A gloomy profit picture could spook investors even more
IT MAY SAVE THE DAY — OR SINK THE MARKETS
A gloomy profit picture could spook investors even more
The third-quarter earnings season comes at a pivotal time for the stock market, as stocks are coming off their first 10% correction in four years and are still working through a bottoming process that has yet to give a definitive all-clear signal.
If earnings from companies in the Standard & Poor’s 500 index top analysts’ lowered expectations and corporate CEOs deliver a favorable future outlook, despite headwinds such as slowing global growth, it could put stocks on more solid footing and propel a year-end rally.
But if the profit picture turns gloomy and profit misses dominate and CEOs warn of tougher days ahead, it could spook investors and spark additional selling in what has already been a lousy year for U.S. stocks. Equities have been dragged down this year by global weakness sparked by a slowdown in China, the negative drag on earnings and sales of U.S. multinationals from a stronger dollar, continued weakness in the energy patch and uncertainty over the Federal Reserve’s interest-rate-hike plans.
The starting point is the market’s expectations for the profit-reporting season. Right now, expectations are downbeat.
Analysts expect third-quarter earnings for the S&P 500 to contract 4.2% vs. the
third quarter of 2014, says Thomson Reuters I/B/E/S. However, analysts also predicted drops at the start of both the first and second quarters, but profits eked out gains of 2.2% and 1.3%, respectively. It is not uncommon for earnings to top expectations by 4 or 5 percentage points, history shows.
The low bar may actually be bullish. “The negative expectations may set the market up for a rally,” Patrick Adams, money manager at Choice Investment Management, wrote to clients.
The unofficial start to the profit-reporting season kicks off Thursday with results from aluminum maker Alcoa.
The S&P 500, which in late August suffered its first 10% correction since 2011, heads into the profit-reporting season down 3% for the year and 6% below its record close in May.
Analysts have become increasingly negative on quarterly profits, with nine of 10 sectors suffering downward revisions heading into the reporting season, Thomson says.
Only five sectors are now expected to post positive earnings growth, with telecom (+11.4%), consumer discretionary (+11.4%) and financials (+10%) expected to fair the best. On the negative side of the spectrum, the energy sector is ex- pected to see its earnings plunge 65%, while earnings in the materials sectors are seen contracting more than 15%.
“S&P earnings,” says Liz Ann Sonders, chief investment strategist at Charles Schwab, “are expected to head south into negative territory; bringing overall economic worries along with them.” The good news: Sonders says the risk of recession remains low, which is a positive for stocks. Still, she is cautious— or neutral — on the market’s near-term outlook.
Adam Parker, equity strategist at Morgan Stanley, wondered aloud in a research report Monday whether the low earnings bar is the “catalyst we have waited for.”
Parker expects profits to end up growing 4% in the third quarter, extending its streak of positive quarters to 27. The last time earnings had a negative quarter was in the first quarter of 2009 during the financial crisis, he adds.
Earnings growth is expected to recover gradually in coming quarters, adds Parker.