With profit estimates in free fall over the past few months, expectations for the fourth quarter are now looking unusually attainable, at least according to some market watchers.

According to First Call, the average analyst estimate for fourth-quarter earnings growth now sits at about 17%, down from nearly 28% on July 1.

Of the 951 companies that have preannounced results for the fourth quarter so far, 27% have been positive, 45% have been negative and 27% have predicted in-line results. That puts the ratio of negative to positive warnings at its second-best level in three years, according to Joseph Kalinowski, chief investment strategist at Ehrenkrantz King Nussbaum. Only the second quarter produced a better result.

"Estimates for the fourth quarter are still likely to be cut more than normal between now and the start of the reporting season in January, but by a little less than we had expected and by much less than third-quarter 2002 estimates were cut during that quarter," said Chuck Hill, director of research at First Call.

For his part, Hill expects earnings to grow 15% in the fourth quarter, but said any deviation "is now more likely to be higher than lower." (Hill believes analysts will end up predicting growth of 12% in the fourth quarter.)

Could've Been Worse

One reason that analysts are slightly more optimistic is that the third quarter didn't prove to be the disaster some had feared. With 90% of

S&P 500

companies having already reported their results, earnings are estimated to have risen 7% in the third quarter.

That represents a substantial drop from analysts' original estimates, of course, but it's not as bad as some hardcore bears had projected. Tom McManus, an analyst at Banc of America, had been looking for just 3% growth.

Among the groups that ultimately fared well in the quarter were the consumer cyclicals, which rose 27% year-over-year, despite more difficult comparisons to last year. Technology issues, meanwhile, saw profits increase by 26%, although a big chunk of that was due to

Microsoft

(MSFT) - Get Report

, which saw a large positive surprise that is unlikely to be repeated. Energy and materials stocks also saw robust profit growth in the quarter, but mainly due to a dismal performance last year.

While earnings surpassed his overall expectations in the third quarter, McManus continues to believe that Wall Street estimates for the fourth quarter are too high. In fact, he is looking for single-digit growth, saying that companies will probably release any bad news this quarter in order to start 2003 with a fresh slate.

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Companies will want to get bad news out of the way this year so they don't have to recognize those problems in 2003," he said. "Next year, we'll be in an environment where you'll have to show growth or be seen as an underperformer."

At the Bone

Jeffrey Saut, chief investment strategist at Raymond James, agrees that fourth-quarter targets are overly optimistic. He noted that revenue growth has proven elusive this year and said any profit gains have come largely from cost-cutting, which he feels is unsustainable.

"To me this is deja vu all over again," he said. "Earnings were supposed to be up 19% in the third quarter, then 14% then 12% and they ended up (at 7%)."

Although Saut does believe the economy and earnings bottomed last year, he said the rebound will be so mild that economic growth of 2% to 2.5% might be a stretch. Even Hill concedes that with the economy so fragile "the earnings recovery could easily be derailed."

Other headwinds, such as underfunded pension plans, which require large cash infusions, and the expensing of stock options could also pressure results, analysts say.

Certain ominous signs have started to appear.

Estimates for technology stocks' earnings growth in the current quarter have been slashed to just 16% from 32% on Oct. 1. And even projections for consumer issues have been cut to 26% from 32% at the start of October.

For Hill, the more serious problem is not the fourth quarter, but the outlook for the first quarter of 2003. Analysts are currently calling for 13.2% growth in the first quarter, but Hill said that estimate could come down significantly because companies will start to face tough comparisons.

Estimates for the first quarter have been crumbling in recent weeks. In the technology space, earnings projections have already been cut to just 15% from 28% at the start of October.

"That seems to indicate that the more robust pickup in capital spending that was expected by many to occur in the first quarter may be pushed back to the second quarter or later," Hill said.

Industrial sector estimates have slid to just 7% from 12%, while the materials sector, which faces very easy comparisons, has seen estimates decline to 69% from 105%. In the consumer sector, estimates have fallen to 18% from 21% at the start of October.

"A number of warning flags for consumer cyclical sector earnings continue to fly high," Hill said. "We not only need the consumer to spend well during holiday shopping season, but we need the consumer to do so without exhausting their will to spend in the first quarter."