Since October, estimates for first-quarter earnings growth have tumbled while the S&P 500 has surged. With the earnings season starting next week, the outlook is not as sunny as in previous quarters.
Investors will assess whether slower growth is priced into the U.S. stock market, or if the S&P 500's retreat from Monday's four-year high is the start of a larger decline - if results disappoint.
Fund managers will look for earnings to offer insight into how companies are faring amid mixed economic indicators and a resurgence of concerns about Europe. Strong results could extend the multi-month rally while weak ones could provide a catalyst for further declines.
If management commentary indicates that business is holding up despite the apparent slowing of European economies, that would be very encouraging for stocks, said John Carey, portfolio manager at Pioneer Investment Management in Boston, who helps oversee about $260 billion.
On the other hand, if orders are dropping or consumer spending doesn't appear sustainable, that could lead to some downward pricing action and earnings revisions.
A TIME FOR CAUTION
The latest trends haven't been encouraging. Analysts have trimmed estimates, management teams have grown more cautious, and overall growth rates have fallen sharply.
S&P 500 companies' earnings are seen rising 3.2 percent in the first quarter, according to Thomson Reuters data, compared with growth of 9.2 percent in the fourth quarter and a jump of almost 19 percent in the first quarter of 2011 over the year-ago period.
Analysts have been cutting estimates steadily in the last few months, but the ratio of cuts to increases leveled off in March, Bank of America-Merrill Lynch wrote in a recent note. That indicates analysts are still cutting estimates, but at a decreasing rate.
Bank of America-Merrill Lynch also pointed out that corporate management teams were becoming more cautious relative to expectations as well. Overall, data from StarMine, a unit of Thomson Reuters, shows most sectors with declining estimates, particularly materials and telecom stocks.
We feel it is too early to switch to a positive short-term signal, given worrisome trends in guidance and sales revisions, Bank of America-Merrill Lynch wrote to clients.
On the positive side, Bed Bath & Beyond
Over the last several weeks, growth estimates have dropped markedly even as economic data has generally shown improved U.S. demand and the equity market has rallied.
On the first of October, first-quarter earnings were seen growing more than 10 percent. While estimates have dropped by more than two-thirds since then, the S&P 500 has climbed 27 percent, raising the question of whether the slowing growth has been priced into the market.
Tobias Levkovich, chief U.S. equity strategist at Citigroup, wrote that the season may generate the next obstacle for investors, saying they had become too accustomed to upside surprises.
Friday's nonfarm payrolls report will come into play next week, as the U.S. market will be open only briefly for futures trading, and the cash market will be closed entirely. The forecast calls for 203,000 jobs added in March, down from February.
LOWERING THE BAR
The second quarter got off to a weak start. The Standard & Poor's 500 Index <.SPX> ended the quarter's first week with a loss of 0.7 percent - its worst weekly performance since December. That was in sharp contrast to the rally on Monday - the quarter's first trading day - when the S&P 500 ended at 1,418.90, its highest close since mid-May 2008.
At Thursday's close, the Dow Jones industrial average <.DJI> was down 1.2 percent for the week, while the Nasdaq Composite Index <.IXIC> was down 0.4 percent.
It is possible that analysts have become too pessimistic.
Warnings have dominated the pre-earnings season. Of the 121 pre-announcements, 68 percent are negative ones, compared with 58 percent in the first quarter a year ago.
The reduced expectations leave more room for upside surprises, said Michael Mullaney, a portfolio manager who helps manage $9.5 billion at Fiduciary Trust Co in Boston.
However, there is still concern that the recent burst of economic growth will prove transitory - and that demand will sag after a warmer-than-usual winter in the United States.
Earnings are expected to be weak this quarter, and if you strip out Apple Inc
(Wall St Week Ahead runs every week. Questions or comments on this column can be emailed to: ryan.vlastelica(at)thomsonreuters.com)
(Editing by Jan Paschal)