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As stocks hit record highs, so do profit warnings

Adam Shell
Thursday, 12 Dec 2013 | 12:20 PM ET
Trader on the floor of the New York Stock Exchange.
Getty Images
Trader on the floor of the New York Stock Exchange.

A potential warning to stock investors: the fourth-quarter earnings pre-announcement season is shaping up to be the most negative on record.

In what seems like a major disconnect, the number of profit warnings relative to upbeat guidance is the widest it has ever been—at a time when the U.S. stock market is trading near record territory. The S&P 500 stock index notched a new closing high of 1809 Monday.

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For every 10 companies warning of weaker-than-expected earnings for the October-through-December period, only one has said it will top forecasts, says earnings-tracker Thomson Reuters.

The actual 10.4-to-1 negative-to-positive pre-announcement ratio is on track to eclipse the prior record of 6.8 warnings for every positive one back in the first quarter of 2001. The long-term ratio is 2.3 warnings for each positive one.

"This is off the charts, I've never seen it this high," says Gregory Harrison, analyst at Thomson Reuters.

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Is this mass downgrade of the year-end profit outlook by corporate CEOs, which some blame on the 16-day government shutdown, a threat to the stock market's upward march?

Oddly,despite CEOs muted outlook, Wall Street, while worried, doesn't necessarily seethe weak earnings guidance as a bull market killer.

Wall Street has come up with a handful of reasons why the negative earnings data might not be as damaging to the bull case as one might imagine.

(Read more: Forget profit, new fund trades on superstition)

1. Estimates already slashed. Since the start of 2013, Wall Street has cut profit forecasts in half for the final quarter of 2013. Analysts now expect 7.8 percent growth, down from 17.6 percent on Jan. 1 and 11 percent on Oct. 1. In short, the bar companies must hurdle has already been lowered.

2. CEOs more cautious.
"Corporate leaders are very unsure about the outlook," says Alan Skrainka, chief investment officer at Cornerstone Wealth Management. "Setting low expectations is the best way to avoid a (profit) disappointment later." Stocks tend to perform better when a company tops profit forecasts.

Mark Litzerman, equity research manager for Wells Fargo Private Bank, notes that CEOs have been issuing more negative guidance in recent quarters. Indeed, four of the 10 most-negative profit pre-announcement seasons have come in 2013.

3. It's still a Fed-driven market.
Stocks have been driven by the Federal Reserve's easy-money policies the past few years. And while CEO profit warnings are worrisome, "an earnings disappointment will be transient if the Fed waits until March to taper,"or reduce its monthly bond purchases, says David Kotok, chief investment officer at Cumberland Advisors.

4. U.S.companies are strong.
Sure, CEOs are cautious, but U.S. companies have posted record profits every year since 2011. "Although companies' earnings may slow they're still making a ton of money and cash flow is even better," says Neil Hennessy, chief investment officer at Hennessy Funds.

5. Profits to improve. "I think we'll get some modest improvement in earnings in 2014," says Bob Doll, chief equity strategist at Nuveen Investments. Profitability will get a boost from consumers that feel richer due to rising stock and home prices. He also expects U.S. companies to spend more and sees stronger growth in Europe and China.

—By Adam Shell, USA TODAY.

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