Edging Up Before Earnings

Stocks ended up Monday, but had another day of swinging between red and green as investors reassess their expectations for the year ahead.

First and foremost, investors are being forced to reconsider their bets on Federal Reserve interest rate cuts after Friday's stronger-than-expected jobs report and Monday's comments by Fed Vice Chairman Donald Kohn: "The economy appears to be weathering the downturn in housing with limited collateral effects," Kohn said in a midday speech in Atlanta. While "inflation appears to be easing," a decrease in inflation was "by no means assured," he added.

Second, as Alcoa(AA Quote) kicks off fourth-quarter earnings season Tuesday, investors are bracing for the possible end of the S&P 500's long-running streak of double-digit earnings growth. A spate of 2007 earnings guidance is also on tap.

"We suspect that there will be confirmation of projected slowing earnings growth in 2007 relative to 2006," writes Tobias Levkovich, chief U.S. equities strategist at Citigroup. Despite expectations for weaker earnings, "we are not convinced that the Street is fully ready to accept this development gracefully."

In particular, analysts may be overestimating earnings growth in consumer staples, technology and utilities, writes Levkovich, who is forecasting 7.2% earnings growth for the S&P 500 in 2007 vs. the Thomson First Call consensus of 9.3%.

According to Thomson Financial, the S&P 500's streak of 13 quarters of double-digit EPS growth is about to be broken, as estimates for the fourth quarter have come down lately. Thomson now forecasts 9.6% average growth, with energy the weakest sector with an 8% year-over-year decline. Financials are expected to be strongest, posting a 34% year-over-year increase. (Standard & Poor's says there have been 19 straight quarters of double-digit earnings growth based on its calculation of operating earnings vs. Thomson's blend of analysts' consensus, which may include both pro forma and operating results.)