Estimated Second-Quarter Earnings Growth April 1 Estimate July 3 Estimate Financials 12% 14% Technology 23% 20% Health Care 11% 6% Consumer Cyclicals -3% -7% Industrials -9% -11% Consumer Staples 5% 4% Energy 34% 36% Communication Services -7% -4% Materials 3% -11% Utilities -17% -22% Transports 8% 0% Source: First Call
By Monica Rivituso July 10, 2003
IT'S BEEN BANDIED about all over the financial media. But will it ever come to pass?
We speak, naturally, of the much-prophesied second-half recovery.
For years, market prognosticators have talked up the idea that a rebound was only months away. Next week's stampede of second-quarter earnings reports should provide some important clues as to whether a dramatic earnings recovery later this year is in the cards, or just another pipe dream.
Overall, profit reports should be pretty good, according to Chuck Hill, director of research for First Call. Earnings preannouncements haven't been any more or less negative than normal. Ditto for estimate revisions. Analysts expect a 5.3% increase in earnings for the Standard & Poor's 500 in the second quarter. While the current consensus is lower than the 7% growth analysts expected on April 1, Hill is nonplussed. He thinks actual results could top expectations by more than the 2.8% they typically do, which would result in earnings growth of 8% to 10% for the quarter.
As always, though, quarterly conference calls get thorny when management starts gazing into the future. A company can top estimates handily, then throw a wet towel over everything by issuing a cautious outlook — or worse, lowering the bar for the next quarter. So far, companies have said precious little to indicate that the business environment is looking substantially brighter in the second half.
The same can be said for the latest economic indicators. Last week, the Labor Department reported that the economy shed 30,000 jobs in June, bringing the number of jobs lost in the last five months to nearly 400,000. Making matters worse, last month the unemployment rate hit a nine-year high of 6.4% from 6.1% in May. And jobless claims surged another 5,000 last week to 439,000 — far worse than the 8,000 decline economists expected.
Encouragingly, analysts didn't take a knife to future estimates after first-quarter reports were issued — a departure from the gutting that had occurred in previous quarters. But did companies merely postpone an eventual earnings-estimate slashing, or will their numbers actually stick? "We're not at the point where I'd rule out having the numbers hold up," says Hill. "But you have to be a bit more skeptical now, since there isn't much buzz out there about things getting better. And we're running out of time."
Not to mention that the market is burdened with high expectations. With the Nasdaq up nearly 31% this year, technology companies have the most to lose by reporting disappointing numbers — and their earnings are the most vulnerable, given the excess technological capacity that remains from the 1990s boom. Tech companies are expected to increase earnings by 20% — second only to the 36% expected for the energy sector. We'll hear what Intel (INTC), Motorola (MOT), IBM (IBM) and Nokia (NOK) have to say next week. Cisco Systems (CSCO) will sound in with its quarterly report next month.
We don't mean to minimize the favorable signs in tech land that have emerged in recent weeks. Take Taiwan Semiconductor Manufacturing (TSM). On Monday, the world's largest contract chip manufacturer said second-quarter sales rose 13% from a year ago. "That's one of the tech canaries that we watch," says Hill. "To hear them singing the right song is good."
But savvy investors know the tech sector doesn't exist in a vacuum. The concern isn't so much that forward tech-sector earnings estimates will be cut — chances are there'll be some trimming, as there always is. But what could really throw a wrench into a recovery scenario is if estimates in the consumer-cyclical and materials sectors are slashed, says Hill. Why? Both groups are heavily dependent on consumer spending, and drastic profit revisions would signal that consumers are getting weak in the knees. Without strong consumer spending, a tech recovery simply won't happen.
Ominously, a couple of caution flags are waving in these very corners of the market. Back on April 1, analysts expected second-quarter earnings for consumer-cyclical companies to decline by 3%. As of July 3, they expected a 7% drop. Likewise in April, the materials sector was expected to increase earnings by 3% in the second quarter. Now analysts see profits declining 11%. Both of these groups have also seen preannouncements run more negative than normal.
Alcoa's (AA) results Wednesday hardly helped. The aluminum giant posted a lower second-quarter profit that beat consensus estimates by a few pennies, earning 27 cents a share, compared with 28 cents a year ago. But the company said it didn't see any upturn on the horizon — news that doesn't bode well for that eagerly awaited second-half recovery.
And just what would such a recovery look like? Somewhere along the line, investors and analysts tossed aside the notion of a gradual recovery. The run-up in equities seems to call for a full-throttle rebound. Based on earnings consensus estimates, analysts forecast a 12.8% increase in third-quarter profits for the S&P 500 and a 21.4% increase for the fourth quarter. Provided the typical pattern of preannouncements, estimate revisions and earnings surprises occur, those numbers could shake out to be about 13% and 20%, respectively, according to First Call. But whether investors should expect "typical" patterns is a matter of debate.
"I think those numbers will get shaved at least a little bit," says Hill. "Are we talking 12% and 19% [for the third and fourth quarter, respectively], or are we talking 10% and 15%? I don't know."
One thing's certain: Next week's earnings results should provide some clues.
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