result.
But he doesn’t think that will happen again, which means he thinks this earnings season will be harder to endure.
“Sentiment is not nearly as bleak (contrarian) as it was headed into 2Q22 and 3Q22 reports, and stocks and bonds are not dramatically oversold, as previously,” he said. Meanwhile, he notes the housing market is fading while wage gains are slowing and the yield curve is getting more negative — all signs that a recession is drawing near.
All of that sounds very negative, but Emanuel points out some real positives for stocks over the shorter term. Historically, stocks that do very badly one year tend to outperform in the next year, and vice versa.
Emanuel tries to balance this complicated mix of factors by finding stocks that did poorly last year and are likely to deliver better-than-expected results in the earnings season that’s about to begin.
Here is his two-part criteria for spotting potential outperformers: First he finds Russell 1000 stocks that underperformed their index in 2022, and have high short interest or outsize implied volatility, as indicated by options market pricing. Emanuel uses those two statistics as evidence that investors are overly bearish about those stocks.
Then he looks for stocks with above-average earnings revisions that have consistently beaten expectations over the last two years, with sales and earnings both coming in ahead of Wall Street consensus in seven of the last eight quarters. He also wants to find stocks with forward price-to-earnings ratios that are discounted compared to their five-year averages. That’s a reason to believe the stocks are inexpensive and could beat expectations again, and then rally.
“This list is, not surprisingly given sector underperformance, Tech heavy. Also prominent is Real Estate,” he wrote.
The 16 stocks that make the cut are listed below, ranked from lowest to highest based on the size of the price-to-earnings discounts Emanuel writes about.