NEW YORK (TheStreet) -- For most people in normal times, it's tough to get worked up about such things as non-GAAP operating income, amortization and depreciation, and SGA expenses and provisions for loan losses.
But these are most certainly
normal times, and this autumn is shaping up as the most intriguing earnings season in recent memory. The question on everyone's mind is pretty obvious: What will the third-quarter results of the nation's biggest corporations tell us about the relative health of the economy and the potential for recovery? And is the enormous stock market rally, building since late spring, sustainable?
"There's no question that these earnings, for the market, are going to be absolutely critically important," says Paul Mendelsohn, the chief strategist at Windham Financial, an adviser to institutional investors.
No one's expecting all the mysteries to be solved. But investors nonetheless will be scouring the earnings press releases, 10-Q filings and executive conference calls for at least some clues on where the economy stands.
As ever, the bellwethers come first. Already this week,
impressed investors with their third-quarter results. Up Thursday are
; Friday morning brings
. And with the heart of the reporting season upon us, a few clear themes have developed.
First, it's all about the revenue. To a degree not seen in a long time, the bottom line will take a back seat to the top. "I've never seen people more concerned about revenue," says
, chief market strategist at the trading firm BTIG who writes for TheStreet. (It is, after all, called
season, not revenue season.)
The reason? Investors, by keying in on top-line results, want to see whether big corporations are really seeing the improvement in business conditions, and demand, promised by certain recent economic data. The positive trends have been mapped -- from the Institute of Supply Management's manufacturing index that went positive in late September for the first time since January 2008, to improving factory orders and durable goods stats and consumer-price indexes, to the GDP itself, the contraction in which has steadily slowed to a point where economists now expect the third-quarter number to show expansion.
Investors and market pros will largely ignore revenue comparisons with the third quarter of 2008, however. Barring only a few sectors, such as insurance and healthcare, year-over-year revenue comparisons will be uniformly poor. Instead, the most important metric will be revenue against expectations, says Charles Rotblut, senior market analyst at Zacks Investment Research.
What are those expectations? Zacks, for one, is forecasting the median company in the
to report a 6.9% drop in third-quarter revenue from a year ago and a 15% decline in earnings.
Comparing results with Wall Street forecasts always raises that ancient bugaboo of expectation management, the partially contrived process by which corporate executives guide Wall Street conservatively, like a football coach downplaying the quality of his own team before a big game.
One corporate behemoth didn't do such a good job in this regard recently. The case of
Johnson & Johnson
and its third-quarter report shows what can happen during this tense earnings season when a company misses its top-line targets, even as it surpasses profit expectations.
On Tuesday, the drug and consumer-goods company said its third-quarter revenue amounted to $15.1 billion. What was Wall Street looking for? $15.2 billion. Bang, not only did JNJ shares slide by as much as 3%, but the entire stock market declined with it as investors worried about what the company's report might mean for corporate earnings in general.
Intel, on the other hand, which released results after the market closed Tuesday, posted $9.4 billion in revenue, topping targets by a $300 million margin, enough to boost its shares and equities markets worldwide. By busting out such top-line figures, Intel sparked euphoria, despite what even the company conceded was continuing weakness in the crucial enterprise market.
Not everyone believes revenue is the end-all be-all this quarter. BTIG's O'Rourke, for instance, suggests that there's some danger in placing such a strong emphasis on revenue, which, as with Johnson & Johnson, "might not bump up as far as people might like."
But that, for O'Rourke and other bullish observers like him, isn't all that important. Instead, he notes the painful and ubiquitous cost-cutting measures that corporations, as everyone knows, have initiated since the beginning of the financial crisis last year. Through mass layoffs and capital-expenditure reductions, companies have paired their operations down to the bone.
, for instance, the first bellwether company to report third-quarter results, announced last week that it sliced its research-and-development spending by 36% in the third quarter compared with a year ago.
Of course, it's just this sort of cost-cutting, most significantly putting people out of work, that produces and deepens recessions in the first place. The proverbial chicken-and-egg situation develops, few more vicious than the current one. And with unemployment knocking on 10% and likely to surpass it, consumer spending, the most important leg of any recovery, remains a long way off.
Indeed, the third quarter will likely provide further evidence of the trend that became unmistakably apparent in the second quarter. For the most part, radical streamlining on the part of companies will translate into profit growth. And revenue that increases even a tiny bit relative to the first and second quarters of the year "will drop straight to the bottom line," says O'Rourke.
Further, because many companies booked losses in the year's earlier periods, tax rates will decline and significant portions of those companies' later profits will remain on their balance sheets.
"Oh yeah, I'm a bull," O'Rourke says. "But this is the first stage. As these cash flows starting building up now, companies will hopefully start to get out there sooner and start hiring and spending again, so we don't end up with a double dip next year."
Yes, the dreaded double dip. It wouldn't be earnings season without the obligatory crystal-ball gazing -- the financial guidance provided by executives in their press releases and conference calls. Once again, experts are looking for confirmation of the broader improvement trend.
"There's an expectation that companies will give decent guidance for the fourth quarter, or guidance that either confirms or is a little better than what analysts are expecting," says Zacks' Rotblut. With that sort of belief built into the market, the shares of any company that serves up a profit warning "will probably get punished."
According to Macroeconomic advisors, a consultancy, corporate profits in general will likely increase by 27% in 2009 from the abysmal 2008, and 8.3% in 2010.
That might sound like a buoyant projection. But don't expect the outlooks within third-quarter earnings reports to offer much evidence about whether economic recovery will stall or quicken next year, many market watchers say.
"I suspect it's going to be mixed and sector sensitive," says Windham Financial's Mendelsohn about the guidance companies are likely to give. "There will be winners and losers," he adds, with investors rotating their dollars into the former and out of the latter. "I think it's going to be a stock pickers' market. It's not a question of, 'Will we go higher?' It's a question of who are the winners, who are the losers, and being in the right place."
Mendelsohn himself is long commodities-related companies, from miners to agricultural plays. (
, to that end, report next week.) His logic? If there's an economic recovery, those stocks will benefit. If there isn't, a potentially weaker dollar will help commodities anyway.
And what of the sustainability of the rally in the face of the earnings-report onslaught? The specter remains that the market has already built into prices whatever good news emerges from the third quarter.
"You don't really know if a recovery is real or an apparition at this point," says O'Rourke. "But until you see data points that gives you clarity, in my opinion you have to err on the side of it being real, because otherwise you're just speculating."
-- Reported by Scott Eden in New York
Scott Eden has covered business -- both large and small -- for more than a decade. Prior to joining TheStreet.com, he worked as a features reporter for Dealmaker and Trader Monthly magazines. Before that, he wrote for the Chicago Reader, that city's weekly paper. Early in his career, he was a staff reporter at the Dow Jones News Service. His reporting has appeared in The Wall Street Journal, Men's Journal, the St. Petersburg (Fla.) Times, and the Believer magazine, among other publications. He's also the author of Touchdown Jesus (Simon & Schuster, 2005), a nonfiction book about Notre Dame football fans and the business and politics of big-time college sports. He has degrees from Notre Dame and Washington University in St. Louis.