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Great Earnings, but So What? Investors Have Other Worries

More than 80 percent of companies have beaten earnings expectations.

Worries about the European debt crisis and a slowdown in the U.S. are holding back a stock rally, despite the positive earnings news.

Growing worries about a European-led economic slowdown are overshadowing what could be the best earnings season ever, at least compared to expectations.

A trader takes a break outside of the NYSE.
Oliver Quillia for CNBC.com
A trader takes a break outside of the NYSE.

More than four of the five Standard & Poor's 500 companies that have reported so far have beaten Wall Street estimates. Yet stocks have barely budged in the more than two weeks that have passed since Alcoa kicked off this round.

The reason for investor hesitation seems clear: Spainhas emerged as the latest and biggest threat in the European debt crisis , while U.S. economic data has been at best mixed and in some cases hinting of a stumble ahead.

"People are saying, how deep is this European thing going to get?" says Sam Stovall, chief equity strategist at S&P-Capital IQ. "Both China and the U.S. are closely tied to Europe. Basically, we're mountain climbers — the U.S. is in front, China is behind and Europe is tethered to us. But if Europe should fall, it could drag the rest of us down the mountain as well."

Thursday's reports featured more sound beats from a pair of Wall Street behemoths — Bank of America and Morgan Stanley — both of which showed stellar profit gains, particularly compared to expectations. Throw in more upside surprises from fellow Dow components Travelers and Du Pont and it seemed as if the market should have been primed for a rally.

But the entire backdrop of earnings has been through sharply lowered expectations. Thomson Reuters I/B/E/S back in October first saw 10.2 percent earnings growth, then cut that view to 5.5 percent in January, before finally lowering its expectations all the way down to 3.2 percent just before the Alcoa release.

Investors, then, may be taking a dim view of companies clearing an aggressively lowered bar.

"That's what companies do," says Stovall, whose firm was looking for just a 0.5 percent S&P 500 profit growth this quarter, which has been adjusted higher to 2.5 percent. "They manage expectations and end up beating as the quarter progresses. We're certainly seeing that."

Lurking as well is the European crisis, which was supposed to be staved off for perhaps years after the European Central Bankinstituted its Long-Term Refinancing Operationto recapitalize banks, which in turn were to use the funds to buy sovereign debt.

But the fund already appears to be drying up and European banks find themselves still in a weakened position, possibly necessitating another LTRO round and yet another effort to convince global investors that the debt crisis can be contained. What might have been a shallow European recession now looks like it could be worse.

That's yet another narrative to help drown out the positive earnings news.

"Global growth is slowing. You're feeling the impact in both Europe and Asia," says Lee Markowitz, partner at Continental Capital Advisors in New York. "The strong earnings is a reflection of what happened in the past. Looking forward, the headwinds are gaining so much momentum that there's no more room for stocks to go up."

Markowitz is so concerned about the global growth picture that he is advising clients to head to full cash allocations in their portfolios and to use any plays otherwise to short the stock market.

Finally, the market has to tangle with sputtering U.S. economic trends.

Weekly jobless claims, perhaps the most-watched data point these days, have been trending higher after getting a boost from increased economic activity due to unseasonably warm weather.

Housing salesnumbers also have been disappointing, and even manufacturing indexes from the various local Federal Reserve branches have been showing pullbacks though employment components remain strong.

"If you look at the economic data, they've been coming in soggier than estimates. That has to be weighing on investor psyches," says Quincy Krosby, chief market strategist at Prudential Annuities in Newark. "While we don't want to think this is another year that the momentum is going to wane and wane dramatically, you look at the data and say, 'Wait a minute, there's a similarity.'"

As such, investors have begun to get defensive.

"It's always a good time to reconsider and reposition," says Mitch Schlesinger, managing director at FBB Capital Partners in Bethesda, Md. "It doesn't mean getting out of stocks entirely, but maybe some defensive positions with dividend plays."

The market had been waiting for a pause off its hard charge from the October lows and got a mild drop in the early part of the month that could get worse if the stormclouds don't part.

"Investors are expecting more of a pullback," Krosby says. "Give them enough of a pullback and there will be buying. But we're not there yet."