Stocks Rise Sharply Again. Is It Time to Buy or Take Cover?

As stocks rally sharply for a third day, bullish investors are heading into the second-quarter earnings season next week with a spring in their step. But some signs are emerging behind the scenes that companies may not be able to live up to Wall Street's rosy profit forecasts, and the consequences for businesses that fail to make the cut can be severe.

Discount retailer Family Dollar (FDO), for example, reported a sharp 19% profit jump for the current quarter on Wednesday but issued guidance that fell short of what analysts were expecting. The company saw its stock hammered subsequently, with shares falling about 8% to close at $36.30 on Thursday.

While the company continued to see a positive trend overall in discretionary items, it also noted growing uncertainty in the overall economy. "And with that, we've taken a very conservative view of the fourth quarter," Family Dollar President R. James Kelly said in a conference call with investors.

Toning Down Expectations

Family Dollar joins a growing list of companies that have recently taken a more guarded view of the economic environment. And investors may be in for more stock market volatility as other companies opt to play it safe and issue weaker-than-expected outlooks.

Some heavyweight Wall Street houses, meanwhile, have already started to tone down their optimism. Citing slower profit growth, investment bank UBS (UBS) cut its price target for the S&P this year to 1,150, from 1,350, on Wednesday.

UBS chief U.S. market strategist cut his 2010 S&P earnings forecast about 8% to $84 per share, from $91. Earnings estimates for 2011 were cut about 10% to $87 per share, from $97.

Some bulls with impressive track records like Jeff Saut, the chief investment strategist at Raymond James, see a buying opportunity in the rising alarm. Many customers at the brokerage "are almost as freaked as they were from January of 2009 and March of 2009, when the bottoming process was being completed," he told Bloomberg. "My hunch is we're going to get a rally.''

Still, investors should brace for turbulence. More companies could use the growing sense of uncertainty to ratchet down the lofty expectations pinned on them as well.