U.S. News

Market Outlook: Stocks Face Pitfalls as Earnings Season Begins

Phyllis Burke Goffney

Potential pitfalls in the credit markets and pressure from steadily rising oil prices could create new turbulence in a stock market that analysts say would otherwise benefit from stronger-than-expected corporate earnings.

Starting Monday, earnings season is in full swing and analysts think many companies will weigh in with profits above the Wall Street range. For the S&P 500, the consensus is for second-quarter earnings growth of 4.6%.

"I expect us to see the same sort of chop that we've been seeing since mid-May," Adam Lass, senior market analyst, at WaveStrength Options Weekly, told CNBC.com.  "The market is desperately looking for a clue and it's going to zigzag until it can wrap its mind around something solid."

Stocks have struggled in recent weeks to gain momentum as rising Treasury yields fueled investor concerns about the cost of borrowing money.

"The credit market and fixed-income are driving the noteworthy changes in the financial markets right now," said Stephen Wood, portfolio strategist at the Russell Investment Group. "If money becomes more expensive, will private equity firms be able to buy businesses? I think the fixed-income market stays choppy through the summer."

"There's a lot of uncertainty," said Kevin Kerr, senior analyst at Resource Trader Alert. "We have oil prices making kind of a new high and terrorism acts in London.  Also, we still have the subprime thing lingering overhead."

Oil, Housing Possible Spoilers

Many analysts believe earnings could once again surprise to the upside, giving the market a lift. However, they say the recent runup in oil and continued problems related to housing could spoil the party.

"As we start earnings, people will be anxious to see what impact things like higher energy prices have had on companies," said John Massey, co-head of equities at AIG SunAmerica. "We are also going to be watching to hear from financial companies on the impact from higher yields and mortgage troubles."

This past week, oil climbed above $72 a barrel to trade at a 10-month high after renewed violence and kidnappings in Nigeria, Africa's biggest oil producer.

"People have totally given up hope for $65 or $55 a barrel oil," said Lass. "That's just a continuous drain on the market."

"Oil is most certainly acting as a tax on an already strained American consumer," said Michael Barron, CEO of Knot Capital. "It's simply one more headwind that the economy faces that it doesn't need right now."

Kerr says analysts will be closely watching energy inventory reports next week to see how gasoline supplies fared during the Fourth of July holiday.  "A new high in crude would definitely have a negative impact on the market," said Kerr.

Trouble at two Bear Stearns hedge funds exposed to subprime mortgages fueled recent worries that the subprime mortgage problem would spread to the broader credit market. Martin Weiss, CEO of Weiss Research, believes the housing and mortgage meltdown will continue to weigh on investors.

"The problem we are seeing in the U.S. market, so far, is the tip of the iceberg," said Weiss. "The difficulty Bear Stearns is having is not limited just to them.  There are other hedge funds in a similar situation."

Weiss also predicts the slump in housing will drag down corporate earnings beyond the home builders. "I expect to see some significant disappointments in those sectors tied directly or indirectly to the housing situation and that would include things like home products," he said.

Strategies for Turbulent Times

WaveStrength's Adam Lass believes the housing slump has created an opportunity in real estate investments trusts.  "The REITs have been lumped in with regular homeowners real estate," said Lass. "These guys manage property like high-end malls and buildings in New York.  They're making money."

Lass recommends the Dow Jones U.S. Real Estate Trust , which tracks the price and yield of the Dow Jones U.S. Real Estate Index. The index includes real estate holding companies and REITs.

AIG SunAmerica's Massey likes Proctor & Gamble. He looks for consumer staples that seem like they are at good valuations.  He also likes drug store chain CVS."I think their acquisition of Caremark gives them a lot of advantages over their competitors," said Massey. 

AIG SunAmerica's funds own Proctor & Gamble and CVS.

Weiss suggests investors put their money in companies overseas. "The growth we're seeing in emerging markets is not a bubble, it's a long-term trend," he said. "Overall, I'm skeptical about the U.S. market.  I am very positive on Brazil, China and other emerging markets."

Weiss likes two international exchange-traded funds: the FTSE/Xinhua China 25 Index  and the MSCI Brazil Index. "These two ETFs have continually outperformed the Dow by a wide margin and this pattern continues today."

Ned Gray, senior portfolio manager for the Delaware Global Value Fund, likes Mexican cement company Cemexand French cement maker Lafarge. "We believe they have a very solid fundamental business that has more life to it than it's getting credit for," he said.

Gray also likes hand tools manufacturer Techtronic Industries.  "Again, there's a perception of cyclicality in the business model," said Gray.  "There is actually consolidation going on in the industry and their business model is focused on growing in several different markets."

Delaware Global Value owns Cemex, Lafarge and Techtronic Industries in its portfolio.

Kerr at Resource Trader Alert is particularly cautious, saying investors should stash a good portion of their money in cash right now.

"I'd take a wait and see approach at this point," said Kerr.  "I think a prudent investor would leave at least 50% in cash and then re-evaluate as things unfold."

Phyllis Burke Goffney is a news editor at CNBC.com.  She can be reached at phyllis.goffney@nbcuni.com.