Will A Bad Earnings Season End The Rally?

MSN Money April 10, 2012

4/9/2012 7:06 PM ET

By Jim Jubak

Alcoa's profit reports kicks off what promises to be a challenging season. Here's what to watch for from a few key companies -- and how to come up with a game plan.

Everybody "knows" that first-quarter earnings growth for U.S. stocks will be anemic. The projection for year-to-year earnings growth on Standard & Poor's 500 ($INX) stocks is just 0.93%, according to Standard & Poor's Capital IQ. That compares with 19.68% earnings growth in the first quarter of 2011.

Logically, this means stocks are headed for a correction as companies report their first-quarter results beginning with Alcoa (AA) on Tuesday.

"Logically," that is, for realms outside the stock market. In the logic of the stock market, however, the result is by no means certain. What "everyone knows" is frequently already accounted for in share prices. But sometimes, what everyone knows isn't really believed by investors.

Intellectually, investors may know that projections for first-quarter earnings growth are extremely low, but in their hearts -- and in their investment actions -- they may remain much more optimistic. And, anyway, the earnings results of last quarter are history. For stock prices going forward, the important numbers are companies' projections -- guidance -- for the second quarter and the rest of 2012. Expectations for future growth are what make investors buy or sell.

Latest news on earnings season

So what will it be -- up or down? -- for the market this earnings season? And what strategy do I recommend?

I wouldn't recommend any big directional bet on the market as a whole -- I think the uncertainties are too high. But I would like to be sitting on some cash. (My Jubak's Picks portfolio finished 2011 with almost 40% in cash, and, despite some recent buys, I've still got a hefty cash position. So do you, if you did some selective selling into the rally. Otherwise, you might need to do some selective selling now to be ready for investing opportunities.)

Jim Jubak

I want to be ready to jump on any sell-off because of a short-term disappointment in a stock I'd like to own for the long term. The second half of 2012 looks better in global macroeconomic terms than the first half of the year, and I'd love to pick up some fundamentally strong long-term buys at temporarily depressed prices.

So let me explain how I calculate the risks and uncertainties of this first-quarter earnings season.

The current projection of just 0.93% year-to-year earnings growth doesn't capture how rapidly pessimism about earnings in the first quarter has set in. In September, Wall Street was looking for 10% growth in the first quarter. By January, projections were down to 4.5%, according to S&P Capital IQ. And now we're at 0.93% with the quarter done and earnings reports set to start arriving.

For the first quarter of 2012, earnings per S&P 500 share are projected at $23.85. In the first quarter of 2011, earnings per index share came in at $23.63.

Of course, the S&P 500 Index finished the first quarter of 2012 at 1,408.47, up from 1,325.83 on March 31, 2011. The index is thus 6.23% higher than it was a year ago, even though growth in the quarter just completed is projected as 18.75 percentage points lower than in the first quarter of 2011.

Add in the sentiment and macroeconomic background, and it looks as if we're headed for an almost-certain sell-off. This rally was up 28.1% from the Oct. 3 low through March 31. Many investors are sitting on big profits -- exactly the situation that leads to profit-taking as sellers decide to protect their gains. After the disappointing jobs number for March -- just 120,000 new jobs when the market was looking for 205,000 -- voices calling the market overbought and in need of a correction have gained in number and volume.

Sinking Spanish and Italian bond prices -- and rising yields on Spanish and Italian bonds -- have raised fears that the eurozone is facing another round of its apparently never-ending debt crisis. Higher-than-expected inflation from China in March -- a 3.6% annual rate, instead of the 3.4% expected by economists -- was announced over the weekend, increasing worries about growth in that economy. These factors certainly haven't helped.

I think that meager first-quarter earnings growth, against a background of macroeconomic worries and sentiment looking for a correction, is likely to produce a drop in market indexes.

But I don't think that's by any means as certain as a backward-looking analysis of the market and the economy would suggest. Guidance for the second quarter and the rest of 2012 will be key.

Case study in aluminum

Let's use Alcoa, which reports Tuesday, as an example. Even if you don't care a penny about Alcoa, the stock is a perfect template for how the earnings season is likely to play out.

The consensus among Wall Street analysts is that Alcoa will report a first-quarter loss of 3 cents a share. That would match the loss of 3 cents a share, after one-time items, for the fourth quarter, but it would represent a big drop from the 28 cents a share recorded in the first quarter of 2011.

The earnings pattern here isn't encouraging. From 32 cents per share in the quarter ended in June, earnings at Alcoa have dropped to 14 cents in the third quarter to a 3-cent-per-share loss in the fourth quarter. Analysts have cut their projections for the first quarter from 10 cents a share 90 days ago to the current consensus of another 3-cents-a-share loss. The spread isn't encouraging, either, with a high analyst estimate of 7 cents per share to a low estimate of an 11-cent-per-share loss.

All that information is already out there and is part of the reason shares have fallen 9.2% from March 19, the March high, to the April 6 close.

Nobody is going to be surprised if Alcoa reports a loss. But the stock might drop if some of the folks who currently hold the shares are among the optimists hoping for 7 cents a share and decide to sell on a report of a loss.

The surprise might indeed be if Alcoa beats the estimates by a penny or two. That might push the shares up in after-hours trading.

But the make-or-break on the shares, the thing that might make them move up or down substantially -- and that might actually generate a trend in the stock that might last more than a day or two -- is what Alcoa says about the second quarter and the rest of 2012. When the company reported fourth-quarter earnings in January, it said it expected aluminum consumption to grow by 7% in 2012, down from 10% growth in 2011. According to the company, China would continue to grow faster than the global economy as a whole, at 12%.

The decline from 10% growth in 2011 to 7% growth in 2012 wasn't quite as disheartening as it sounded. The company was looking for a drop in global production that would support aluminum prices as about 1.1 million metric tons of production in China went idle and the rest of the world kicked in an additional 700,000 tons of curtailments.

But it wasn't exactly good news, either, because 531,000 metric tons of that global curtailment would come from Alcoa itself. The company confirmed those cuts, announced in January, on April 5.

And that's where we stand. I think what the stock market wants to hear from Alcoa isn't whether first-quarter earnings were a few pennies lost or gained but what the company now projects as global demand growth -- is it still 7%? -- and its projection of demand growth from China -- is it still 12%? -- for the rest of 2012. That will drive the trend in the stock.

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The stock market has been over rated for the past year. Every company has been hurting but has shown some sort of profit by changing their models of doing business. (i.e.- laying off people, selling assets. ) All this has done is rob Peter to pay Paul and to show a small profit so that people will dump more money into these companies. Remember Enron? That is what they did and look what happened to everyone that worked for them and to the people that held their stock.

0 0ReportSpamslodeth1 hour ago

Wow!!! With expectations so low for earnings what happens when every company exceeds expecatations. I don't think I am headed for the sidelines just yet. The selloff before earnings is typical of investors dumping and creating fear so they can buy back cheap. April has always been the best month for investors...let's see what happens.

1 0ReportSpamRicky Bebe1 hour agoFor God sake PROPHET, throw Willman a flashlight so he can find the exit door. 0 1ReportSpamjlum2 hours ago

The future smells like QE3.

2 0ReportSpamRichmingle.com...the millionaires dating4 hours agoNever end guys.. but for us , we should know how to be a millionaire ... 1 0ReportSpamWillman7 hours agoOnly idiots try to time the market. Long term investment is the way to go. Ignore the day to day noise... 1 19ReportSpamseniorkissing .com10 hours agoWhether you're looking for fun conversation or serious discussion of single life at 50+, you've come to the right place......share thoughts, ask questions, and find out what other 50+ singles are thinking. Meanwhile come to meet activity partner, soul mate, companion, romance, friendship, or ideal match. Admirers of 50 plus singles are also encouraged to join. Look at my name,it is a nice place for older people.Best wishes to everyone

The two left Bob to his own devices. The old riverman and the astonishingly thawed and rejuvenated Mr. Fox disappeared in the private office. Bob proffered a question to the busy Collins, discovered himself free until afternoon, and so went out through the office and into the clear open air.

2 9ReportSpamTheprophetofprofit.14 hours ago

Earnings, schmearnings.

Analyze the obvious until it hurts or, head for the sidelines until we get a better read on what happens in November. I try to keep it simple.

It frees up more time for golf. Even the President knows that.

21 1ReportSpamAdd a commentReportPlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease use this form to notify the moderators. They will investigate your report and take appropriate action. If necessary, they report all illegal activity to the proper authorities.CategoriesSpamChild pornography or exploitationProfanity, vulgarity or obscenityCopyright infringementHarassment or threatThreats of suicideOtherAdditional comments(optional) 100 character limitAre you sure you want to delete this comment?/**/ DATA PROVIDERS

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[BRIEFING.COM] The major market averages have rolled over to session lows as the Nasdaq leads the decline with a loss of 1.7%. ViroPharma (VPHM 23.21, -5.40) is lower by 18.9% on word that Akorn launched the generic version of the company’s Vancocin after the Food & Drug Administration denied its citizen petition regarding bioequivalence and exclusivity. Today’s weakness has dropped the stock to its worst levels since November 28. ... More

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