October started with a bang Friday, and the market's performance in September, historically the weakest month of the year, was even more noteworthy.

Considering all the things working against the stock market, relative strength last month and an impressive start to this month could be sending a bullish signal for the coming earnings season.

But the view is not universal, and some analysts continue to think that when companies begin reporting third-quarter earnings later this month, investors will be disappointed.

On Friday, the

Nasdaq

surged 2.34%, the

S&P 500

gained 1.5%, and the

Dow

industrials rose 1.1%. Some analysts said investors were trying to get on the right side of the fourth quarter, historically a strong one for stocks.

The same historical perspective also shows that September is one of the weakest months for stocks. According to the Stock Trader's Almanac, September has been the worst month for the major averages over the past 53 years.

But September '04 bucked the trend, with the S&P 500 up 1%, the Nasdaq gaining 3%, and only the Dow lagging, down less than 1%.

"We are surprised at the market's stability in the face of all the bad news," said Tim Ghriskey, senior partner at Connecticut-based Ghriskey Capital.

Indeed, in September, the

Federal Reserve

hiked interest rates for the third time this year, oil prices hit $50 a barrel for the first time on record, data on consumer spending have been disappointing, a top analyst from Banc of America lowered his equity exposure, and earnings growth estimates for the third quarter have been ratcheted down for the first time since the second quarter of 2003.

Analysts have offered various explanations for the market's resilience. Some say it's a sign that all of the negative news has now been priced in and that stocks will make further progress in the seasonally strong fourth quarter.

Ghriskey is in the bullish camp. "We think the most likely outcome is for the market to rally once we get a cessation of this bad news or get some good news," he said.

This year, third-quarter profits are expected to be up some 14% from the same quarter last year, according to First Call, with technology, basic materials and energy companies showing the strongest growth. That would be double the long-term average earnings growth of 7% a year.

On the other hand, 14% growth in the third quarter would mark a substantial deceleration from the 20% earnings growth posted in each of the last four quarters.

Paul Nolte, director of investments at Hinsdale Associates, cautions that the third-quarter earnings season might not be the positive catalyst that some investors are hoping for.

"What happened in the second quarter was that even though the numbers were very good, the market didn't react very well because the comments about subsequent quarters were not very good," he said. "We'll continue to see that; we're seeing it in the overall economic numbers."

Indeed, economists have become more concerned about fourth-quarter gross domestic product in recent weeks, as oil prices have soared to new heights. High energy prices are forcing consumers to cut back on discretionary spending and are squeezing corporate profit margins, as businesses are unable to pass these costs along to the public.

"We're still nervous about fourth-quarter growth," said Ian Shepherdson, chief economist at High Frequency Economics. "If oil prices don't come down, real after-tax income growth in the fourth quarter could be less than 2%."

For momentum in the economy to continue, Shepherdson said consumption must increase. "There is a very good chance that the pace of inventory building has peaked," he said. "We cannot rely on corporate activity to continue supplying the beef to the GDP numbers."

Analysts are currently expecting earnings to grow by around 15% in the fourth quarter, but any deterioration in the economy could result in a downward revision. "The data point to a muddling-through economy, so I would expect comments from corporate America to be less than stellar," Nolte said.

Tom McManus, the Banc of America analyst who recommended a lower equity weighting last month, said he is looking for "much more downside guidance" over the coming weeks, which is particularly worrying because valuations are so high.

The S&P 500 now trades at about 18 times trailing earnings, above the long-term average of 15, but down from a multiple of around 21 at the market's peak in March this year. Still, McManus said current P/E ratios are being pulled down by a few big laggards.

Most common stocks are "quite fully valued," he said, but large-cap stocks like

Coca-Cola

(KO) - Get Report

,

Colgate

(CL) - Get Report

,

Pfizer

(PFE) - Get Report

and

Exxon Mobil

(XOM) - Get Report

are trading at their lowest valuation levels in years.

"We are uncomfortable recommending a normal equity weighting without being able to find a normal complement of attractively valued companies," he said.

Although stocks fared relatively well in September, the third quarter as a whole was a letdown for the market, and failed to break a bearish trend characterized by lower highs and lower lows. The S&P fell 2.3% over the last three months, while the Dow shed 3.4%. The Nasdaq tumbled 7.4%.

Hinsdale's Nolte said the technical condition of the market has actually improved recently, which could point to a short-term bounce. But he noted that until this year's trading range is broken, "we're likely to be in a market that continues to bounce around."

Jim Melcher, president of Balestra Capital, agrees, saying he is looking for sideways trading through the remainder of the year.

"There's an attitude that it's going to pick up, that we're all going to make money, that we're all going to retire rich," he said. "None of this is true. The market is very much in denial."

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