Stocks may benefit from low earnings expectations

A trader works on the floor of the New York Stock Exchange in New York July 6, 2009.

NEW YORK (Reuters) - U.S. earnings may not perform a turnabout in the second quarter, but expectations finally are looking up, suggesting financial statements could hold more than the usual share of surprises from prominent companies.

For the quarter, earnings are still expected to decline sharply from the year-ago period. Data compiled by Thomson Reuters shows analysts expect a decrease of about 36 percent in Standard & Poor's 500 corporate earnings from a year earlier, which would mean no improvement from the first quarter.

But the early indication from companies and the recent trend in analyst revisions suggest that forecasts have finally bottomed out, possibly opening the door to stronger performances going forward.

That could bode well for stocks, which have rallied from 12-year lows in March on hoped-for signs of an economic rebound. The rebound in stocks presaged an upturn in earnings expectations, which started to improve in mid-May.

"The expectations are such that we'll have more surprises to the upside than to the downside," said Maury Fertig, chief investment officer of Relative Value Partners in Northbrook, Illinois.

Aluminum company Alcoa Inc, whose results on Wednesday will kick off the season's reports, is expected to post a third consecutive quarterly loss. If there is going to be earnings strength, it is not likely to come from the materials sector, which is expected to show a year-over-year decline of 79 percent, according to Thomson Reuters.

A ROSIER PICTURE?

But earnings projections have seen an upward trajectory. Estimates for six of the 10 S&P industry sectors have been revised higher over the past four weeks, according to researchers at Birinyi Associates Inc., led by the consumer discretionary sector, although much of the change has to do with the removal of General Motors Inc from the index.

Others revised higher include consumer staples, technology and telecommunications.

This trend could result in a higher-than-usual percentage of companies exceeding estimates, which has averaged 66 percent, according to Thomson Reuters.

Analysts seem less inclined to slash estimates, said Dirk Van Dijk, analyst at Zacks Investment Research in Chicago.

"We have been noticing recently there have been more positive upgrades to estimates than cuts," he said.

There have been fewer warnings by companies as well, said John Butters, director of U.S. earnings for Thomson Reuters, noting that these changes may indicate a bottom in the earnings downturn.

The same can be said for actual results so far. Headed into the week, of the 23 S&P 500 companies that had reported results, 18 had exceeded expectations, according to Zacks. Should that continue, it could heighten the appeal of equities after stocks stumbled through most of May and June.

"The recent news is encouraging," said Burt White, chief investment officer at LPL Financial in Boston. "We're starting to see better-than-expected pre-announcements, which bodes well for the quarter.

HIT LOW POINT

"I believe the market has hit its low point of this earnings cycle, and I think we're going to start to see higher earnings throughout the rest of this year and into 2010."

That's not to say the results are going to be strong. Not one sector is expected to show year-over-year growth in the second quarter, with a 2 percent decline in healthcare the "best" sector for the moment.

Larger sectors, such as energy, industrials and financials, are likely to continue to be hurt by cost issues and lack of consumer demand. But White believes energy may be able to beat estimates because of the recent spike in oil prices -- crude oil has risen from $33.55 a barrel in February to a high of $73.38 in June.

Still, energy is forecast to be among the worst-performing sectors, with a projected earnings decline of about 65 percent from last year. Earnings for the industrials sector, meanwhile, are seen declining 42 percent and financials down 53 percent.

What remains to be seen, however, is whether the performance of companies in the second quarter will be enough to lift investor spirits. The expectation has been for an economic resurgence in the second half of 2009, but demand remains sluggish, and cautious words from large companies will temper enthusiasm from equity investors.

Based on current projections, the S&P 500 should show a dramatic increase in earnings by the fourth quarter - a 182 percent increase from a year ago, in fact.

"All these companies are laying off people like crazy. It's going to be hard to believe that they aren't going to be profitable by the fourth quarter," said Keith Springer, president of Capital Financial Advisory Services in Sacramento,

California.

Not all are optimistic, however. Investor Warren Buffett said in late June the economy has not picked up. If corporations' assessment of current conditions echo that sentiment, the market may continue to struggle.

(Additional reporting by Chuck Mikolajczak and Ellis Mnyandu; Editing by Kenneth Barry)