Meet the Street: What to Expect From the Upcoming Earnings Season

Time has flown, even if no one's had that much fun.

It's been almost a month since Sept. 11, and the third-quarter confessional period has crept up on a Wall Street that has its eyes on the larger issues of war. Nonetheless, earnings warnings are coming out fast and furious, so to shed light on what trends are emerging, TheStreet.com sat down with Joe Kalinowski, equity strategist with Thomson Financial.

Joe Kalinowski Equity Strategist, Thomson Financial Market Strategy

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After sorting through the early part of the third-quarter preannouncement season, Kalinowski says that technology will continue to underperform, and that there's no doubt we're in an earnings recession. Read on for more.

TSC: Last week, you put out a report on the earnings outlook for the third quarter, discussing the upcoming preannouncement season. By and large, what were your findings? And what sectors were hit hardest by the events of Sept. 11, based on the numbers of negative preannouncements made so far?

Kalinowski: We are seeing an acceleration in earnings warnings. While we haven't seen an explosion of warnings hitting the marketplace, we are seeing a steady flow of warnings and expect that to continue in the coming weeks.

We are seeing heavy earnings warnings from technology, which continues to suffer amid frozen capital spending, and consumer services as consumers cut back on leisure spending. We are seeing an unusually high number of warnings from the transportation sector for obvious reasons, and from financial companies. With billions of dollars in property damage and life insurance claims, as well as the closure of the U.S. equity markets, finance companies have been hurt.

TSC: Is this overall trend towards companies preannouncing increasing?

Kalinowski: Actually, I have been saying that the severity of the preannouncements have been subsiding since Q1 2001, and that the negative preannouncements have had less of an impact on equity prices as time has gone on.

TSC: You write that analysts expect a rebound of 18.6% in the S&P 500 during 2002. Sounds like a lot of wishful thinking to me. How can analysts set targets like this in one of the most economically uncertain markets in the history of the United States? What are they basing these targets on?

Kalinowski: The analyst community has had a difficult enough time forecasting next quarter, let alone next year. True, the business environment has been a roller-coaster ride since 1997, but we need to understand these figures will come down as time progresses. In fact, on average, analysts typically decrease their forecasts by 9% to 12% from the start of the year to the finish. This year will see significant earnings deterioration.

TSC: Are we in an earnings recession?

Kalinowski: Earnings recession? Absolutely. In fact, even before the events of Sept. 11, the behavior of corporate earnings was indicating an economic recession. Now the consensus is convinced of two consecutive quarters of contraction in real GDP.

TSC: For quite some time, market watchers have pointed to the consumer as the main reason why the United States has avoided a recession. With terrorists attacking on American soil, unchecked fear and speculation running wild, and a slowdown already on the horizon -- how can consumer spending possibly be expected to continue to stay strong?

Kalinowski: In the months after Iraq invaded Kuwait, consumer confidence [as measured by the Conference Board] dropped significantly, and ultimately consumer spending [was] affected. Given the fact that the recent attacks were on American soil by a phantom enemy makes this situation far worse. We are watching movements in the earnings forecasts for consumer cyclicals, and expect further declines going forward.

TSC: What does history tell you about sectors that are likely to not preannounce but simply take their lumps as they make their actual announcements? I'm surprised, for instance, at the low percentage of warnings in the energy sector, even though natural gas prices are off nearly 80% from their peak and oil prices are down nearly 35% from the top of the cycle. Surprising to you?

Kalinowski: Actually, I am seeing consensus forecasts for energy companies start to come down. We are getting more negative preannouncements than normal in the sector. Also, after two straight years of analysts' leap-frogging each other in raising their estimates, last month we've seen the first monthly decline in the 12-month-forward EPS estimates for energy companies. The changes in the underlying commodity usually take some time to filter to the bottom line, and this is what we are currently seeing.

TSC: What can we expect from regional banks in the third quarter? What does your intelligence tell you about the fourth quarter and 2002 numbers for the banks?

Kalinowski: The short-term effects of the faltering economy will have a negative impact on share prices, but one needs to be familiar enough with the industry to decide when all the bad news is factored into current prices. Longer term, the U.S. financial situation remains healthy, and liquidity by the Fed will be assured in order to avoid any type of banking crisis.