Behind the Money

Why Earnings May Be Better Than All the Dire Forecasts

Chief executives and analysts have lowered expectations by so much for earnings reporting season, stocks may continue their 2012 gains as results come in higher than expected.

A fifth of the companies in the S&P 500 have come out with negative warnings about fourth quarter results, compared to just 30 with positive preannouncements, according to Thomson Reuters.

This three-to-one ratio is the most negative since the heart of the recession in 2008.

In the last four weeks, the consensus analyst estimate has dropped on more than a third of the broader S&P 1500 Index, according to Bespoke Investment Group.

Analysts have taken down estimates on a broad group of companies, with Alcoa , Goldman Sachs and Target among the hardest hit.

Alcoa, which reported after the bell on Monday, posted a quarterly loss that met Wall Street's expectations, while revenue was above analysts' forecast, sending shares slightly higher in after-hours trading.

“The ratio of negative to positive earnings preannouncements has been a reliable contrarian indicator of market performance during earnings season throughout the years,” said Jason Trennert of Strategas Research Partners, in a note to clients Monday. “Higher-than-average readings, in contrast, can provide the impetus for upside surprises and, by extension, stronger markets.”

While it may seem counterintuitive, Strategas and others believe that if companies and analysts have already cleared the air, only good news can come out of the earnings season.

Strategas found that that when the negative-to-positive warnings ratio is greater than about two-to-one, the S&P 500 , on average, increases more than two percent during that subsequent reporting season.

Despite the negative announcements and slashed estimates, the S&P 500 is up almost two percent in 2012, following a six percent increase in December. JPMorgan reports on Friday, but the real action heats up next week when more than 40 members of the index provide results.

Recent strong economic data, such as Friday’s better-than-expected jobs report, has added to confidence that forecasts given during this month will be more positive than the actual results.

“As long as the market believes we have solid traction in our economic recovery, than we can live with slashed earnings estimates,” said Jim Iuorio, a trader with TJM Institutional Services.

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