Double Dip or a Bull Market? Earnings Could Tell the Story

Published: Thursday, 8 Jul 2010 | 5:16 PM ET
CNBC

With investors wrestling over whether the market has seen merely a normal pullback or is teetering on brink of something far worse, investors again are likely to focus far more on what companies see in their future than what happened in their past.

"It's not really going to be about the numbers themselves. No one's expecting a lot of top-line growth, no one's expecting blowout earnings except in rare cases," says Michael Cohn, chief investment strategist at Global Arena Investment Management in New York. "It's all about the outlook."

Indeed, expectations from the April through June reporting season are fairly muted.

The Standard & Poor's 500 [.SPX 1070.25 9.98 (+0.94%) ] components are likely to see about a 27 percent earnings growth from the same period in 2009, according to Bank of America Merrill Lynch.

But 2009 numbers provide dubious competition: The economy then remained in the throes of the deepest downturn since the Great Depression and companies were taking essentially a kitchen-sink approach to cutting expenses rather than generating revenue.

Analysts this time around are hopeful that companies will begin to show more progress that growth isn't simply on inventory rebuilding and doing more with less, but with actual increases in production and consumption.

"This isn't a double-dip, it's just a soft spot. We get one in every recovery," says Burt White, chief investment officer at LPL Financial in Boston. "We think the top line is going to definitely move forward and probably be at a post-recession post-crisis high and we're going to be moving in a very positive direction."

Though the economy continues to confront challenges from high unemployment and sovereign debt issues in Europe, White thinks the bigger picture shows a much healthier US economy.

He specifically likes the technology and consumer discretionary sectors while being more pessimistic about energy and materials.

"The bigger issue is the fact that interest rates are zero, the Fed is on the sidelines, input costs are down and employment is moving forward but at a very slow rate, which means profit margins will be very good," he says. "You mix that all together and you end up with a pretty good temperature for companies."

Despite a generally positive mood for earnings, analysts lately have been uniformly shaving both their projections for gross domestic product and employment growth.

BofA/Merrill Lynch cut its 2010 GDP projection from 3.2 to 3.0 percent and the 2011 figure from 3.3 percent to 2.6 percent, while saying its projection for the S&P above 1300 no longer stood. Standard & Poor's itself recently pulled back its projection for the 500 from 1270 to 1190.

But neither firm said the revisions would be reflected in corporate earnings.

"We have long argued that S&P 500 has limited exposure to US consumer discretionary spending and home construction," BofAML analysts said in a research note. "Hence these revisions to US GDP estimates have little impact to our S&P 500 EPS."

Nevertheless, the convergence of conflicting signals provides a tough landscape—weighing relatively good company prospects against signs in the economy that continue to scare investors and keep nearly $3 trillion on the sidelines in money market accounts.

"[E]ven though S&P equity analysts' earnings prospects are positive, our economic forecast is neutral, while our technical outlooks is decidedly negative," Sam Stovall, S&P's chief investment strategist, said in a note.

"Specifically, deteriorating technical equity and fixed-income market indicators and unfavorable historical precedents, combined with heightened volatility...increase the range of investment outcomes, in our view, and merit a more conservative investment stance," he added.

S&P remains on the high side for its earnings projections, looking for a total gain of 42 percent in the quarter and 44 percent for the year, financials, materials and energy leading the way.

Not everyone is so optimistic.

"Earnings may surprise to the upside, causing the market to bounce one more time. But the real issue is consumption and the deflationary environment," says Mike Rubino, CEO of Rubino Financial Group in Troy, Mich. "We do expect downward revisions in the second quarter, which will lead to a cascading of the market."

A number of companies have come to what is referred as the "confessional," with preannouncements to brace the market for what is ahead.

While negative preannouncements have outnumbered the positive by a 70 to 59 margin, that's actually less than the normal 2-to-1 downward ratio.

"It's called under-promise and outperform," Global Arena's Cohn says. "It's going to be tough sledding. There is a good possibility that if the worst doesn't come to fruition by the end of the third quarter, then the market could move up nicely in the fourth quarter."