Earnings Will Be Bad, But What's Ahead Matters More

The worst kept-secret on Wall Street is that this quarter's earnings season will be disastrous. The best-kept secret is what lies beyond the carnage.

It's what's past the horizon that pre-occupies market-watchers these days, as investors look for some daylight to crack through the recession storm.

"The biggest question for everyone is, have the share prices already discounted not the fourth quarter (of 2008) but the second quarter and third quarter of this year?" says Quincy Krosby, chief investment strategist at The Hartford. "Obviously, everyone is going to focus on guidance. The question is, how much guidance does anyone have at this stage?"

But trying to divine some critical post-recession truths could be easier said than done.

Outlooks are likely to paint an equally grim picture as earnings, though companies could provide clues as to what to expect in the later part of the year when the worst of the recession is expected to pass.

Specifically, investors will be looking to see what President-elect Barack Obama has in store in terms of tax policy and economic stimulus.

"What we expect is choppiness and headline risk, but also headline gains," Krosby says. "We're hoping there's a positive surprise from the stimulus package in terms of tax cuts for corporations. Because there's so much unknown, it's a difficult haul."

As for earnings reports, the two primary areas Wall Street will be looking at are the employment picture and the outlook for credit.

If bellwether companies report that there won't be major layoffs, and CEOs start talking about being able to raise capital after a year in which money was as scarce as hope, that could lead to optimism and prevent a major earnings-season selloff.

Earnings have been a mixed bag in the first week, with large banks on tap next week after Citigroup reported earnings Friday that weren't quite as bad as some had expected.

"What the equity markets on a macro level want is some clarity on liquidity, and end this sort of deer-in-the-headlights look that seems to be permeating every aspect of business," says Lee Schultheis, chief investment strategist and portfolio manager at AIP Funds in Harrison, N.Y. "I doubt there's been a situation in most everyone's collective market history where they felt less certainty on what general conditions will be like."

And with the uncertainty, investors are likely to hedge their bets with cautious equity plays and a continued preference for corporate debt rather than stock.

Cyclical stocks, such as energy, materials and consumer discretionary should be popular, as will some hidden gems in the beer and tobacco industries--sectors that tend to benefit in economic hard times.

Overall, though, investors are likely to be cautious.

"Earnings continue to get worse yet the stock market itself isn't. Some are taking that as a positive sign that the markets are looking forward to the recovery and that may well indeed be the case," says Chip Hanlon, president of Delta Global Advisors, in Huntington Beach, Calif.

"The other way to look at is, is the stock market kidding itself that the recovery will be here earlier than it really will? ... I just think that investors are going to end up being surprised that as bad as things are in the fourth quarter they are likely to be worse through the first quarter and through the year."

CONTINUED : Pockets of Strength

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