What a Week: Running to Stand Still

Earnings season gets off to a troubling start but major averages sidestep the selling temptation.
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Stocks started 2006 with a bang, producing a decent year's worth of percentage gains in just the first two weeks.

But this sprinting market hit a few hurdles this week, which ended mixed for the major averages. For the rally to resume in earnest, the bull will need to show not only that it's got the legs of a long-distance runner but also the agility to jump over obstacles in its path.

Before fourth-quarter earnings season begins in earnest next week, signs of strain appeared, notably on Thursday and early Friday. Major indices made a late-session comeback, however, a sign of bullishness ahead a three-day long holiday weekend. (U.S. financial markets are closed Monday in observance of Martin Luther King Day.)

The

Dow Jones Industrial Average

slid 2.49 points, or 0.02%, to 10,959.87 Friday, rebounding from an earlier low of 10,921. The blue-chip index managed to close above 11,000 twice this week, but it succumbed to profit warnings and downgrades of several of its components. For the week, the Dow fell fractionally.

The

S&P 500

index rose 1.55 points, or 0.12%, to 1287.61 Friday, reversing an earlier dip to 1282. The Nasdaq Composite advanced 0.02% to 2317.04, after falling to an intraday low of 2308. For the week, the S&P advanced 0.1% and the Nasdaq rose 0.7%.

Some attributed the late week selling pressure to nervousness about Iran's nuclear ambitions, which helped propel crude oil prices briefly back above the $65 barrel on Thursday.

But as investors prepared for the next onslaught of earnings, they were left to ponder if the market had run too far too quickly. "We may have made three quarters of our gains for the year in just over the past two weeks," says Jack Ablin, chief investment officer at Harris Trust.

Chief among the immediate concerns is not only whether expectations about fourth-quarter earnings will be met but mostly what outlook companies will provide about the coming quarters.

According to the Thomson First Call consensus of analysts estimates, S&P 500 earnings are expected to have increased 13.4% from the year-ago quarter, and are seen rising 13% in 2006. That roughly matches the 13% growth seen in 2005, which seems somewhat out of whack as economists predict the economy will slow this year.

"Fourth-quarter earnings should be OK, and I think most companies will meet or exceed expectations," Ablin says. "But my concern is that they will also guide lower for the coming quarters so that it will be a mixed blessing."

Investors were reminded about the forces already exerting pressure on the economy and profits during the week, as

Alcoa

(AA) - Get Report

,

DuPont

(DD) - Get Report

,

Phelps Dodge

(PD) - Get Report

and

Tyco

(TYC)

issued profit warnings.

All three cyclical companies face rising input costs, namely energy, and have had little success passing on those costs to their customers. All three have some degree of exposure to the distraught auto industry, which has been avidly seeking cost cuts.

General Motors

(GM) - Get Report

CEO Rick Wagoner made new promises in that direction on Friday. That did little for its shares, which slipped 2% this week on concerns that investor Kirk Kerkorian may pressure GM to cut its dividend.

But similar deflationary trends have helped keep core producer prices down in December. While higher energy prices boosted the headline PPI by 0.9%, the core index rose only 0.1%. That's good news for those hoping the

Federal Reserve

will soon end its 18-month-long rate-tightening campaign.

Heavy discounts in December led to higher auto sales, themselves lifting overall retail sales for that month by a less-than-expected 0.7%.

Treasury prices rallied sharply Friday in reaction to the lackluster economic data, with the 10-year note ending the week yielding 4.35%, down 3 basis points for the week.

Depressed auto sales weighed on consumer spending numbers, and on economic growth for the fourth quarter as a whole. Some economists, such as Joel Naroff, president of Naroff Economic Advisors, reckon this may have cut fourth-quarter GDP growth to 2% vs. 4.1% in the third quarter.

Heavy discounts at nonauto retailers also might prove to be a concern in the coming earnings season, according to Marc Pado, market strategist at Cantor Fitzgerald.

While December retail sales have pretty much met expectations, the retail sector of the market has advanced pretty strongly in anticipation, he notes. The consumer discretionary sector of the S&P 500 was up 3.53% by Wednesday's close and 2.7% by Thursday's close. The S&P retail sector index was still up 2.6% for the year by Friday's close.

"The good news have already been priced in and if those big discounts have cannibalized forward looking sales, the market will have to adjust," Pado says.

Among his chief concerns are sales at electronics retailers such as

Best Buy

(BBY) - Get Report

. Lower sales of electronics also would sap demand for chips -- not good news for semiconductor issues, which have led tech shares and the market higher over the past few weeks.

The Philadelphia semiconductor index, or SOX, was up 9.8% in January through Friday's close. Deutsche Bank halted

AMD's

(AMD) - Get Report

15% rise so far this year when it downgraded the stock Friday; AMD dropped 3.5%.

Some other areas of the tech arena don't seem that bright either.

Lucent Technologies

(LU)

, which provides systems, software and services to communications service providers, warned of a revenue shortfall in 2006.

The market tends to move in a choppy fashion during earnings season, as the stories of individual companies and of their shares take center stage.

Still, the risks seem more tilted to the downside as a slowing economy -- a scenario in which the struggling auto industry and high commodity costs play no small part -- already seems to be increasingly in the cards, even if it proves to be only a temporary phenomenon.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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