Even middling Q4 earnings could lift stocks
With expectations low, a beat-and-raise quarter may be in the cards.
Aluminum giant Alcoa (AA) kicked off fourth-quarter earnings season on Monday by swinging to a deep net loss compared with a strong year-ago profit. And Alcoa's report was actually pretty good news. If the Dow component's results are any indication of things to come, a relatively lackluster earnings season could still provide a lift to stocks.
That's because even though Alcoa recorded a net loss, on an adjusted basis it matched Wall Street's estimate, according to data from Thomson Reuters. Even better, revenue came in well above analysts' average forecast, and the company said demand for aluminum is rising.
In other words, results weren't nearly as bad as feared -- and the market loves pleasant surprises. Given the tepid outlook for fourth-quarter corporate incomes, more of what Alcoa -- which is InvestorPlace editor Jeff Reeves's top stock pick for 2012 -- delivered is just what stocks need.
Earnings growth is expected to slow sharply in the most recent quarter, as profit margins looked to have peaked. True, corporate income hit record highs in recent quarters, but that was driven by margin expansion, not sales growth, which continues to remain sluggish.
Recall that in the midst and immediate aftermath of the recession, companies slashed costs by laying off workers. They also benefited from lower energy and other input costs, which have since rebounded off their lows. (Oil, for example, is back at $100 a barrel after dipping below $40 during the depths of the downturn.)
Those margin- and profit-boosting effects are now mostly played out, and so it has come to this: The S&P 500 is expected to post quarterly earnings gains of just 7.8% year-over-year, according Thomson Reuters data, the slowest growth rate in two years.
More troubling is that companies have been slashing guidance. High-profile retailers such as Target (TGT), J.C. Penny (JCP), Kohl's (KSS), Children's Place (PLCE) and American Eagle Outfitters (AEO) all issued disappointing outlooks last week after reporting weaker-than-expected December sales.
Indeed, companies in the S&P 500 have issued 99 negative earnings preannouncements for the fourth quarter vs. 30 positive preannouncements. That's the worst ratio since the fourth quarter of 2008, during the last recession, write Thomson Reuters analysts Jharonne Martis and Greg Harrison
The question for investors in the short run is how much of the slowdown is already reflected in share prices. The forward price-earnings ratio of the S&P 500 stands a bit above 12, according to Birinyi Associates -- a bargain-basement level. That's partly due to anxiety over the euro zone crisis, but it also reflects at least some recognition that earnings growth is slowing and S&P P/E's future trajectory is unclear.
Fortunately, if there's a silver lining for investors heading into earnings season, it's that expectations are very low, and nothing gives stocks a pop quite like companies beating Wall Street estimates and -- especially -- raising their guidance.
Deutsche Bank chief equity strategist Binky Chadha thinks a beat-and-raise quarter is very much in the cards for the market. The S&P 500 should eclipse Street estimates and, in the aggregate, raise its outlook, Chadha says in a note to clients, partly because analysts cut their forecasts more than corporations lowered their guidance.
Furthermore, upward earnings revisions historically follow macroeconomic data surprises, notes Chadha, and we've seen plenty of good news lately, at least as far as the U.S. economy is concerned.
If that beat-and-raise scenario comes to pass, stocks could shrug off an earnings season of less than double-digit-percent growth -- and perhaps even shine. If nothing else, Alcoa's better-than-expected report looks to have gotten the season off to a decent start.
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