When It Comes to Second-Quarter Earnings, Investors Hope for Worst
Company, heal thyself.
With the second-quarter earnings season kicking off after the July 4 holiday, investors are hoping to hear that companies are starting to salve their deep wounds.
Investors are already conceding terrible earnings figures for the quarter that was. Year-over-year earnings for
S&P 500 companies are expected to have declined 16.9%, the worst quarter since the 1991 recession, according to earnings tracker
Thomson Financial/First Call
. First-quarter earnings were down 6.3%. Most sectors are going to show declines, with the most horrible results from technology and transportation and the best in energy and health care.
The hope among investors is that the second quarter was the absolute worst of the profits collapse. Because there's no way to predict future performance, investors will key in on the outlook companies give when they release their earnings reports -- whether they sound more encouraged and if there are tangible reasons for encouragement.
"'Things have stabilized,' " said Brian Gilmartin, portfolio manager at
Trinity Asset Management
in Chicago. "That would be the best thing we could hear."
In this turbulent first half, expectations for a recovery in corporate profits have generally been sucked away by the crushing reality of the current economic environment. Some market pros see folly in optimism, thinking there's just not enough evidence for hopes that CEOs are going to find a golden needle in a wet, smelly haystack.
The unbridled optimists, however, have a few more chips in their pile now, thanks to steady interest-rate cuts from the
Federal Reserve and companies' whiplash efforts to reduce costs. The fundamental backdrop for stocks has improved in the past few months, even if its effects aren't yet being realized.
With these changes, investors have greater hope for coming quarters -- and that's where the outlook from business executives enters the picture. For the past two reporting seasons, the hackneyed, depressing cliche out of corporate America was "visibility, lack thereof." This time out, investors listening to second-quarter earnings reports hope the phrase will be retired.
"We want to hear that they're re-engaging with customers, that there's stabilization of revenues, that inventories are back to normal levels or that there's a work-off of inventories going on, and they're at the proper capacity," said Art Hogan, chief market analyst at
Jefferies
. "We want to hear a lot more of that than 'visibility' and not knowing where the bottom is."
Are We Earning Yet?
The preannouncement season has been mildly encouraging in this regard. A few technology companies, such as
Xilinx
(XLNX) - Get Report
and
Oracle
(ORCL) - Get Report
, have sounded cautiously optimistic. Still, executives at the likes of
Sun Microsystems
(SUNW) - Get Report
and
Nokia
(NOK) - Get Report
are pessimistic as they continue to cope with excess capacity and reduced demand for their products.
Fewer companies are releasing negative news, a tentative sign overall that corporate profits may have hit bottom. Through last Wednesday, there were fewer preannouncements than at this time last quarter (in part due to previously reduced expectations), according to Joseph Kalinowski, equity strategist at Thomson. There have been a total of 825 preannouncements: 146 positive, 538 negative and 141 saying earnings would be in line with expectations. By this time last quarter, 846 companies had preannounced, with 114 positive, 578 negative and 144 meeting expectations.
Investors are justifying this slower pace of warnings as a base on which to build, shaky though that base may be. Economic reports remain mixed, and orders for technology products are still weak. Outside energy and health care, some investors don't see much cause for hope, if only because others are expecting too much. Historically, four quarters of negative earnings growth have followed previous recessions (and this economy may be in one now.) Not counting this quarter, there's only one on the books now.
"Expectations for the second half of the year are still too high," said David Sowerby, portfolio manager at
Loomis Sayles
. "About 80% of what we do is going to still be driven off liquidity and the Fed, rather than the
mea culpas
from earnings."
Summer Wind
One tell that the economic cycle has started to swing out of the muck will be words out of cyclical technology companies, such as chip and computer makers, whose business improves with the economy. The S&P technology sector is expected to have been the hardest hit in the second quarter, showing a 62% decline in earnings growth, according to Thomson. After massive spending in the past several years (which peaked with year-over-year growth of 47.3% at this time last year), tech earnings are going to suffer for some time. Economists at
Salomon Smith Barney
believe technology earnings won't recover their previous power for another three years, at least.
Among other sectors, transportation companies are next to the slaughter. Year-over-year growth is expected to be down 61%, according to Thomson. The decline in demand, along with higher energy costs and less travel, put the brakes on these companies.
It's estimated that earnings for consumer cyclical companies fell 38.8% in the second quarter. Investors hope to hear positive words here, because cyclical names like retailers should benefit in coming quarters if the economy rebounds. Basic-materials companies should show a 42.2% decline, and communications companies are expected to have a 32.5% drop.
Earnings of financial companies are expected to be down 1.9% for the quarter, with declines in trading revenue and investment banking offset by companies doing brisk activity in mortgages and other businesses helped by lower interest rates.
Not every sector is expected to show a drop. The energy sector should report year-over-year growth of 14.3%. Increased demand and costs for power are anticipated to lift utilities, with a gain of 11% in earnings year over year. Health care, which includes insurers, device makers and pharmaceutical companies, is expected to climb 11.7%.
Consumer staples, which include food, beer and tobacco, are expected to grow 2% year over year. It seems investors allowed themselves a few vices to help reduce the misery of a dire market.