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Profit Outlook Skids Lower, Led By Financial Sector
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News Editor
Third-quarter earnings are expected to be the weakest in five years, but much of the slowdown may be confined to the battered financial sector.
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According to the latest estimates compiled by Thomson Financial, corporate profits are now expected to inch up only 0.2% for the quarter. That's down from a 0.8% increase forecast just the day before and a 6.2% rise expected last July.
The sharply lowered expections are mainly due to the rash of bad news from financial firms, which were hit hard by the meltdown in the subprime and credit markets over the summer.
In recent weeks, financial giants such as Citigroup, UBS, Washington Mutual and Merrill Lynch have all issued profit warnings. And because the financial sector makes up about 28% of the earnings in the Standard & Poor's 500 Index, that's skewing the average for all corporate earnings.
"You cannot have a good quarter without the financials," said Howard Silverblatt, senior index analyst at Standard & Poor's.
"Upside Surprises"
Still, other sectors such as technology and healthcare are expected to show much stronger results. And, as in past quarters, many market watchers think earnings won't be as bad as forecast, leading to some "upside surprises."
"The assumption is that estimates have been brought down so much for the third quarter that the market would easily beat them," said Peter Dunay, investment strategist at Leeb Capital
Management, a New York fund.
Alcoa will be the first of the Dow 30 companies to release its results later Tuesday. The aluminum producer is expected to post a 5% increase in third-quarter earnings.
General Electric, another Dow component and the parent of CNBC and CNBC.com, will report its results on Friday. Others on this week's calendar include Costco Wholesale on Wednesday and PepsiCo on Thursday.
Even though the financial sector will take the brunt of bad earnings, analysts have been lowering expectations for other sectors as well. And some market pros think they may have gone too far.
"I think the estimate for this quarter...is probably too low," said David Spika, vice president and investment strategist of WHG Funds, in an interview on CNBC's "Power Lunch." "The fear of what was going to happen in the financial sector, I think, caused analysts to ratchet down their estimates too far."
Spika expects to see good earnings out of the energy and technology sectors as well as some of the basic materials companies and others in industries exposed to foreign growth.
"I think we’re going to see earnings surprises to the upside - not double-digit levels - but to the upside, and I think the market’s going to be pleased," Spika said.
Large Losses on Loans
The financial services sector has been rocked by turmoil in the credit markets, and will likely post weak profit. Revenue from mortgages and refinancing has shrunk, hurt by a soft housing market, rising default rates, and a liquidity crunch. Liquidity pressures also caused losses in fixed-income investments and dealt a body blow to merger and acquisition activity.
Investors have already seen a mixed bag of results from the major brokerages such as Bear Stearns, which fell far short of analyst expectations, and Goldman Sachs Group, which played its cards right and profited. And there has been a hint of what's to come as Citigroup, UBS, Washington Mutual and Merrill Lynch said they would all record loan-related losses in the third quarter. Wall Street has largely taken these announcements in stride, and some bullish investors think that the banks will be overly cautious with this quarter's charges, so much so that there could be reversals of these items in futures periods.
“The vast majority of the fallout is in a limited number of companies,” James Paulsen, chief investment strategist at Wells Capital Management. “To them, it’s devastating.”
Investors will be paying close attention to several bellwether companies in the lending sector to gauge the extent of the lending crisis. Among them are student lender SLM Corp., which is more commonly known as Sallie Mae, and M&T Bank, which is one of the first regional banks to release its third-quarter results.
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