Wall Street may be bracing for a pullback as U.S. earnings season begins next week – if the clouds of profit warnings from bellwethers ranging from FedEx to Hewlett-Packard lead to a downpour of lower profits – or even losses.
Thanks to aggressive stimulus plans from central banks around the world, the Standard & Poor’s 500 index <.SPX> gained 5.8 percent over the third quarter. That sharp rally occurred even as companies were struggling. Earnings for that period are forecast to fall 2.4 percent from the year-ago quarter. If that happens, this would be the first earnings decline in three years, according to Thomson Reuters data.
Market strategists and investors say U.S. stock valuations are broadly out of sync with earnings estimates. They forecast a pullback in stocks in the coming weeks as more companies report results and reduce expectations for the fourth quarter and beyond.
Fourth-quarter estimates for S&P 500 companies show a 9.5 percent gain in profit from a year ago, according to Thomson Reuters data. Analysts say that outlook is too high, given what investors are already hearing from the corporate world.
“It’s a divergence right now where the valuations as far as equity prices (are concerned) have soared, and are really putting in place a stronger economy and stronger fundamentals,” said Alan Lancz, president of Alan B. Lancz & Associates Inc., an investment advisory firm in Toledo, Ohio.
“But earnings will be the telltale sign,” Lancz added. “And if the guidance isn’t particularly strong, the market might be setting itself up for a little disappointment. I don’t see a major correction, but I do see a pullback.”
The earnings season will kick off on Tuesday with results from Dow component Alcoa
JPMorgan Chase & Co
Nearly half of S&P 500 companies guiding lower for third- quarter earnings blamed weakness in Europe, according to a Thomson Reuters survey. Another 11 percent blamed the weak global economy, 8 percent cited strength in the U.S. dollar, and 6 percent cited the slowdown in China, the survey showed.
Weakness in the U.S. economy hasn’t helped. The final read on U.S. second-quarter gross domestic product last month showed growth of just 1.3 percent, weaker than an expected 1.7 percent.
On Thursday, software maker Informatica Corp
“Parts of Europe aren’t just in recession, they’re in depression,” said Jeff Kleintop, chief market strategist at LPL Financial in Boston. “I think (analysts) underestimated the extent of the global slowdown, and maybe are still underestimating it.”
TECH FEELS CHILL FROM CHINA
While estimates have come down sharply in all 10 S&P 500 sectors since the start of the year, technology is one area where the lower expectations are most notable. Slower growth in China is a big factor in that trend.
Earnings growth in the tech sector is expected to be just 2.3 percent for the quarter, compared with a July 1 forecast of 13.1 percent. Apple Inc
Technology’s profit growth has been crucial for the S&P 500. Minus technology, S&P 500 earnings are expected to be down 3.4 percent.
The tech sector is where the slowdown in China’s economy is having the biggest impact, Kleintop said.
“They consume a lot of U.S. technology products,” he said.
Recent data shows that the pace of growth in China, the world’s second-largest economy, may slow for a seventh quarter, straining earnings in the tech and materials sectors. [ID:nL1E8L4DUF]
Applied Materials Inc
On Wednesday, shares of Hewlett-Packard Co
The S&P 500 sectors showing the biggest projected earnings decline are materials, forecast down 24 percent, and energy, expected down 18.8 percent, Thomson Reuters data show, with those declines tied largely to the global slowdown.
In contrast, consumer discretionary stocks are expected to have the strongest profit growth for the quarter, with Thomson Reuters data showing a gain of 7.7 percent. But in that sector, too, companies, including apparel retailer Express Inc
ANEMIC REVENUE OUTLOOK
With tepid revenue growth, U.S. companies have been topping Wall Street’s earnings expectations in recent quarters through cost reductions. That path to beating profit forecasts, however, will become increasingly difficult as many companies have already made most of the obvious cuts.
“Forward expectations are just too high,” said Barry Knapp, managing director of equity research at Barclays Capital in New York.
Revenue for the third quarter is expected to be down 0.1 percent from a year ago for S&P 500 companies, and down 0.4 percent minus Apple, Thomson Reuters corporate earnings research analyst Greg Harrison said.
In all, the negative-to-positive ratio for earnings forecasts is 4.3 to 1, the most negative since the third quarter of 2001, he said.
Tech and materials were also among sectors with the most negative outlooks for the quarter, with tech’s negative-to-positive guidance at 5.4 to 1 and materials at 7 to 1.
Corporate America’s concerns were exemplified by General Electric Co
NEW YORK (Reuters) – (By Caroline Valetkevitch; Reporting by Caroline Valetkevitch; Additional reporting by Steve James and Chuck Mikolajczak in New York and Scott Malone in Boston; Editing by Tiffany Wu and Jan Paschal)