Fourth-Quarter Earnings May Be Flimsy

Fourth-quarter earnings season is expected to look relatively strong at first glance -- but dig a little deeper, and there isn't much to get excited about.

In a few weeks, companies will begin reporting results for the final quarter of the year, and analysts are forecasting 12.9% year-on-year growth, according to earnings tracker Thomson Financial/First Call. Profits grew 6.8% in the third quarter and 1.4% in the second quarter. They fell 11.5% in the first quarter.

"The fourth-quarter comparisons are the easiest of the year," due to low numbers in the prior-year quarter, said Joseph Kalinowski, chief investment officer at Ehrenkrantz King Nussbaum. "That is part of the reason why forecasts are high."

Earnings warnings have continued to pile on the market in recent weeks. So far, 603 companies have said that fourth-quarter earnings will come in below expectations, compared with 511 warnings at this point in the third quarter, according to Thomson Financial/First Call.

Negative preannouncements may be a drag on analysts' forecasts over the next two weeks. "The consensus is likely to come down to the high single digits or low double digits," said Kalinowski.

To take a sector view, most of the weakness is expected to be concentrated in retail and technology.

Several companies, including Wal-Mart (WMT), Federated (FD) and Target (TGT), already have said that sales were weak in December, when consumers were reluctant to spend on holiday gifts.

Meanwhile, technology firms CompuDyne (CDCY), Silicon Storage (SSTI), Ultimate Electronics (ULTE) and Midway Games (MWY) have said they would miss fourth-quarter estimates.

"These warnings were the key reason that we did not have a Santa Claus rally," said Kalinowski.

More negative news may come from the financial sector. It is not unusual for banks to take charges in the fourth quarter to clean up their books before the beginning of the new year. Last week, Citigroup (C) said it would take a $1.5 billion charge against earnings to cover loan losses and lawsuits related to regulatory investigations.