"Things will get better in the fourth quarter because comparisons will be much easier."
That mantra isn't aging well. After the heady market gains notched in April amid high hopes for a coming recovery, a slew of earnings confessions during the past two weeks have dragged stocks lower. Investors now worry that the fourth quarter -- when Wall Street hoped for the beginning of corporate good cheer -- may only deliver a lump of coal.
The growing belief is that the economic recovery won't translate to positive earnings growth until at least the first quarter of 2002. That's especially so for big-cap technology shares.
"It's part of a long bottoming-out process, but whether it's the fourth quarter or the first quarter next year, it's going to take a lot longer than anybody thought," says Larry Rice, chief investment officer at
Making matters more dicey, tech price-to-earnings multiples are still historically high, meaning the near-term expectations -- at the very least -- for these companies are still too high. If the wheel keeps spinning as it has been, the markets may see more of the same cycle -- more cautious tones from companies about the end of the year, followed by more market selloffs -- for the next few months.
Down, Down, Down
The fourth quarter of the year is supposed to be the period when the earnings outlook shifts from horrific to merely terrible. The current expectation for fourth quarter year-over-year earnings growth is 7.2%. However, it's anticipated that figure will be revised sharply downward, perhaps even into negative territory.
But the picture is bleaker for technology shares.
First Call/Thomson Financial
expects year-over-year growth in the
technology universe, which makes up 17% of the
S&P 500, to decline 18.4%, and even that may be optimistic, according to Joseph Kalinowski, equity strategist at First Call. Still, people can't help but feel somewhat optimistic when compared with the expected year-over-year declines of 56.1% and 43.9% expected for the second and third quarters.
And that's the old mantra again: that comparisons -- that is, looking at current growth compared with a year ago -- are becoming "easier," which is sort of like saying you've only been hit by two trucks this year instead of four. In searching for positive signs that business is improving, there's so far not much beyond
, which in recent weeks have offered some cautious optimism.
Analyst expectations are going to be revised downward as the fourth quarter approaches. As part of this process of slight improvement, Kalinowski points out that the aggressive revisions the market was met with during the first quarter shouldn't be repeated. Ultimately, the minus 18.4% figure for the fourth quarter is probably optimistic.
"I think we'll revert to the norm, a more normal cutting of forecasts, as opposed to huge slashing," Kalinowski says. "But there's more downside in terms of the bottom line."
Investors may not respond kindly. Sure, comparisons will get easier, but technology companies are unlikely to revisit the earlier rate of growth that investors became used to for several years to come. Steven Wieting, economist at
Salomon Smith Barney
, wrote this week that the S&P technology sector may not recover its peak earnings power until as early as 2004.
There's still a significant amount of optimism being factored into stock prices. As of Monday, the S&P technology sector was trading at a multiple of 35 times expected 12-month forward earnings, according to Tom McManus, equity portfolio strategist at
Bank of America
, which is quite optimistic.
He notes, in addition, that stocks are trading at 50 times expected second-quarter earnings, annualized. The marked difference in the figures shows the degree of optimism embedded in forthcoming earnings estimates -- if earnings estimates are revised lower, technology stocks will look more overvalued (or they'll have to come down). McManus thinks that's a good possibility.
"Investors, should they not see marked improvements beyond the third quarter, are likely to punish these stocks at these valuations," he says.
Are investors starting to take the hint? It's a little early to assume that's the case. Investor optimism hasn't lasted long in this market (witness the seven straight declines for the
). Pessimism has a way of running out just when valuations look merely ridiculous instead of ludicrous, however.
Maybe it's a sign when a
mildly positive outlook from the CFO of Oracle produced only a temporary rally in the technology sector Tuesday. That, at least, suggests investors think they'd better think it out again.