"Investors Shouldn't Panic"

The Street has already anticipated an earnings slowdown, says S&P's David Wyss, who predicts a post-election rally

While the third-quarter earnings season doesn't officially start until Oct. 7, negative preannouncements are already starting to pile up. On Sept. 10, aluminum manufacturer Alcoa (AA ), a Dow component, warned that it could miss profit estimates by 42%, driving blue-chip stocks down early in the day. And in recent weeks, chipmakers Texas Instruments (TXN ) and National Semiconductor (NSM ) have reduced revenue expectations and warned about softer-than-expected demand. Among the companies due to report this week are Best Buy (BBY ), Campbell Soup (CPB ), Kroger (KR ), and Oracle (ORCL ).

The third-quarter preannouncement negative-to-positive ratio -- a measure of whether preannouncements from S&P 500 companies are bad or good -- is at 1.7. That's well above what it was in recent quarters, though slightly below the historical average of 2.0. But despite what some see as a disappointing outlook, it's likely the market won't take a big hit, believes David Wyss, Standard & Poor's chief economist. "Investors shouldn't panic about the negative preannouncements because they appear to have discounted slower earnings growth already," he says.

Wyss corresponded by e-mail with BusinessWeek Online's Suzanne Robitaille about what to expect this coming earnings season. Here are edited excerpts of their exchange:

Q: Will negative earnings preannouncements this early hurt the market?


Stock prices don't seem to have risen on the stronger-than-expected second-quarter earnings, which suggests they are pricing in a slowdown in the second half.

Q: Do you think companies will make more negative preannouncements this than usual?


I think they'll be about normal. We've had a period of outperforming expectations. I think that expectations are coming into line with reality and that there will be fewer surprises.

Q: Why is earnings growth decelerating so sharply?


Earnings are decelerating in large part because the base is so much higher for the second half. Earnings started to jump in the second half of 2003, and we just can't get the same kind of percent increases off that high base. Corporate profits are at a record high relative to gross domestic product, so it's hard to see them rising faster than GDP much longer.

Going forward, the economy is slowing due to rising interest rates, the absence of further tax cuts, and still-weak employment growth. Higher oil prices have caused us at S&P to lower our forecast further. Slower GDP growth will imply slower earnings growth.

Q: Best Buy, Campbell Soup, Kroger, and Oracle are reporting third-quarter results next week. Can the market shrug off any weak reports from these companies?


Weakness in one sector or small set of companies is not likely to upset [the market].

Q: What's your projection for third-quarter earnings growth?


We see a 16% rise. We expect 2005 operating earnings to rise about 7%, just slightly above nominal GDP growth.

Q: Some forecasters see a rally even if third-quarter earnings miss expectations. What do you think?


I think we'll see a post-election rally even if earnings are near expectations. The end of election uncertainty, at least if there's not a major terrorist event, should help.

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