Do Low Earnings Expectations Equate to a Big Opportunity? (Update 1)

NEW YORK ( TheStreet) -- Here's another sign that bullishness is back in fashion, expectations for the fourth-quarter earnings have come down significantly in the past few months and that's being spun as a positive for the broad market.

"The good news is expectations are low despite the economy showing some signs of improvement," writes Gary Thayer, chief macro strategist at Wells Fargo Advisors. "We believe investors are more likely to see better than expected results rather than weaker than expected results."

The truth is, though, investors typically always see better than expected results with roughly 70% of companies beating the Wall Street earnings view in most quarters. Of course, a lower hurdle creates a scenario of increased headline comfort but it's debatable whether that should be enough to support a rally for the broad market off current levels. After all, there had to be reasons worthy enough for expectations to come down in the first place, right?

Well yeah, there has been in fact. Putting aside the big-picture fears of about the havoc a boiling over of Europe's sovereign debt crisis would wreak, there has been a rash of corporate warnings for Wall Street to parse. Through Friday, 130 S&P 500 companies had pre-announced their fourth-quarter results. Of that number, 99, just shy 20% of the companies in the 500, offered up negative pre-announcements vs. 30 positive ones, according to Thomson Reuters, which offered this bit of perspective.

"By dividing 99 by 30, one arrives at an N/P (negative to positive) ratio of 3.3 for the S&P 500 Index," the firm said. "This 3.3 ratio is the largest showing since the 3.5 ratio in Q4 2008, in the midst of the last recession, and above the long-term aggregate (since 1995) N/P ratio for the S&P 500 (2.3)."

Some of the more high-profile warnings have included Intel ( INTC), Texas Instruments ( TXN) and DuPont ( DD). Many smaller-cap companies have sounded the alarm too, most recently Acme Packet ( APKT) last week.

Ahead of Alcoa's ( AA) report after Monday's closing bell, Wall Street is now expecting year-over-year earnings growth of 7.8% for the S&P 500, down from an outlook of 15% in early October, according to Thomson.

Alcoa posted an in-line loss so not much to go by there, but the Dow component's results are tied to aluminum prices so the red ink the company spilled in the fourth quarter was no surprise, which partly explains the stock's 40%-plus drop in 2011, second worst among the blue chips.

Meantime, both Juniper Networks ( JNPR) and Liz Claiborne ( LIZ) back off their previous financial projections, so the warnings keep coming. Juniper's stock had a rather muted reaction to the news, suggesting Wall Street's low expectations may provide some insulation even companies fall short of goals.

S&P Capital IQ is a bit lower, forecasting earnings growth of 7.2%, but it's still fairly bullish after crunching the numbers to account for just how much companies typically beat by.

"After posting year-over-year advances in S&P 500 operating results of 19.7%, 19.2% and 17.6% for the first through third quarters, respectively, S&P Capital IQ consensus earnings project a 7.2% increase in Q4 2011 EPS," writes Sam Stovall, chief equity strategist. "At first blush, it appears that the trend in earnings growth is beginning to slow dramatically. But remember that early in each of the prior reporting periods estimates were an average 55% below the final result."

If that outperformance comes to pass this time around -- a big if of course, as Stovall notes -- then earnings growth for the fourth quarter could come in at a more respectable 11%.

S&P Capital IQ and Thomson are in agreement on which sectors will do the worst -- telecommunications, materials and utilities -- with the trio seen posting declines. Both firms see earnings from utilities down 3.2% in the quarter. S&P Capital IQ is looking for declines of 9.5% and 8.4% from telecom and materials, respectively, with Thomson seeing drops of 18.6% and 8.6% on the same basis.

To be fair, one of the main reasons analyst expectations for earnings growth have come down is the year-over-year comparisons are getting harder as the market gets farther away from the disruption caused by the credit crisis in late 2008 and the subsequent recession.

The economic data has indeed improved but the recovery has been slow and steady, rather than gangbusters, and the volatility the markets have experienced from late summer on has given corporate America some pause about diving into expansion mode. In addition, even as America has gotten back on track to some extent, emerging markets have seen a slowdown in the past year.

If investors are more concerned about performance in relation to analyst expectations than they are about actual earnings growth, which is often the case for near-term trading, than the fact that expectations have come down does present a potential positive. But it shouldn't be seen as an indication that earnings are particularly robust, especially given the outsized amount of warnings seen ahead of the actual reports.

-- Written by Michael Baron in New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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