Presidential politics, Iranian mischief, Spain’s sinking credit rating and whatever whisper leaks out of Ben Bernanke’s mouth. Over the short term, the stock market is impacted by a lot of noise. Some of the noise is truly relevant; other noise, not so much.
Over the longer term, however, one metric impacts stock prices more than any other, the metric of corporate profits, otherwise called earnings.
Reported earnings are the most pertinent information about a company. On a real level, a stock’s price is simply a reflection of how much an investor is willing to pay today for the current and potential future earnings generated by a business.
It is said, therefore, that earnings drive stock prices, and this being true, right now we may have an issue.
Wall Street understandably spends a lot of time and resources on researching and predicting corporate earnings. The results of all this effort are called estimates, and earnings estimates set the stage for the stock market in general.
Right now, Wall Street is bracing for storm clouds on the horizon. The professionals who compile earnings research are called analysts, and going into the third quarter a large majority of analysts expect corporate earnings to decline for the first time in three years. According to the news company Reuters, analysts expect earnings to fall by about 2.5 percent this quarter.
Publicly traded companies devote considerable effort into communicating with investors, through analysts, regarding their upcoming earnings reports and what should be expected. The dominant negative analyst attitude about earnings now is due in large part to data reported by Reuters that indicates that 91 of the companies listed in the S&P 500 have indicated their earnings will be lower than originally expected.
In total, 91 profit warnings out of 500 companies is concerning. We haven’t seen this level of corporate pessimism in some time.
Earnings “season” actually started this week, and over the next month or so, most companies will report their third quarter results. Aluminum company Alcoa maintains the tradition of announcing its earnings first.
Interestingly, this industrial bellwether actually posted earnings that were a little better than expected. At the same time, however, the company also provided guidance that it expected weaker sales going forward.
I personally feel that after a nice multi-month run, the stock market is looking for a reason to take a breather. I also believe earnings will be a bit better than currently expected.
The combination of a pause in the current rally, general pessimism about earnings and the reality that earnings may be better than expected could create a bit of opportunity. The next few weeks will be interesting indeed.