Stocks ended up Monday, but had another day of swinging between red and green as investors reassess their expectations for the year ahead. First and foremost, investors are being forced to reconsider their bets on Federal Reserve interest rate cuts after Friday's stronger-than-expected jobs report and Monday's comments by Fed Vice Chairman Donald Kohn: "The economy appears to be weathering the downturn in housing with limited collateral effects," Kohn said in a midday speech in Atlanta. While "inflation appears to be easing," a decrease in inflation was "by no means assured," he added. Second, as Alcoa ( AA) kicks off fourth-quarter earnings season Tuesday, investors are bracing for the possible end of the S&P 500's long-running streak of double-digit earnings growth. A spate of 2007 earnings guidance is also on tap. "We suspect that there will be confirmation of projected slowing earnings growth in 2007 relative to 2006," writes Tobias Levkovich, chief U.S. equities strategist at Citigroup. Despite expectations for weaker earnings, "we are not convinced that the Street is fully ready to accept this development gracefully." In particular, analysts may be overestimating earnings growth in consumer staples, technology and utilities, writes Levkovich, who is forecasting 7.2% earnings growth for the S&P 500 in 2007 vs. the Thomson First Call consensus of 9.3%. According to Thomson Financial, the S&P 500's streak of 13 quarters of double-digit EPS growth is about to be broken, as estimates for the fourth quarter have come down lately. Thomson now forecasts 9.6% average growth, with energy the weakest sector with an 8% year-over-year decline. Financials are expected to be strongest, posting a 34% year-over-year increase. (Standard & Poor's says there have been 19 straight quarters of double-digit earnings growth based on its calculation of operating earnings vs. Thomson's blend of analysts' consensus, which may include both pro forma and operating results.)
As investors adjust their expectations, buyers also should take note that earnings season has yielded fewer gains in the past four years' bull market than the off-season, according to Birinyi Associates. The earnings off-season has provided 55.4% of the gains in the bull market since October 2002, while earnings season provides only 13%, according to the research firm. For aluminum producer Alcoa, the fourth quarter was not likely weak, but then again, expectations may be too high. Thomson reports the consensus expects 86% earnings growth for the company in the fourth quarter and a 14% rise in revenue. Shares of Alcoa slipped 1% Monday. More broadly, high expectations for the 2007 stock market have taken hold in the mainstream, and that is worrisome, writes John Roque, senior technical analyst at Natexis Bleichroeder. Roque compiled a list of headlines from late December and early January, which includes the all-caps USA Today headline: "10 REASONS WHY THE S&P COULD HIT A RECORD HIGH," and "No Retreat; How The Bulls Stole Wall Street" in The Wall Street Journal. "So, with sentiment having shifted, at least according to the above headlines, we believe a more cautious outlook for stocks and equity markets is warranted," he writes. Roque adds that several technical factors support his caution. New lows on the NYSE are increasing as new highs decline, and the last three times this indicator showed such a pattern, the S&P 500 lost 7.6% from March to April 2005; 6.24% from August to mid-Oct 2005; and 8.3% from May to mid-June 2006, he writes. A similar correction now puts the S&P 500 down in the 1326 area, or a 6.2% correction from current levels. Roque notes that NYSE cumulative volume is starting to turn down, as is the percentage of stocks trading above their 200-day moving averages. Such technical indicators often signal the start of a corrective phase.
Nevertheless, the Dow Jones Industrial Average gained 0.2% Monday to close at 12,423.49, while the S&P 500 closed up 0.2% at 1412.84. The Nasdaq Composite added just 0.16% to close at 2438.20.