Why Fourth-Quarter Earnings Are Likely to Look Great [Video]

Fourth-quarter earnings season unofficially kicks off after Monday's closing bell with a report from aluminum giant Alcoa (AA). Once again, the profit reports are expected to be a tale of strong profit growth, thanks more to cost cuts than revenue gains.

Analysts, on average, expect the S&P 500 ($INX) to post a 32% gain in fourth-quarter earnings on just a 6% rise in sales, according to data from Thomson Reuters.

Financials will once again lead all sectors with year-over-year profit growth of...wait for it...1,383%. (Easy comparisons are the reason why.) Take financials out of the equation, and that 32% S&P 500 earnings growth rate would drop to 11%, according to Thomson Reuters.

Fourth-quarter 2010 earnings
Fourth-quarter 2010 earnings

Earnings estimates for financials in the final quarter of 2010 are by no means abnormally high, wrote Thomson Reuters analyst Christine Short in note to clients Friday. Rather, it's just that last year's fourth-quarter numbers were so low.

"Thus, the current earnings estimate for [fourth-quarter] 2010 creates a much higher-than-normal growth rate because of the contrast to weaker than usual earnings in [fourth quarter] 2009," Short wrote.

Primed for a Pullback?

After financials, the materials, energy and technology sectors are expected to have the highest year-over-year growth rates, at 28%, 26% and 13%, respectively, according to Thomson Reuters data. Of the 10 major sectors of the S&P 500, only utilities is seen posting an earnings decline. Analysts see the sector's profits declining 3% in the aggregate, hurt by softer earnings from electric utilities.

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But don't be surprised if the market takes a breather even if results come in better than Wall Street expects. The Dow Jones Industrial Average ($INDU) is up nearly 17% since early September, and the S&P 500 has rallied more than 20%.

"People are going to be looking at these earnings to see if this move we've had over the last quarter is really justified," says Kenny Polcari, managing director at interdealer broker ICAP Corporates. "I think we're going to see a lot of better-than-expected earnings, but quite honestly I think that's already baked into the market."

Some profit-taking, however, would ultimately be healthy for stocks, if only to set the stage for more sustainable gains farther out, the veteran NYSE trader says. "Having some profit-taking wouldn't be the worst thing in the world," says Polcari. "I'm kind of hoping we do have some profit-taking on this news because I think the market is kind of ahead of itself."

For more on Polcari's outlook from the floor of the New York Stock Exchange (NYX), see the video above.

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