Praying for Good Earnings
By Amey Stone
For at least a little while on Apr. 15, it looked as though General Electric's (GE ) uplifting report on first-quarter earnings would be enough to get stock buyers back in the game. The Dow Jones industrial average had fallen 125 points on Apr. 14, following a 104-point drop the day before. But stocks bounced only briefly on news of GE's 25% profit jump and management's expectation of broad-based strength for the rest of 2005 and into 2006. In a less nervous time, such news might have sparked a Wall Street rally.
Instead, jolted by mounting evidence of an economic slowdown as well as a serious disappointment from tech bellwether IBM (IBM ), investors resumed their selling. The Dow closed down 191 points on Apr. 15 for a total three-day slide of 421 points, or 4%.
Now investors are left praying that as earnings season really kicks into gear the week starting Apr. 18 -- only 13% of the S&P had reported by the morning of Apr. 15 -- the news will prove positive enough to lift the market out of its funk. At this rate, reports will have to be darn good.
Investors have been battered since April began with disappointing economic reports. The murky climate actually traces back to weak March payrolls, continuing with a surging trade deficit. And March retail sales saw only half the growth expected. Consumer confidence is a slippery slope downward by many measures.
Most unnerving of all was the 5-cents earnings miss from IBM. Wall Street expected earnings per share of 90 cents, but Big Blue reported EPS of only 85 cents, citing an inability to close deals at the end of the quarter, especially in countries with "soft economic conditions." Ouch!
Such shocks aside, the leading edge of earnings season has been pretty decent in aggregate. Aside from the few clunkers like IBM and Harley Davidson (HDI ), bright spots have been common, such as Apple (AAPL ), PepsiCo (PEP ), Southwest (LUV ), and Citigroup (C ). While not as many companies have beat targets on average -- and more have fallen short -- at this stage "that's by no means a valuable forecast of how a quarter is going to finish out," says David Dropsey, research analyst with Thomson Financial.
Wall Street is expecting earnings growth of 8.6% for the first quarter of 2005, which comes on top of growth of 27.5% in 2004's first quarter. "Earnings growth is slower, but net earnings are still at their highest level, and they continue to increase," Dropsey points out.
The problem is that investors are now paying more attention to management commentary about the future than to the report on the past quarter -- and that commentary hasn't been very optimistic, says Nicholas Bohnsack, an investment strategist with International Strategy & Investment in New York. "We've seen a pattern of companies coming in with strong earnings but cautious about the second quarter or balance of the year," he says.
ISI, like many strategists, recommends that investors shift out of consumer cyclical stocks in favor of more defensive sectors such as utilities and consumer staples. That rotation between stock groups has contributed to market volatility, Bohnsack says, but he doesn't believe it presages a major meltdown.
After all, while the bad news is that the economy has hit a soft patch, the good news is that some of the factors that brought it about are already starting to change for the better. Crude oil trading on the New York Mercantile Exchange has dropped to $50 a barrel, from a high of $57 just weeks earlier. And minutes from the Federal Reserve meeting on Mar. 22 indicate that rate hikes for the rest of the year won't be as aggressive as many investors feared.
"The recent softening of oil prices may be the harbinger of better times for employment and consumer spending," surmised Moody's Investors Service in an Apr. 14 report. Moody's analysts also noted that the labor market is in good shape -- improving enough to keep consumers spending, but not enough to spark inflation.
Edward Yardeni, investment strategist at Oak Associates, believes the underlying economy is sound. "There is no foreseeable reflation, stagnation, deflation, or recession in my outlook," he wrote in an Apr.13 report.
"At some point, we'll start to see the impact of lower oil, and people will realize the Fed has stopped tightening," says Bohnsack. Even before that, "the market is going to discount the fact that, after the economy slows, it's going to reaccelerate."
Some investment strategists believe a buying opportunity is around the corner, particularly as stock valuations drop. But most investors will want to see the downward momentum reverse before they jump in. Apr. 18 brings earnings from Bank of America (BAC ) and Eli Lilly (LLY ). On Apr. 19, Johnson & Johnson (JNJ ), Yahoo! (YHOO ), and Intel (INTC ) report. In quick succession afterward come Ford (F ), eBay (EBAY ), McDonald's (MCD ), and Merck (MRK ). Watch for these earnings reports to set the stage -- for better or worse.
Amey Stone is a senior writer at BusinessWeek Online
Edited by Patricia O'Connell