Stocks Week Ahead: Earnings Season Puts Investors on Edge

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By Ryan Vlastelica

NEW YORK -- This week marks the first big week of second-quarter earnings, and it is sure to bring both joy and misery to Wall Street.

Investors will concentrate on market fundamentals after weeks when Federal Reserve policies have dominated the market. If they see companies are still struggling, stocks could take a fall.

Even after Fed Chairman Ben Bernanke scared markets in June by telling investors the Fed is likely to reduce monetary stimulus in the coming months, stocks have recovered, with both the Dow Jones industrial average and S&P 500 climbing to all-time highs. In an appearance earlier this week, the Fed chairman said monetary policy was likely to be accommodative for some time.
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"We're in the terminal stages of a Bernanke-driven bubble," said Walter Zimmerman, a technical analyst at United-ICAP in Jersey City, N.J. "While a lot of damage has been done to the bear case, eventually bad news like weak earnings growth will start to bear fruit."

To be sure, the Fed, which has shown a much friendlier face to investors lately, will not be out of the picture. Bernanke will appear before congressional committees Wednesday and Thursday to deliver the semiannual testimony about monetary policy. However, few surprises are expected.

The S&P's 17.8 percent advance in 2013 is largely attributable to the central bank's accommodative policies. The major indexes made impressive gains in the week: the Dow (^DJI) up 2.1 percent, the S&P 500 (^GSPC) 3 percent higher and the Nasdaq (^IXIC) up 3.5 percent. It was the third straight week of gains for all three, and the best week for the S&P and Nasdaq since early January.

"The Fed has been able to prevent a big sell-off so far, but eventually the economy will have to catch up to the market or the market will fall back to match the economy," said Scott Armiger, who helps oversee $5.6 billion as portfolio manager at Christiana Trust in Greenville, Del.

More Focus on Earnings

That analysts are now turning their focus to earnings, believing the Fed's power to buoy stocks is waning, may not be a positive if the rally is going to continue.

Earnings are seen growing 2.8 percent in the second quarter, according to Thomson Reuters data, a far cry from the 8.4 percent growth forecast by analysts Jan. 1. Revenue is now seen increasing 1.5 percent.

For every company that has said it expects positive earnings, 6.5 have lowered their forecasts, the worst positive-to-negative ratio since the first quarter of 2001.

United Parcel Service (UPS), the world's largest package delivery company, tumbled Friday after giving a weak profit outlook, citing economic conditions as one reason.

Companies can appear to look good when they beat a lowered earnings bar, but signs of weakness will hurt a market that is hovering near all-time highs and seeking new catalysts to spur further gains.

'Positive Risk/Reward'

"The second quarter wasn't particularly robust, and estimates seem to still be too high," said Barry Knapp, managing director of equity research at Barclays Capital in New York.

"We don't really see any sector where there is a positive risk/reward, just places where there are more likely to be negative surprises."

In the coming week about 70 S&P 500 companies will report results. If the results indicate that companies' earnings are still weak despite intervention by the world's major central banks, shares could slump.

General Electric (GE), Verizon (VZ), Johnson & Johnson (JNJ) and UnitedHealth (UNH) are among the biggest names, as are giant tech companies Microsoft (MSFT), Intel (INTC), Google (GOOG) and IBM (IBM).

Financial companies may be the most in view as investors look to reports from Bank of America (BAC), Citigroup (C), Goldman Sachs (GS) and Morgan Stanley (MS), among others. The sector is seen posting profit growth of 19.6 percent in the quarter, by far the highest among S&P groups.

"Since they have the highest growth expectations, it will be especially important for the market that they live up to those expectations," said Sam Stovall, chief investment strategist for Standard & Poor's Equity Research Services in New York. "Those results will be pivotal."

Early results from financial companies were mixed. Wells Fargo (WFC) and JPMorgan Chase (JPM) posted profits that beat forecasts, though JPMorgan said it might be forced to accelerate cost-cutting because of difficult market conditions.

Among economic reports, June retail sales will be released Monday, with consumer prices and housing starts, both for June, later in the week. The Philadelphia Fed survey of manufacturers for July is due Thursday.

If You Only Know 5 Things About Investing, Make It These
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Stocks Week Ahead: Earnings Season Puts Investors on Edge

Warren Buffett is a great investor, but what makes him rich is that he's been a great investor for two thirds of a century. Of his current $60 billion net worth, $59.7 billion was added after his 50th birthday, and $57 billion came after his 60th. If Buffett started saving in his 30s and retired in his 60s, you would have never heard of him. His secret is time.

Most people don't start saving in meaningful amounts until a decade or two before retirement, which severely limits the power of compounding. That's unfortunate, and there's no way to fix it retroactively. It's a good reminder of how important it is to teach young people to start saving as soon as possible.

Future market returns will equal the dividend yield + earnings growth +/- change in the earnings multiple (valuations). That's really all there is to it.

The dividend yield we know: It's currently 2%. A reasonable guess of future earnings growth is 5% a year. What about the change in earnings multiples? That's totally unknowable.

Earnings multiples reflect people's feelings about the future. And there's just no way to know what people are going to think about the future in the future. How could you?

If someone said, "I think most people will be in a 10% better mood in the year 2023," we'd call them delusional. When someone does the same thing by projecting 10-year market returns, we call them analysts.

Someone who bought a low-cost S&P 500 index fund in 2003 earned a 97% return by the end of 2012. That's great! And they didn't need to know a thing about portfolio management, technical analysis, or suffer through a single segment of "The Lighting Round."

Meanwhile, the average equity market neutral fancy-pants hedge fund lost 4.7% of its value over the same period, according to data from Dow Jones Credit Suisse Hedge Fund Indices. The average long-short equity hedge fund produced a 96% total return -- still short of an index fund.

Investing is not like a computer: Simple and basic can be more powerful than complex and cutting-edge. And it's not like golf: The spectators have a pretty good chance of humbling the pros.

Most investors understand that stocks produce superior long-term returns, but at the cost of higher volatility. Yet every time -- every single time -- there's even a hint of volatility, the same cry is heard from the investing public: "What is going on?!"

Nine times out of ten, the correct answer is the same: Nothing is going on. This is just what stocks do.

Since 1900 the S&P 500 (^GSPC) has returned about 6% per year, but the average difference between any year's highest close and lowest close is 23%. Remember this the next time someone tries to explain why the market is up or down by a few percentage points. They are basically trying to explain why summer came after spring.

Someone once asked J.P. Morgan what the market will do. "It will fluctuate," he allegedly said. Truer words have never been spoken.

The vast majority of financial products are sold by people whose only interest in your wealth is the amount of fees they can sucker you out of.

You need no experience, credentials, or even common sense to be a financial pundit. Sadly, the louder and more bombastic a pundit is, the more attention he'll receive, even though it makes him more likely to be wrong.

This is perhaps the most important theory in finance. Until it is understood you stand a high chance of being bamboozled and misled at every corner.

"Everything else is cream cheese."
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