Business | Markets

Big-name profit warnings may mean a pullback

Market strategists and investors say US stock valuations are broadly out of sync with earnings estimates

  • Reuters
  • Published: 14:16 October 6, 2012
  • Gulf News

  • Image Credit: Reuters
  • Traders atf the New York Stock Exchange. The earnings season will kick off on Tuesday with results from Dow component Alcoa after the bell.

New York: Wall Street may be bracing for a pullback as US earnings season begins next week — if the clouds of profit warnings from bellwethers ranging from FedEx to Hewlett-Packard lead to a downpour of lower profits — or even losses.

Thanks to aggressive stimulus plans from central banks around the world, the Standard & Poor’s 500 index gained 5.8 per cent over the third quarter. That sharp rally occurred even as companies were struggling. Earnings for that period are forecast to fall 2.4 per cent from the year-ago quarter. If that happens, this would be the first earnings decline in three years, according to Thomson Reuters data.

Market strategists and investors say US stock valuations are broadly out of sync with earnings estimates. They forecast a pullback in stocks in the coming weeks as more companies report results and reduce expectations for the fourth quarter and beyond.

Fourth-quarter estimates for S&P 500 companies show a 9.5 per cent gain in profit from a year ago, according to Thomson Reuters data. Analysts say that outlook is too high, given what investors are already hearing from the corporate world.

“It’s a divergence right now where the valuations as far as equity prices [are concerned] have soared, and are really putting in place a stronger economy and stronger fundamentals,” said Alan Lancz, president of Alan B. Lancz & Associates Inc, an investment advisory firm in Toledo, Ohio.

“But earnings will be the telltale sign,” Lancz added. “And if the guidance isn’t particularly strong, the market might be setting itself up for a little disappointment. I don’t see a major correction, but I do see a pullback.”

The earnings season will kick off on Tuesday with results from Dow component Alcoa after the bell. Analysts expect Alcoa’s third-quarter results to show it broke even, down from a profit of 15 cents per share a year earlier, according to Thomson Reuters I/B/E/S.

JPMorgan Chase & Co and Wells Fargo, the first big financial names to report, are also on tap next week.

Blame Europe

Nearly half of S&P 500 companies guiding lower for third- quarter earnings blamed weakness in Europe, according to a Thomson Reuters survey. Another 11 per cent blamed the weak global economy, 8 per cent cited strength in the US dollar, and 6 per cent cited the slowdown in China, the survey showed.

Weakness in the US economy hasn’t helped. The final read on US second-quarter gross domestic product last month showed growth of just 1.3 per cent, weaker than an expected 1.7 per cent.

On Thursday, software maker Informatica Corp issued a profit warning and said business conditions were worsening in Europe. The software company is considered a bellwether because its products are used alongside those made by larger software companies.

“Parts of Europe aren’t just in recession, they’re in depression,” said Jeff Kleintop, chief market strategist at LPL Financial in Boston. “I think [analysts] underestimated the extent of the global slowdown, and maybe are still underestimating it.”

Tech feels chill from China

While estimates have come down sharply in all 10 S&P 500 sectors since the start of the year, technology is one area where the lower expectations are most notable. Slower growth in China is a big factor in that trend.

Earnings growth in the tech sector is expected to be just 2.3 per cent for the quarter, compared with a July 1 forecast of 13.1 per cent. Apple Inc is a big driver of those gains.

Technology’s profit growth has been crucial for the S&P 500.

Minus technology, S&P 500 earnings are expected to be down 3.4 per cent.

The tech sector is where the slowdown in China’s economy is having the biggest impact, Kleintop said.

“They consume a lot of US technology products,” he said.

Recent data shows that the pace of growth in China, the world’s second-largest economy, may slow for a seventh quarter, straining earnings in the tech and materials sectors.

Applied Materials Inc lowered its third-quarter estimates in August, citing China and Europe. On Wednesday, the chip gear maker said it planned to cut its global work force by 6 per cent to 9 per cent.

FedEx Corp, the world’s second-largest package delivery company, cut its fiscal 2013 forecast on September 18, saying a weakening global economy gives its customers a reason to switch to less expensive and slower shipping options. FedEx said its earnings could drop as much as 6 percent for its fiscal 2013 year, which will end in May.

On Wednesday, shares of Hewlett-Packard Co fell a whopping 13 per cent to a nine-year low after it forecast a far steeper-than-expected drop in 2013 profit. The slide in HP’s stock price sharply cut the Dow industrials’ gains for the day.

The S&P 500 sectors showing the biggest projected earnings decline are materials, forecast down 24 per cent, and energy, expected down 18.8 per cent, Thomson Reuters data show, with those declines tied largely to the global slowdown.

In contrast, consumer discretionary stocks are expected to have the strongest profit growth for the quarter, with Thomson Reuters data showing a gain of 7.7 per cent. But in that sector, too, companies, including apparel retailer Express Inc — not an S&P 500 component — have warned about the third quarter.

Anaemic revenue outlook

With tepid revenue growth, US companies have been topping Wall Street’s earnings expectations in recent quarters through cost reductions. That path to beating profit forecasts, however, will become increasingly difficult as many companies have already made most of the obvious cuts.

“Forward expectations are just too high,” said Barry Knapp, managing director of equity research at Barclays Capital in New York.

Revenue for the third quarter is expected to be down 0.1 per cent from a year ago for S&P 500 companies, and down 0.4 per cent minus Apple, Thomson Reuters corporate earnings research analyst Greg Harrison said.

In all, the negative-to-positive ratio for earnings forecasts is 4.3 to 1, the most negative since the third quarter of 2001, he said.

Tech and materials were also among sectors with the most negative outlooks for the quarter, with tech’s negative-to-positive guidance at 5.4 to 1 and materials at 7 to 1.

Corporate America’s concerns were exemplified by General Electric Co Chief Executive Jeff Immelt, who told a meeting of analysts and investors last week: “I think the United States is OK. Europe, we remained concerned about. Asia — our part of Asia, particularly China, is not that bad.”

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