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Market's Next Big Worry: A Dismal Earnings Season Ahead

An ominous cloud is about to hover over the stock market's feel-good 2012 story: Earnings season, which begins in just a few weeks, is shaping up to be the worst since the financial crisis.

Traders work on the floor of the New York Stock Exchange
Getty Images
Traders work on the floor of the New York Stock Exchange

Projections for first-quarter earnings growth are running as low as 0.5 percent, according to Standard & Poor's/Capital IQ. And that's coming off a mediocre fourth quarter from 2011, indicating that the days of big earnings improvements that followed the depths of the 2008 financial crisis are over.

"If there's a concern, it's earnings," says Jim Paulsen, chief market strategist at Wells Capital Management in Minneapolis. "Earnings are going to be far slower than they've been. There's almost no way by the laws of physical science that they can't be."

What that will mean to the stock market and its bull run that began in Octoberis unclear.

After all, stocks have powered higher before without the benefit of strong earnings to back them up, and those betting on the market to keep roaring here are hoping the same thing happens this time.

But after a surge that has taken the S&P 500 up 28 percent in five months, a psychological nudge could be all the marketneeds to lose some shine.

"We built the earnings already. We did a good job of it — now it's more about getting paid for what we already built," Paulsen says. "If you're going to tell me earnings are going to collapse, that is a real concern. The markets will have a problem with that. If you're going to tell me that earnings are going to slow to 5 percent growth, I don't think that's an issue. In some sense, it's a natural progression."

Corporate America is coming off a quarter in which 63 percent of S&P 500 companies beat earnings estimates.

But those beats came on sharply lowered expectations, and the primary drivers for the aggregate beat were blowout earnings from Apple and Caterpillar . Until those two bellwether companies reported, the beat rate was running closer to 55 percent.

Some are wondering whether the market can get away with an even worse performance this time around, particularly considering how far stocks have run.

"Traders are now really fearful that companies are not going to be able to hit their earnings targets next time around," says Todd Schoenberger, managing director at LandColt Trading in Lewes, Del. "That may be the catalyst to really get stocks trending lower, and it could very well stay that way the rest of the year."

S&P is expecting full-year earnings growth of 5 percent that would send the "500" to an aggregate of about $105 per share.

In this upcoming period — earnings season officially kicks off April 10 when Alcoa reports — the best sectors are expected to be industrials (10 percent growth) followed by information technology (4 percent) and consumer discretionary (3 percent). The weakest sectors likely will be materials (down 15.5 percent), telecom (minus-14 percent) and utilities (down 4 percent), according to Sam Stovall, S&P's chief equity strategist.

In all, six of the 10 S&P 500 sectors are likely to see earnings declines.

Companies themselves have been preparing investors for a letdown, with the level of negative preannouncements at their highest level since the March 2009 market lows.

And money continues to pour out of domestic stock-based mutual funds, with another $2.84 billion leaving last week, according to the Investment Company Institute.

"The bar is set pretty low. People aren't really expecting much," Stovall says. "We had a very nice run in the market. If there is to be a disappointment, now would be the time for it to occur."

Investors, then, may be gearing up for another round of sell-in-May-and-go-away, which was a highly successful strategy in 2011.

"Going forward, everyone wants to know where the earnings are coming from," Schoenberger says. "Realistically, you probably should lock in the gains while you gain."