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Market Outlook: Slower Profit Growth May Still Offer Upside Surprises

Wall Street is sharply lowering expectations for first-quarter earnings growth, but some market pros think individual companies could offer investors some pleasant surprises.

After 14 straight quarters of double-digit earnings gains for the S&P 500, analysts surveyed by Thomson Financial are forecasting first-quarter earnings to grow only 4.5%, roughly half the initial estimate of 8.7%. Analysts polled by Reuters Estimates also dropped their first-quarter S&P 500 outlook to 5.5% growth from 9.2%.

For the year, the Thomson survey projected S&P 500 earnings growth of 6.7%, down from 9.3% intitially, while Reuters Estimates is now calling for a 7.4% gain, down from 9.6%.

Despite these lowered expectations, not everyone is so pesimistic.

"By the time it's all said and done, we sort of sniff a surprise in the making," Michael Thompson, managing director of global research at Thomsom Financial, told CNBC. "It's probably going to come in more 7% to 8%, and that's the historic average for the S&P 500."

Other investment strategists agree.

"Earnings are slowing, but in each of the last four quarters, we've had about three times as many positive surprises as negative surprises," said Dirk van Dijk, director of research at Zacks Investment Research. "I'd say the odds are, we once again have more positive than negative surprises, although perhaps not quite at that three to one ratio."

Sectors to Watch

Some sectors are more likely to beat the trend than others. Analysts expect consumer staples companies will post the best quarterly earnings, with an estimated 11% growth, according to Thomson. Consumer discretionary companies are expected to report the worst earnings, with a decline of 10%.

"The financials will certainly be suffering, but a good question will be how well the consumer durables and consumer disposables are are holding up," Rob Brown, chief investment officer at Genworth Financial Asset Management, told CNBC.com. "We want to see what's going on with the retailers. We're sort of sitting here on pins and needles--waiting."

"I expect the materials sector to have a solid quarter," said Andrew Mickey, senior analyst for BreakAway Investor. "I believe the materials and mining stocks could have earnings as high as 15%. Nickel and cobalt have hit record highs. Also copper prices are back above $3 a pound."

"Certainly the subprime industry is going to have problems," said Jeffrey Saut, chief investment strategist at Raymond James. "I think technology is also going to have a difficult time. (Miscrosoft's) Vista is a complete flop so far. There are inventory builds in tech to work through and the demand isn't there."

Finding Good Bargains

Earnings season kicks off in full swing April 10 when Dow component Alcoa reports quarterly results. Some analysts say investors might want to sit tight in the meantime.

"Our view is that we are at a transition point for the first time in six years," said Brown. "If you are overly exposed in some areas to a pullback, take some of your chips off of the table and put it in short-term Treasuries."

Other analysts still see good stock prospects for long-term investors now.

"We would be overweighting healthcare, which has been a sector with quality earnings and low P/E prices," said Sandy Lincoln, chief market strategist at Wayne Hummer Asset Management. "We also like the tech sector in the higher risk end of the market. The rationale for tech is there are a lot of new launches coming this year from companies including Adobe and Microsoft . Also the sector is not all that expensive by historical standards."

"Go to the energy sector, especially oil services," said BreakAway's Mickey. "One of my favorites is Acergy , (an offshore oil services company that provides seabed-to-surface engineering and construction). They have an order backlog of one and a half years. That's going to be the place to be."

Mickey does not own Acergy personally, but recommends the stock in his newsletter.

"The drilling stocks are our favorite," Craig Hodges, portfolio manager of The Hodges Fund, told CNBC.com. "They have tremendous pricing power worldwide. There is a shortage of deepwater drillers, so their day rates are doubling and tripling."

Hodges recommends Transocean , which is one of the top ten holdings in his fund. He believes the stock should trade at $100 a share on current earnings.

"I would overweight energy and overweight stuff," said Saut. "Stuff would be products like oil, gas, coal, cement and timber. Things the China's and India's of the world need. Demand for commodities is still strong and we're overweight in those areas."

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