Market Outlook: Profits Need to Beat Forecasts to Boost Stocks
As corporate earnings reports begin in earnest next week, merely meeting Wall Street expectations may not be good enough. Companies may have to beat forecasts to compete for investor dollars.
So many companies issued modest first-quarter guidance in January that many analysts are expecting the actual results to be higher than forecasts.
"It's kind of a mental switcheroo," Steven Lord, chief investment strategist at The Trend Investment Group, told CNBC.com. "Meeting expectations in a reduced earnings environment may not be enough. This is typical for a late cycle when the executives cover their tails, lowering expectations, so that the stock doesn't get killed."
After 14 consecutive quarters of double-digit earnings for the S&P 500, analysts are only expecting earnings to grow 3.4% in the first quarter, according to Thomson Financial. That reflects Wall Street's anticipation of a slowing economy.
This past week, the Blue Chip Economic Indicators panel of economists cut their forecast for U.S. gross domestic product to 2.3% for 2007, the slowest growth since 2002.
Looking Beyond Consensus
Some analysts say if enough companies fail to beat expectations, that could drive the market down.
"If earnings come in at just 3%, even though that's the consensus, I don't think the market will react positively to that," said Vince Farrell, managing director at Scotsman Capital Management.. "My guess is that we will be disappointed."
"I think expectations are significantly higher than that for individual stocks and that's the source of our cautiousness," Alan Skrainka, chief market strategist at Edward Jones, told CNBC.com. "If overall consensus is around 3% and oil stocks are up double digits, that means there will be concerns in other sectors."
However, Bruce Bittles, chief investment strategist at Robert W. Baird, believes lower earnings expectations are already built into current market prices. "If earnings come in at consensus or slightly below, I don't think it's going to have a devastating effect on the market because very few people think we can continue with double-digit earnings growth," said Bittles.
And even if earnings come in above expectations, guidance could have a bigger impact on the stock.
This past week, for instance, Wal-Mart reported better-than-expected same-store sales for March but warned sales could weaken in April.
"It wouldn't be surprising to see companies perform well to the upside in the first quarter, but continue to give forward guidance that's cautious." Jordon Posner, managing director at Matrix Asset Advisors, told CNBC.com.
There's also the danger that continued corporate low-balling of earnings may eventually fail to help the stock.
"Some companies tell it straight, but some are setting the bar lower than they should and they are not giving true guidance," Rick Pendergraft, chief investment analyst for Investor's Daily Edge, told CNBC.com. "The longer it goes on, the more you will see people kind of taking that into account and the stock doesn't really react because there is such a history."
While investing in the broader market may have worked in the recent past, many analysts believe certain sectors or companies are more likely to shine in a slowing earnings environment.
Last week, Alcoa kicked off earnings season by saying first-quarter profit rose 9% due to higher metal prices and strong demand from aerospace and industrial customers.
General Electric , another Dow component, also posted higher first-quarter results, helped by strong demand for heavy equipment. GE is the parent company of CNBC.
This coming week, investors will hear from Eli Lilly, Coca-Cola, Johnson & Johnson, Altria and Caterpillar, as well as major tech companies including Google, IBM, Yahoo and eBay.
"I think earnings will be all over the map," said Vinny Catalano, global investment strategist at Blue Marble Research. "I think a lot of sectors, industries and individual companies are going to surprise to the upside and to the downside. This is going to be a period where selectivity is going to matter an awful lot."
Financial Sector Impact
The financial sector will also have a big impact on the markets this week as many of the major banks and brokerage firms report earnings. Dow component Citigroup reports on Monday with JP Morgan Chase, Bank of America and Merrill Lynch also reporting later in the week.
"I definitely think the financial sector is the most vulnerable sector in the market," said Richard Suttmeier, chief market strategist at RightSide.com. "I'm more concerned about the community and regional banks. That's where the overexposure is to this real estate dilemma that we're facing."
Posner likes the financial sector, but advises investors to stick to the big names.
"The larger banks and brokers are more diverse companies that can withstand the mortgage crisis issue and they are exposed to the M&A activity," said Posner. He recommends Citigroup , which Matrix Asset Advisors owns in its portfolio.
A blowout first-quarter earnings report is no guarantee that a stock will rise. As soon as companies report quarterly earnings, analysts often turn their attention immediately to the company's likely performance for the next quarter and the remainder of the year.
Arthur Hogan, managing director at Jefferies, believes lower guidance can sometimes be a buying opportunity.
Take Advantage of Selloffs
"As you come into next week, buy those companies that have a history of giving lackluster guidance and sort of set the bar low, but beat it frequently," said Hogan. "Take advantage of any selloff during earnings reporting season to add to positions."
Ernie Ankrim, chief investment strategist at Russell Investment Group, urges investors to look for good companies, not so much good sectors.
"Our fund managers are underweight in financial services, but overweight Goldman Sachs ," said Ankrim. "We're sort of neutral in consumer discretionary, but heavily overweight in McDonald's , Starbucks and Google."
Catalano recommends investors put their money in select exchange-traded funds. "I like the defense industry fund, ITA , and Europe 350, IEV ," he said. "I would be short TLT , which is the 20-year Treasury because I think rates are going to rise."
Phyllis Burke Goffney is a News Editor at CNBC.com. She can be reached at firstname.lastname@example.org.