Maryland Smith Research / September 3, 2017

Cracking the Wall Street Earnings Puzzle

Clues Help Analysts Anticipate the Fed’s Next Move

Cracking the Wall Street Earnings Puzzle

Wall Street responds to surprises, but not always in intuitive ways. Share prices go up at the firm level when a company issues a stronger than expected earnings report, which makes sense. But the opposite often happens at the aggregate level when companies collectively exceed expectations. Share prices can drop instead of rise.

“That’s the puzzle,” says Rebecca Hann, an accounting professor at the University of Maryland’s Robert H. Smith School of Business.  In a recent paper published in the Journal of Accounting and Economics, Hann and two Smith School PhD co-authors trace the counterintuitive market reaction to the influence of monetary policy from the Federal Reserve.

Savvy investors understand that the Fed likes to raise interest rates during growth periods, which tends to drive stock prices downward. So investors brace themselves for the impact following a robust earnings season — like waiting for the other proverbial shoe to drop.

“When earnings news are good, investors anticipate that the Fed is going to take action,” Hann says. “It’s about expectation.”

Wall Street analysts have long debated the link between aggregate earnings surprises and monetary policy, but Hann and her co-authors quantify the association using Federal funds futures data. She says the information is useful because it can help analysts forecast the Fed’s monetary policy.

“Everyone watches the Fed’s next move,” Hann says. “The minute Janet Yellen speaks, you can see the stock market move with her message.”

Read more: Aggregate Earnings Surprises, Monetary Policy, and Stock Returns is featured in the Journal of Accounting and Economics.

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