How a high bar for earnings is impacting the market

US Head of Equity & Derivative Strategy at BNP Paribas Greg Boutle joined Yahoo Finance Live to break down how the market is being impacted by a high bar for earnings.

Video Transcript

ADAM SHAPIRO: All right, we're almost 15 minutes to the closing bell-- want to check markets right now. It looks as if we're going to break the two-day down streak, with the S&P 500 up almost a full percent, got the Dow up over 300 points-- almost 1%, and the NASDAQ is up 1%, up about 130 points. So with that in mind, let's bring into the stream Greg Boutle.

He is US Head of Equity and Derivatives Strategy at BNP Paribas. It's good to have you here. And there was something you pointed out that you now think long optionality is much more interesting to consider for tactical directional plays through earnings, especially with volatility returning to these markets. When you say, long optionality, are you saying that investors should be looking at long puts to protect for a sell-off that might be coming?

GREG BOUTLE: Yeah, thank you for having me on. Well, I think there's a couple of ways you can look at this. You know, investors can be considering long optionality plays. It could be calls as well as put's. I mean, one of the strategies people often consider is replacing outright Delta by owning call options. It limits risk in a similar way to owning a put option would.

Essentially, the rationale for our view change here isn't so much that we think volatility is likely to pick up aggressively in the coming weeks-- although we could get some movement around earnings season-- it's more the fact that volatility has cheapened a lot over the last month. We've seen the VIX this quarter come back in from above 20, a level it's been stubbornly above, and it's now back into a kind of mid to high teens range.

So I think that it's fair to say optionality is now closer to fair value than it has been for a while. And it certainly offers some opportunities, I think, to buy options tactically.

SEANA SMITH: Greg, you mentioned earnings season-- we've heard it from a couple of companies so far, and the results have been pretty strong-- by a wide margin beating the Street's expectations. Is this something that you expect to continue during this earnings season? And how are you positioned right now as a result?

GREG BOUTLE: Well, I think earnings season is very likely to be strong. The issue is that I think everybody thinks that earnings season is very likely to be strong. So I think the bar has been set very high. What we've seen so far through earnings season has been encouraging, but we've seen a better day for markets today, but a couple of wobbles in the prior two sessions.

When we look at just the broader equity market, we can look at some technical indicators-- things like the RSI on the S&P. The last two times that we saw the market this technically overbought were June and September last year. That preceded a kind of 5% to 10% corrections both of those times. So we think there's going to be a very strong earnings season, but we think that the market needs a strong earnings season to justify the rally that we've had going into this reporting season already.

ADAM SHAPIRO: If we need a strong earnings season to justify where the prices are at this point, isn't that a bad sign for those of us who might hold stock and need to sell it in a year?

GREG BOUTLE: I mean, it could be. But equally, we might actually get those high expectations met. Or indeed, we could see some beats come through. So the bar is high, but the outlook is for kind of explosive growth in the coming quarters. We certainly are becoming a little bit more cautious about what might be in store for equities through the balance of the year, though.

It's not so much that we're concerned about earnings, although we are a little bit concerned that the strong earnings outlook is now more reflected in the price. And what we're a little bit concerned about are two things. One is the potential for a higher rate environment in the second half of the year. And the second is the potential for corporate tax increases. These are two things which could weigh, particularly on some of the large cap, more tech-orientated names that dominate the major US indices.

SEANA SMITH: That's interesting, though. So you don't think the likelihood or the possibility, I guess I should say, of higher taxes, that that has not been priced into the market yet?

GREG BOUTLE: No, I don't think so. In fact, it's quite interesting-- if you go back four years and look at the introduction of the Tax Cuts and Jobs Act, even though the market knew that was coming, it didn't really react until that legislation was passed. And if you go back and look at the consensus forecast bottom-up for single stocks in December 2017, January 2018, there were massive upgrades that came through.

And indeed now, when we look out at the consensus forecast, bottom up stock by stock for 2022-2023, we see very little evidence that analysts are forecasting those tax increases in their numbers. So yes, market participants might be expecting this, but we think that we are going to see downgrades come through to corporate earnings in the back end of the year if and when that legislation is passed. And that typically creates some volatility and some difficulty for equity markets.

ADAM SHAPIRO: And you also predicted those who could be hit by this would be the large cap tech stocks. And we saw that at the beginning of the year. Are we going to go back there?

GREG BOUTLE: Yeah. Well, I think one of the interesting things is when you look at tax rates, it's not just about the headline tax rates. There are a lot of corporates in the US that have relatively low effective tax rates. So if we see headline corporate tax increases, but we also see additional measures to address things like overseas earnings or, perhaps, a minimum tax rate based on book reported earnings, these are the type of things that have a disproportionately large impact on things like some large cap tech, semis, pharma, biotech names-- the sort of names that dominate the NASDAQ.

ADAM SHAPIRO: Greg Boutle is the US Head of Equity and Derivatives Strategy at BNP Paribas.