As the Market Seeks Direction, Earnings Could Lead the Way

first-quarter earnings
first-quarter earnings

The Dow Jones Industrial Average ($INDU) stands at an 18-month high having broken through 11,000 (momentarily) for the first time since September 2008, and yet the stock market, running on the fumes of low volume, is searching for direction. First-quarter earnings season, which unofficially kicks off with Alcoa (AA) after Monday's close, appears to be just what's in order.

Unfortunately, if the recent past is any guide, the direction earnings season will lead the market is probably lower. The S&P 500 ($INX) started the last two earnings seasons trending higher, too -- until the reports started rolling out. The market lost 4% in the second half of January as fourth-quarter numbers were released, and it dropped more than 5% in the last two weeks of October as third-quarter profits came out.

Which makes plenty of sense, after all, since the market is forward-looking, and it has been no secret that earnings -- helped by cost cuts, easy comparisons and, yes, even sales gains -- are rebounding sharply. Jeffrey Kleintop, chief market strategist at LPL Financial in Boston, thinks we'll see a repeat performance of the last two earnings season, where the numbers were strong but stocks pulled back 5% to 10% as investors "sold the news" after "buying the rumor."

A Decent Sampling of Reports This Week

In addition to Alcoa, four other Dow components report this week -- Intel (INTC), Bank of America (BAC), JPMorgan Chase (JPM) and General Electric (GE). That will make for a decent sample of what's in store more broadly. It's also fitting to hear from two giant banks.

Analysts', on average, expect the S&P 500 to post 37% year-over-year quarterly earnings growth, according to data from Thomson Reuters. And once again, the financial sector is forecast to have the highest growth rate in the S&P. Earnings are expected to triple -- but that's on account of those preposterously easy year-ago comparisons. (Exhibit A: credit-crisis poster child Ambac Financial [ABK].) Take financials out of the mix, and the S&P 500's year-over-year growth rate would fall to 27%, according to Thomson Reuters.

Jason Weisberg of Seaport Securities thinks first-quarter earnings season will push the market to upside when all is said and done -- but the going will be "slow" and "painful." However, Dow 12,000 is within reach by year-end, Weisberg says, led by consumer stocks -- both discretionary and noncyclical -- as well as tech stocks.

"I think we're going to see the consumer open his wallet a little bit even though we're not going to see much job growth until next year," says Weisberg from the floor of the New York Stock Exchange. "That being said, I also like technology. People like 'fast' and 'cool,' and that's what technology provides."

With fatter bottom lines a foregone conclusion for the first quarter, investors are more likely to key on sales, says John Stoltzfus, market strategist at Ticonderoga Securities. "Since the recovery began last year, we've seen earnings season thematics move from earnings derived from cost-cutting and belt-tightening to earnings derived from revenue growth and export growth," Stoltzfus told clients Friday. "Now, look to the replacement cycle to kick in further."

Which might just be a bit of a stretch. S&P 500 revenue is expected to grow just 10% in the first quarter, according to Thomson Reuters, led by the energy, materials and technology sectors. Energy giant Chevron (CVX) already did its part, dragging the Dow to within three points of 11,000 Friday with its upbeat forecast. Now it's up to materials leader Alcoa and tech bellwether Intel to put the blue-chip index over the hump.