Published July 6, 2009

WALL STREET INSIGHT
Investor spotlight shifts to Q2 earnings

And investors may be in for some positive surprises, say analysts

By ANDREW MARKS
NEW YORK CORRESPONDENT
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US stock market investors got a rude send-off last Thursday as they got ready for the long holiday weekend, as one of the most crucial pieces of economic data, the monthly unemployment report, offered a stark and gloomy counterpoint to the so-called 'green shoots' that have indicated the economy is approaching the turning point towards recovery.

Poor show: The Dow sank 1.9% last week on poor jobs data. The S&P fell 2.5% and the Nasdaq skidded 2.3%

When the June unemployment numbers came in showing more than 100,000 more jobs lost than expected, it shook investors and traders, who have already begun to lose patience with the concept of 'less bad' being good.

'Now even that notion has taken a big hit,' noted S G Cowen equity trader John O'Donoghue. 'The unemployment number sent a strong message that we can't take for granted that the recession is almost over. It means the spotlight will be on corporate earnings results to show some signs of hope more than they were just a few days ago,' he said.

Indeed, the second quarter earnings reporting season arrives this week at a critical juncture for the US stock market, which has been trading sideways, with a downward trend, since the bank stress test results were announced in May.

'Everyone on Wall Street has been treating an economic recovery in the third quarter as a fait accompli, but last Thursday's employment numbers have brought the dreaded D-word - Deflation - back into the picture,' said David Rosenberg, chief economist and market strategist at Glusken Scheff.

With more than three million jobs now lost since the recession began last summer, 'it should not be lost on anyone that this is the first time since the 1930s depression that the private sector job losses posted in the economic downturn more than wiped out all the gains from the prior expansion', he said.

There is room for hope, however, that positive surprises await investors when corporate America reports its latest results, despite the ongoing and increasing weakening of estimates. Earnings tracker Thompson Reuters said only 56 S&P 500 companies have issued negative EPS pre-announcements for the second quarter, while 37 offered positive EPS pre-announcements. That is a nearly three times better negative-positive ratio than the one heading into the first quarter results, and 25 per cent below the S&P 500's historical average.

'That means that either analysts' estimates are better than usual, or we've likely got a stronger than expected quarter for the second time in a row,' said Larry Adam, chief investment strategist at Deutsche Bank Wealth Management. 'I'm betting it's the latter,' he added.

But last Thursday, investors weren't thinking about the earnings season, as the June jobs report showed employers slashed 467,000 jobs from non-farm payrolls, compared to the 365,000 job losses expected by economists.

The jobs report overwhelmed the good news that factory orders jumped 1.2 per cent in May, the largest increase in nearly a year, as the Dow Jones Industrial Average lost 223.32, or 2.6 per cent, to ruin what had been an encouraging week, and closed at 8,280.74 points on an exceptionally light trading volume of less than 750,000. The S&P 500 fell 2.9 per cent and the Nasdaq shed 2.7 per cent.

For the week, the Dow sank 1.9 per cent. The S&P fell 2.5 per cent and the Nasdaq skidded 2.3 per cent.

Alcoa will kick off the second-quarter earnings season when it reports results after Wednesday's closing bell.

Analysts are expecting another quarter of huge losses for the companies that constitute the S&P 500, with an estimated earnings growth rate of negative-35.5 per cent, according to earnings tracker Thompson Reuters.

On April 1, the estimated growth rate was negative -31.7 per cent. Analysts expect all ten sectors in the S&P 500 to show a year-over-year decline in earnings for the quarter, which would be the first time that has happened since Thompson began tabulating earnings in 1998, said senior equity analyst John Butters.

Mr Adam said that in addition to the lack of profit warnings offering reasons for optimism, 'I'm expecting to see more guidance coming from companies for future quarters as they announce numbers for the last quarter, and that should be a positive for stocks', he said.

But traders warned it's unlikely the second quarter earnings results will have the same big impact on the stock market as was seen with first-quarter results.

'The market was still pretty far down when the first-quarter results started coming in back in early April. Now, the S&P 500 is almost 20 per cent higher than it was at the beginning of the first quarter earnings season,' said Mr O'Donog-hue. The higher valuations stocks have will result in less upside and greater downside, he said.

After Alcoa reports its numbers, just three other S&P 500 companies are expected to announce earnings this week. During the week of July 13, 24 S&P 500 companies and six Dow components are expected to release results.

The peak weeks of the second quarter earnings season will begin from July 20. But that won't keep investors from exercising their increasingly itchy trigger fingers at the first sign of trouble.

The lacklustre start to the earnings season will be compensated by a heavy schedule of economic data this week. The Institute for Supply Management releases its services index for June today. The May reading on consumer credit will come on Wednesday, as well as the Energy Department's weekly inventory report.

Thursday will bring the weekly initial jobless claims report, which is expected to be an important release after claims fell by 16,000 the previous week to 614,000. The May reading on wholesale inventories will also be released on Thursday.

Friday is the busiest day for economic releases, with the June report on import and export prices, the May trade deficit, and the University of Michigan's preliminary report on its consumer sentiment index for July.