Can Stocks Weather Grim Profit Outlooks?

Wall Street
Richard Drew/AP
By Caroline Valetkevitch

NEW YORK -- U.S. companies are sounding the alarm on fourth-quarter earnings, lowering profit estimates just as the stock market is poised to end its best year since 1998.

The ratio of profit warnings to positive outlooks for the current quarter is shaping up to be the worst since at least 1996, based on Thomson Reuters data.

More warnings may jolt the market this week, but market watchers say this trend could be no more than analysts being too optimistic at the beginning and needing to adjust downward.

Stocks rallied Friday after a stronger-than-expected U.S. payrolls report and ended nearly flat on the week after eight straight weeks of gains. The Standard & Poor's 500 index (^GPSC) is up 26.6 percent for the year to date, on track for its best yearly gain in 15 years.

"There's a natural tendency on the part of Wall Street in any given year to be overly optimistic as it relates to the back half of the year. It isn't so much the companies' failing, it's where Wall Street has decided to place the bar," said Matthew Kaufler, portfolio manager for Clover Value Fund (VFCIX) at Federated Investors in Rochester, N.Y.

So any negative news about earnings may "already be in the stock prices," he said.

The market has rallied even though it is faced with the inevitable withdrawal of the Fed's stimulus, the drag on the economy of stubborn high unemployment and the threat of rising interest rates.

As the quarter heads to a close, economic data, including the upbeat November payrolls report, suggest the recovery is building momentum, %VIRTUAL-article-sponsoredlinks%so much so that some investors worry the Federal Reserve may begin curbing its stimulus sooner rather than later.

The signs of a strengthening recovery and uncertainty over when the Fed will act have overshadowed a lot of earnings news lately, and that trend is expected to continue.

U.S. primary dealers surveyed by Reuters on Friday said they expect the Fed will start reducing its bond-buying program no later than March. A handful of firms expect the central bank to take action as early as December.

The policy-making Federal Open Market Committee's next meeting is scheduled for Dec. 17-18.

Still, estimates for fourth-quarter S&P 500 earnings have fallen sharply since the start of the year when analysts were building in much stronger profit gains for the second half of the year.

Earnings for the quarter are now expected to have increased 7.8 percent from a year ago compared with estimates of 17.6 percent at the start of the year and 10.9 percent at the start of the fourth quarter.

Natalie Trunow, chief investment officer of equities at Calvert Investment Management, which has about $13 billion in assets, said the outlooks might not be enough to reverse the positive momentum in the market at least in the near term.

"To some degree, [corporate] guidance is used to manage earnings expectations," Trunow said. "In the first quarter, I think people will expect tapering, so that's a negative. The earnings season will have to compensate for that. If [fourth-quarter] earnings are softer than expected, it will be a double negative."

The 11.4 to 1 negative-to-positive ratio of earnings forecasts sets the fourth quarter up as the most negative on record, based on Reuters data.

So far 120 companies have issued outlooks. In a typical quarter, between 130 and 150 S&P 500 companies issue guidance.

In small and mid-cap stocks, the trend appears much less gloomy.

Thomson Reuters data for S&P 400 companies shows 2.2 negative outlooks for every one positive forecast, while data for S&P 600 companies shows a similar ratio.

The S&P 500 technology sector so far leads in negative outlooks with 28, followed by consumer discretionary companies, with 22 warnings for the fourth quarter.

Steep holiday discounts are expected to result in thinner profit margins for some retailers in the fourth quarter.

Third-quarter growth data showed a sharp rise in business inventories and declining consumer demand, raising questions about the impact on earnings.

"It appears while the percentage [of warnings] is high, it's still not really infiltrating to all sectors," said Peter Cardillo, chief market economist at Rockwell Global Capital in New York. "Obviously it impacts the individual [stocks], but maybe not the market trend."

Signs of a disappointing start to the holiday shopping period dragged on consumer discretionary shares last week. The sector declined 0.7 percent.

The weakness gives investors further reason to focus on November retail sales data, which is due Thursday and likely to be the key report of the week.

"The big news will be retail sales," Cardillo said. "It ties in with consumer spending" ahead of the holidays.

9 Numbers That'll Tell You How the Economy's Really Doing
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Can Stocks Weather Grim Profit Outlooks?
The gross domestic product measures the level of economic activity within a country. To figure the number, the Bureau of Economic Analysis combines the total consumption of goods and services by private individuals and businesses; the total investment in capital for producing goods and services; the total amount spent and consumed by federal, state, and local government entities; and total net exports. It's important, because it serves as the primary gauge of whether the economy is growing or not. Most economists define a recession as two or more consecutive quarters of shrinking GDP.
The CPI measures current price levels for the goods and services that Americans buy. The Bureau of Labor Statistics collects price data on a basket of different items, ranging from necessities like food, clothing and housing to more discretionary expenses like eating out and entertainment. The resulting figure is then compared to those of previous months to determine the inflation rate, which is used in a variety of ways, including cost-of-living increases for Social Security and other government benefits.
The unemployment rate measures the percentage of workers within the total labor force who don't have a job, but who have looked for work in the past four weeks, and who are available to work. Those temporarily laid off from their jobs are also included as unemployed. Yet as critical as the figure is as a measure of how many people are out of work and therefore suffering financial hardship from a lack of a paycheck, one key item to note about the unemployment rate is that the number does not reflect workers who have stopped looking for work entirely. It's therefore important to look beyond the headline numbers to see whether the overall workforce is growing or shrinking.
The trade deficit measures the difference between the value of a nation's imported and exported goods. When exports exceed imports, a country runs a trade surplus. But in the U.S., imports have exceeded exports consistently for decades. The figure is important as a measure of U.S. competitiveness in the global market, as well as the nation's dependence on foreign countries.
Each month, the Bureau of Economic Analysis measures changes in the total amount of income that the U.S. population earns, as well as the total amount they spend on goods and services. But there's a reason we've combined them on one slide: In addition to being useful statistics separately for gauging Americans' earning power and spending activity, looking at those numbers in combination gives you a sense of how much people are saving for their future.
Consumers play a vital role in powering the overall economy, and so measures of how confident they are about the economy's prospects are important in predicting its future health. The Conference Board does a survey asking consumers to give their assessment of both current and future economic conditions, with questions about business and employment conditions as well as expected future family income.
The health of the housing market is closely tied to the overall direction of the broader economy. The S&P/Case-Shiller Home Price Index, named for economists Karl Case and Robert Shiller, provides a way to measure home prices, allowing comparisons not just across time but also among different markets in cities and regions of the nation. The number is important not just to home builders and home buyers, but to the millions of people with jobs related to housing and construction.
Most economic data provides a backward-looking view of what has already happened to the economy. But the Conference Board's Leading Economic Index attempts to gauge the future. To do so, the index looks at data on employment, manufacturing, home construction, consumer sentiment, and the stock and bond markets to put together a complete picture of expected economic conditions ahead.
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