Third quarter earnings season is officially upon us, and it comes at a time when the U.S. stock market as a whole is going through a correction. The carnage is widespread, with favorites Apple, Amazon, Alphabet Holdings (formerly Google), and numerous others seeing declines with no direct news to blame.
So where’s a good place to park some cash going into the earnings season? Analysts John Marshall and Katherine Fogertey of Goldman Sachs have some ideas—25 of them, to be exact. We won’t look at all of them, but here are the highlights.
Amazon, Chipotle Mexican Grill, Ford see potential for upside
The Goldman team identifies the stocks where they see the biggest potential based on the estimates of their firm’s analysts and where their colleagues differ the most from consensus estimates. They see the biggest potential for upward earnings revisions to push upside in Amazon, Chipotle Mexican Grill, and Ford.
Top value fund managers are ready for the small cap bear market to be done
During the bull market, small caps haven't been performing well, but some believe that could be about to change. Breach Inlet Founder and Portfolio Manager Chris Colvin and Gradient Investments President Michael Binger both expect small caps to take off. Q1 2020 hedge fund letters, conferences and more However, not everyone is convinced. BTIG strategist Read More
They see the biggest opportunity for downward revisions to drive downside in Cabela’s, Emerson, Joy Global, and Foot Locker.
Options buyers win in Q2
Strategically, Marshall and Fogertey like buying calls because they believe there’s an elevated level of fear baked into single stock options, which they say suggests a higher potential for “relief rallies.” They pointed out that in the last quarter, buyers of both calls and puts saw big-time benefits because of “high volatility and low correlation” among stocks in the second calendar quarter. They report that S&P 500 stocks moved, on average, up or down by 3.8% on the day of their earnings, marking the biggest average move in the last three years.
Interestingly, the analysts also found signs that the average single stock earnings day moves could go as high as 5% this earnings season.
Puts before earnings
The Goldman team found an “unusually high profit” in purchasing puts before each of the earnings events in the last quarter, put buyers saw at least a 20% return on their premiums over a six-day holding period. In fact, Marshall and Fogertey report that buying puts before last quarter’s earnings brought the highest return since the fourth quarter of 2011, based on mid-market profits for buying calls five days before earnings and selling a day later.
They said the main driver was large earnings moves which were occurring even before Aug. 24 when the entire market was in upheaval.
Call buying before earnings also has consistently outperformed.
They report that stock dispersion in the S&P 500 climbed almost to a 10-year high during the second quarter earnings reporting period, and they expect dispersion to climb again for the third quarter, potentially creating many “single stock opportunities.”
Micro versus macro positions
Heading into the third quarter reporting period, the Goldman Sachs team said the skew on single stock puts is very high, indicating that micro-focused investors are already pricing in another negative round of earnings reports.
They believe expectations are extremely low, and as a result, they’re looking for stocks they believe have the potential for a “relief rally.”
Interestingly, they have found signs of bullish positioning in index options compared to single stock options. They’ve also noted a shift toward the positive in macro, which they agree with. However, they prefer trading macro through single stock calls, as expectations there are lower, providing an opportunity for greater alpha.
All graphs in this article are courtesy Goldman Sachs.