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Lower revenue projections pressure earnings and margins

It is still early in the third quarter earnings season, but traders are already focused on the quarter that matters most: the fourth quarter.

For those 58 or so companies that have reported third quarter earnings by Friday, analysts have lowered fourth quarter earnings an average of 3 percent, according to Earnings Scout.

Fourth quarter earnings are continuing to come down and are now negative.

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S&P 500 fourth quarter earnings estimates (source: Factset)

  • September 30: up 0.2%
  • Today: down 1.5%

It's typical for earnings estimates to be revised downward in the middle of a quarter, but even accounting for this the decline is more aggressive than usual.

That means what analysts are hearing — either in the form of direct guidance or by body language — is not encouraging them.

IBM is the latest big name to send signals that fourth quarter earnings and revenues need to come down. Overnight, at least 10 analysts — including Toni Sacconaghi at Bernstein Research — took numbers down.

Look how much analyst estimates have changed in two days.

IBM fourth quarter analyst estimates:

  • October 19: $5.52
  • October 21: $4.92

That's a decline of roughly 12 percent.

This morning United Technologies reported a Q3 top line beat but revenues were notably light. While the company reaffirmed full year guidance of $6.15 to $6.30, the Factset consensus estimate is $6.29. I can assure you analysts will be taking down Q4 earnings estimates (consensus is $1.55) by a dime or so in the next couple days.

Chip maker Rambus also said this morning that Q4 revenue guidance would be about 11 percent below consensus.

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They are not alone. Analysts are taking down Q4 earnings and revenue estimates, in many cases aggressively. And this is not an industry specific issue. From chips (Micron and Rambus) to agriculture (Monsanto) to slower China consumer (Yum and Wynn) and the oversupplied commodity market (Alcoa). What's behind the downward revisions?

There are several issues, but aside from company specific issues like IBM (which has been losing market share in its core businesses to competitors for several years), the main culprit has been weaker revenues.

Last night industrial giant Eaton guided Q3 operating profit to 95 cents $1, well below prior guidance of $1 to $1.10 and FactSet consensus of $1.01. The issue: Revenues are well below expectations.

A second, but still very important, issue for Q4 revenues is the impact of the strong dollar on multinational companies that get more than half their revenues overseas.

Take IBM, which gets about half its earnings overseas. Look at the reported revenues by region (which includes the effect of the stronger dollar) and then adjusted in constant dollars for the same period last year (and the divested System x business):

IBM Q3 Division Revenue

Europe/Middle East/Africa:

  • Reported: down 16 percent
  • Constant currency: up 1 percent

Asia/Pacific:

  • Reported: down 19 percent
  • Constant currency: down 1 percent

These are enormous differences. Anyone trying to understand the revenue decline needs to factor in currency effects.

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What's the impact of these lower revenues? It means there will be margin pressure.

Despite the fact that we are in an earnings and revenue recession (two or more consecutive quarters of year-over-year declines) stock prices have held up relatively well because margins have been strong. S&P 500 margins of 10.1 percent are near the 10.5 percent record set last quarter. But consistently declining revenues means those margins will be under pressure. To maintain those margins, you are going to have to cut costs.

That holds out the potential for layoffs.

  • Bob Pisani

    A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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