Wall St Week Ahead: US stocks could weather grim profit outlooks

US companies are sounding the alarm on fourth-quarter earnings, lowering profit estimates just as the stock market is poised to end its best year since 1998.

 

The ratio of profit warnings to positive outlooks for the current quarter is shaping up to be the worst since at least 1996, based on Thomson Reuters data.

 

More warnings may jolt the market next week, but market watchers say this trend could be no more than analysts being too optimistic at the beginning and needing to adjust downward.

 

Stocks rallied on Friday after a stronger-than-expected US payrolls report and ended nearly flat on the week after eight straight weeks of gains. The Standard & Poor's 500 index is up 26.6% for the year to date, on track for its best yearly gain in 15 years.

 

"There's a natural tendency on the part of Wall Street in any given year to be overly optimistic as it relates to the back half of the year ... It isn't so much the companies' failing, it's where Wall Street has decided to place the bar," said Matthew Kaufler, portfolio manager for Clover Value Fund at Federated Investors in Rochester, New York.

 

So any negative news about earnings may "already be in the stock prices," he said.

 

The market has rallied even though it is faced with the inevitable withdrawal of the Fed's stimulus, the drag on the economy of stubborn high unemployment and the threat of rising interest rates.

 

As the quarter heads to a close, economic data, including the upbeat November payrolls report, suggest the recovery is building momentum, so much so that some investors worry the Federal Reserve may begin curbing its stimulus sooner rather than later.

 

The signs of a strengthening recovery and uncertainty over when the Fed will act have overshadowed a lot of earnings news lately, and that trend is expected to continue.

 

US primary dealers surveyed by Reuters on Friday said they expect the Fed will start reducing its bond-buying program no later than March. A handful of firms expect the central bank to take action as early as December.

 

The policy-making Federal Open Market Committee's next meeting is scheduled for December 17-18.

 

Still, estimates for fourth-quarter S&P 500 earnings have fallen sharply since the start of the year when analysts were building in much stronger profit gains for the second half of the year.

 

Earnings for the quarter are now expected to have increased 7.8% from a year ago compared with estimates of 17.6% at the start of the year and 10.9% at the start of the fourth quarter.

 

Natalie Trunow, chief investment officer of equities at Calvert Investment Management, which has about $13 billion in assets, said the outlooks might not be enough to reverse the positive momentum in the market at least in the near term.

 

"To some degree, (corporate) guidance is used to manage earnings expectations," Trunow said. "In the first quarter, I think people will expect tapering, so that's a negative. The earnings season will have to compensate for that. If (fourth-quarter) earnings are softer than expected, it will be a double negative."

 

The 11.4 to 1 negative-to-positive ratio of earnings forecasts sets the fourth quarter up as the most negative on record, based on Reuters data.

 

So far 120 companies have issued outlooks. In a typical quarter, between 130 and 150 S&P 500 companies issue guidance.

 

In small and mid-cap stocks, the trend appears much less gloomy.

 

Thomson Reuters data for S&P 400 companies shows 2.2 negative outlooks for every one positive forecast, while data for S&P 600 companies shows a similar ratio.

 

The S&P 500 technology sector so far leads in negative outlooks with 28, followed by consumer discretionary companies, with 22 warnings for the fourth quarter.

 

Steep holiday discounts are expected to result in thinner profit margins for some retailers in the fourth quarter.

 

Third-quarter growth data showed a sharp rise in business inventories and declining consumer demand, raising questions about the impact on earnings.

 

"It appears while the percentage (of warnings) is high, it's still not really infiltrating to all sectors," said Peter Cardillo, chief market economist at Rockwell Global Capital in New York. "Obviously it impacts the individual (stocks), but maybe not the market trend."

 

Signs of a disappointing start to the holiday shopping period dragged on consumer discretionary shares this week. The sector declined 0.7% for the week.

 

The weakness gives investors further reason to focus on November retail sales data, which is due Thursday and likely to be the key report of the week.

 

"The big news will be retail sales," Cardillo said. "It ties in with consumer spending" ahead of the holidays.