After 13 straight quarters of double-digit growth, bottom lines could finally be showing signs of mortality. According to David Dropsey, an analyst with Thomson First Call, Wall Street is projecting 9.1% overall earnings growth for the S&P 500 for the fourth quarter of 2006, down from the estimate of 10% growth just three weeks ago. In the fourth quarter of 2005, earnings jumped 14.4%. But while Corporate America's astounding streak of double-digit earnings growth may have ended, analysts still expect companies to deliver strong fundamentals in the upcoming reporting season. As well, there's still room for stronger-than-expected growth. A lowering of expectations before companies start to report results is typical. "As companies start to report, they're going to beat expectations, so we still expect the growth rate will break back above 10% growth and extend the streak to 14," says Dropsey. "That will probably be it, because comparisons are just getting too tough. We've grown so fast for so long, there's no way we can keep it up." Most economists are forecasting at least some moderation in economic growth for the new year, and investors that have enjoyed a four-year bull market may be starting to get wary of stocks that keep climbing to new highs. Still, actual profit numbers continue to be solid, even if they aren't as impressive as in recent periods. "The fact that we're not falling off a cliff in earnings after this enormous bull run of growth shows you that the markets are still strong," says Dropsey. "Prices of stocks continue to rise, and the fundamentals are there to back it up."
While overall results continue to be strong, a sector breakdown shows that changes are afoot in the marketplace. Energy, which has long been the red-hot growth sector of the U.S. economy, is expected to show some of the weakest results in the fourth quarter, with a year-over-year profit decline of 10% for the sector. Chevron ( CVX) hinted of this reversal of fortune when it warned recently that its fourth-quarter results will be "adversely affected" by recent declines in oil and natural gas prices and lower profit margins. The oil giant raked in $13.4 billion during the first nine months of 2006. Basic materials, estimated to show a 35% increase, is a new leader, thanks to strong performances from companies such as Alcoa ( AA), which already reported stronger-than-expected results last week. But financials, which constitute 27% of the S&P 500, are providing the lion's share of the index's strength. The sector is expected to report an average 34% rise in profits. The big investment banks, such as Goldman Sachs ( GS) and Morgan Stanley ( MS), have enjoyed windfalls from the flurry of mergers and acquisitions that took place last year. Also, insurance companies such as Allianz ( AZ) and American International Group ( AIG) enjoyed the weather, Dropsey says. "Insurance companies are reaping a big reward by not having to pay out a lot of money to hurricane victims this year like they were last year," he says.
Elsewhere, consumer discretionary, a sector that has been a focal point for bearish investors forecasting a slowdown in consumer spending, is expected to show a decline of 2%. But when homebuilders, such as Toll Brothers ( TOL) and Pulte Homes ( PHM), are excluded, the sector is expected to record an 8% increase. The homebuilders continue to be hurt by a slumping U.S. housing market and have seen big profit declines, which are expected to continue into 2007. Lennar ( LEN), for one, has already warned that it will post a hefty loss for the fourth quarter. The tech sector had a few scares, as chipmaker Advanced Micro Devices ( AMD) issued a profit warning last week that sent its shares tumbling. Xilinx ( XLNX) and Texas Instruments ( TXN) also warned in December of disappointments. Elsewhere in technology, Motorola ( MOT) recently said its fourth-quarter sales and earnings would fall below its forecasts because of a shortfall in mobile device sales. Telecommunications on the whole, however, looks headed for strong earnings growth for the quarter. Hugh Johnson, chairman of asset management firm Johnson Illington Advisors, names the sector as one place he is placing bets these days. "I like AT&T ( T) and Alltel ( AT)," says Johnson. He predicts overall earnings growth for the S&P of 9.5% based on his statistical analysis, but he suspects that results will be better than that. "I expect a majority of companies to beat estimates, and my guess is that when all the numbers are in, we'll see yet another double-digit quarter," says Johnson.