Buying into earnings season isn’t the only way to make money in the markets. With valuations stretched and expectations running high, some of the market’s most popular names may be setting up for disappointment — and for short sellers, that could mean opportunity.
The broader market has enjoyed a strong run this year: the S&P 500 has gained roughly 14%, with all 11 sectors in positive territory. But that strength has a downside. When equities rise broadly, they do so on the assumption that corporate profits will continue to grow. And when those expectations become too lofty, even solid earnings can trigger a selloff.
Earnings season often acts as a reality check. Companies are forced to justify their valuations with actual performance — and those that fall even slightly short can see their stocks punished.
Betting on the Downside
Short selling, or wagering on a stock’s decline, is one way to profit from this dynamic. The strategy involves borrowing shares, selling them immediately, and later repurchasing them — ideally at a lower price — to return to the lender, pocketing the difference. It’s a higher-risk trade, but during earnings season, when sentiment swings sharply, it can be lucrative.
Identifying Overstretched Winners
Adam Parker, founder of Trivariate Research, has screened for companies that may be vulnerable heading into their quarterly reports. His method focuses on stocks that have outperformed peers over the past two weeks — a sign that expectations have risen sharply. When sentiment gets too bullish, even a good earnings report can disappoint.
Among his top short candidates this week are Interactive Brokers, Marsh & McLennan, CSX, Bank OZK, and State Street.
Interactive Brokers Group (IBKR)
Shares of Interactive Brokers have outpaced those of industry peers by nearly 7 percentage points in the past two weeks. Such pre-earnings momentum raises the bar considerably for the brokerage firm, leaving little room for error in its upcoming results.
Marsh & McLennan (MMC)
The insurance and professional services group has also rallied, outperforming peers by about 3.8 percentage points. It’s set to release earnings before Thursday’s market open, and investors are clearly expecting strong numbers — perhaps too strong.
CSX Corporation (CSX)
The railroad operator’s shares have gained 1.9 percentage points relative to competitors in recent sessions. That advance may reflect optimism that’s difficult to sustain if revenue growth or freight volumes come in below hopes.
Bank OZK (OZK)
Formerly known as Bank of the Ozarks, the regional lender has climbed roughly 1.4 percentage points ahead of its sector. It’s scheduled to report after the close, and expectations have crept higher — a potential setup for a pullback.
State Street Corporation (STT)
Perhaps the most interesting case is State Street, a major custodian bank and asset manager. The stock has outperformed peers by 2.2 percentage points over the past two weeks and is up 17% year-to-date.
But history suggests that beating earnings estimates may not be enough. According to FactSet, State Street has exceeded analyst expectations in 19 of the past 20 quarters, yet the stock still fell eight times immediately after results. Last quarter, earnings topped forecasts — and the shares still plunged 7.3% the following day.
That pattern could repeat if the bank’s profit growth fails to justify its premium valuation.
Reality Check for a Rally
The stock market’s rally this year has raised the stakes for earnings season. With valuations high across the board, even minor disappointments can trigger sharp corrections.
As Parker puts it, the companies that have performed best into earnings are often the ones with the hardest expectations to meet. And when optimism peaks, short sellers may find the most fertile ground.
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