In this week’s conference call, we took a look at the current U.S. earnings season and how things are stacking up against analyst expectations. What we are seeing so far is that companies are still doing a good job at adapting to the tariff environment and the uncertainty it brings. While we are still in the early innings of the game (sorry, but with the Jays facing off against the Dodgers tonight, I couldn’t resist), the numbers aren’t off to a bad start. With just over a quarter of the S&P500 companies having reported, we have seen a majority beat on earnings in all segments. While there has been a relative weaker performance from consumer discretionaries, materials and communication services, it does look like the third quarter is going to be another win for bulls.

Keep in mind that this sample set represents the 500 largest companies and, as we know, larger cap stocks have dominated the advance in equities since the April correction. The question now is how smaller companies are doing and whether there are risks in this segment that are not being adequately priced into the broader market. There have already been some smoke signals. Last month, sub-prime auto lender Tricolor declared bankruptcy and last week it was revealed that some major financial firms had exposure. JPMorgan for one has announced that it is taking a $170 billion charge. Then there is First Brands, which declared bankruptcy at the end of September with debt of close to $8 billion and operating earnings of only $1.1 billion. Jefferies, a mid-tier lender, took a major hit to its stock price, even though its reported exposure was less than $50 million.

The blame game has already begun. Some are pointing fingers at the rapid expansion of the private credit market and its relative lack of transparency in cases where companies are not publicly traded. The companies under pressure are pointing fingers at Trump’s tariffs and the distortions they’ve created in supply lines and the need by some for alternative finance sources, like so-called “reverse factoring”. Needless to say, there are those starting to draw comparisons to the Great Financial Crisis (GFC). The epicentre then was the sub-prime mortgage market and rapid acceptance of vehicles like collateralized loan obligations (CLOs) and collateralized mortgage obligations (CMOs). Today, it’s a pattern of weak debt covenants and lack of visibility. I’m not going to weigh in on how relevant of a comparison this is, but it does warrant a closer examination of the differences in economic and financial health lower down the credit scale.

One way to do this is by looking at the stock performance of companies that are reporting positive earnings versus those that aren’t. One rationale for this is due to the comparisons between today and the tech bubble in ‘01, where a number of high-rolling companies that couldn’t monetize the world wide web, ultimately fell off the page. For this week’s exercise, we are going to take a look at those publicly traded companies in the U.S. that are north of $120 million in market cap, or close to the bottom threshold for the Russell 2000 index. Of these roughly 2,700 companies, we are going to split them in two – those with positive earnings per share (2,045) and those in the red (703). Finally, I want to see how many companies are trading close to their 52-week highs. For this exercise, I simply chose 10 percent as the threshold. The results are interesting.

Let’s start with those companies that are posting profits. In that group, just over 240 stocks are trading within 10 percent of their 52-week highs, or roughly 11% of the total. Market cap of those companies is about $45.5 trillion and weighted average difference from the 52-week high is 6%. That sounds pretty normal, and it supports the observation that leadership in the U.S. market is excessively concentrated in a few firms. In other words, if we were in normal economic and market conditions, we could say that a large number of positive earning companies are trading at levels that are well below their 52-week highs and might represent good value plays.

Now, have a look at the just over 700 companies that have reported negative earnings in their most recent quarter. Of this group, 127 have share prices that are within 10 percent of their 52-week highs, which is about 18% - higher than what we saw with positive earnings firms. Total market cap of this group is about $660 billion and the weighted average difference from the 52-week high is 5%.

That’s a lot of data, so let’s step back and parse these observations. First, just because companies are losing money, doesn’t mean their stock prices shouldn’t be elevated. After all, a share price is simply the present value of future earnings discounted by prevailing yields. This is the characteristic of a growth stock. But, if the economy is truly succumbing to fatigue, then it is possible that the list of companies with negative earnings will grow and some of them may be valued too highly today.

Keep in mind that this is the publicly traded universe. It doesn’t include the even larger sphere of private firms that don’t report the health of their financial statements or balance sheets, yet are tapping into both publicly traded financial entities and private credit. I do think it will be interesting to watch how small and mid-cap companies do this season. In fact, I believe there is potentially an asymmetry between large-cap growth stocks being the driver of broader market performance and the disproportionate impact that negative news from smaller companies could have. JPMorgan CEO James Diamond may or not be right in saying that where there is one cockroach, there are usually more. But the focus on large-cap earnings might mask a bug or two.

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle