To say that it was a good August is an understatement.
Though typically a month where the market wilts, this August ended up being a time of rejuvenation. As the likelihood of another
Federal Reserve rate hike this year slipped toward the vanishing point, stocks moved steadily higher. By the end of the month, the
S&P 500 had added 6.1%, its best August performance since 1986. This all has placed the post-Labor Day market on some pretty solid footing. The tone is good, Friday's benign
employment report reinforced the case for a soft economic landing, bowling scores are way up, mini-golf scores are way down -- in short, life is sweet.
But whether the market can continue to steam forward is about to be sorely tested. We are about to swing into warnings season, when companies whose third-quarter numbers will fall short of analysts' estimates confess their sins. It has, in fact, already begun -- a number of retailers have warned, as have appliance manufacturer
and Internet consulting firm
wrote stories about the warnings from
Some believe the confession period will be worse than usual this time around.
"I think you will have a larger number of companies indicating the third quarter will be below expectations," says Stanley Nabi, vice chairman of
DLJ Asset Management
. Although the apparent slowing of the economy has been a blessing as far as interest rates are concerned -- the yield on the 10-year Treasury note has fallen by about three-quarters of a percentage point since the Fed last raised rates in May -- the flip side is that corporate profits, too, must slow.
This is not to say that profits will not be robust. The economists at
Salomon Smith Barney
reckon S&P 500 earnings will tack on 15% over last year in the third quarter -- pretty good considering that over the last 20 years or so earnings have grown by about 7%. If there is a problem, it's that investors may have come to think of more recent business activity as the norm. Says Salomon economist Mitchell Held, "It's not so much a slowdown as a slowdown relative to expectations."
For the companies in the S&P, earnings have grown by better than 20% for the last four quarters, a performance that will be hard to repeat without the economy reaccelerating -- something that the Fed would be pretty loath to see. Current forecasts call for S&P earnings growth to fall into the single digits by the first quarter next year, according to
. This could be a problem if investors aren't ready for it.
"Evidence continues to build that stock price-to-earnings multiples, though attractive, are not low enough to protect stock prices against a drop in earnings expectations," says Tom McManus, equity portfolio strategist
Banc of America Securities
McManus believes that there is a great deal of complacency on earnings embedded in the market. Not everyone agrees.
"I don't think there's a tremendous expectation for profits," says Tony Dwyer, chief market strategist at
. The deceleration in profit growth "has been talked about so much, it's been priced in."
Still, Dwyer thinks the market may be heading into something of a rough patch. Earnings warnings can bring out the Cassandra in Wall Street. One warning is taken as a sign that an entire sector has come to woe. The confessing company often abets this process, implying that the trouble they see is affecting their entire industry -- even when that is not the case at all. "After a nice rally, profit-taking is normal, and the market finds an excuse for it," says Dwyer. "The excuse now is going to be upcoming quarterly profits."
But any downdraft, Dwyer emphasizes, will be a time to buy.