Stocks: The Lost Earnings Season

For stock investors, this earnings season is turning into the lost quarter.

This month, companies began unveiling their results from the 2008 third quarter, which included July, August, and September. And the next couple of weeks will be especially busy, with 136 members of the large-cap Standard & Poor's 500-stock index reporting earnings during the week of Oct. 20, and another 114 firms the following week.

Investors are watching earnings results closely, desperate for some insight into an economy at a crucial tipping point. "We're really trying to get a handle on to what degree the economy is beginning to falter," says Robert Bacarella, portfolio manager at Monetta Mutual Funds.
Outlook is Hazy

But the problem, many professional investors say, is that the earnings outlook is just too hazy to provide much useful information this quarter. At the very moment when investors are desperate for certainty, companies' financial results from July and August—before the worst of the credit crunch hit—seem irrelevant.

Instead, many investors are listening to executives give their quarterly updates on future business conditions. However, many company management teams seem as confused as investors. Their statements are vague, and they don't sound confident in past predictions.

Credit problems and financial turmoil have been on investors' minds for more than a year, but credit shocks started hitting the economy in full force in the second half of September. Those troubles, which started with the failures of Lehman Brothers (LEH) and the bailout of insurer American International Group (AIG), have certainly shown up in early third quarter results.
Merrill Results Disappointing

According to Thomson Reuters, third quarter earnings for the S&P 500 are expected to fall 9.1% from a year ago. That includes both actual results from the 82 companies that have reported, and analyst estimates for the remaining companies.

Three weeks ago, on Oct. 1, analysts were predicting S&P 500 earnings would fall only 4.8% from a year ago. Financial firms are partly to blame for the falling estimates. For example, Merrill Lynch (MER) on Oct. 16 reported a loss of $5.56 per share, while analysts were expecting a $5.22-per-share loss.

The stock market usually looks ahead, trying to predict future earnings. So firms' profits or losses from the summer— before the financial crisis heated up—will generally be ignored.
Conference Calls Give Clues

However, says David Chalupnik, head of equities at U.S. Bancorp Asset Management (USB), financial earnings are an exception. He's watching bank earnings very closely to make sure, when it comes to credit losses, "they don't blow up." So far, they haven't. "Expectations are very low," Chalupnik says.

More financial earnings arrive soon from financial outfits National City (NCC) and Fifth Third Bancorp (FITB), both on Oct. 21.

For most other sectors, the focus is not on quarterly financial results, but on what executives say in conference calls after the numbers are released. Chief executives and chief financial officers are being quizzed on what they expect for the fourth quarter and especially from 2009. "People are really mostly focused on next year," says John Thornton, portfolio manager at the Stephens Small Cap growth and Mid Cap Growth Funds.
Credit Crunch Sinking In

However, so far execs aren't giving investors what they want. "They're vague," Bacarella says. They're saying, "'It's very hard for us to forecast,'" he adds. "They themselves are not sure."

Companies are only beginning to feel the impact of the credit crunch and a slowing U.S. and global economy. "Management teams are going to be pretty cautious and pretty hazy," Thornton says.

According to Thomson Reuters, industry analysts currently expect 2009 earnings for the S&P 500 to rise almost 20% from 2008 levels. For Chalupnik, this is "wildly optimistic." He expects earnings to fall next year as the U.S. slips into recession. Many other investors seem to agree: The S&P 500 is down more than 20% in the past month.
Energy Outfits Feeling the Pain

Financial firms aren't the only area of concern for equity investors. Earnings at energy and material firms are expected to suffer from the fall in commodity prices. "People are very nervous about energy fundamentals," Thornton says. On the other hand, a firm like DuPont (DD), due to report earnings on Oct. 21, could benefit from lower oil prices because its costs for raw materials will fall but could suffer from a U.S. recession.

Tech firm executives should be worried that a U.S. recession slows spending on technology by corporations. Apple (APPL) is due to report earnings on Oct. 21, while Microsoft (MSFT) reports on Oct. 23.

Expectations for consumer firms "have dropped off a cliff," Chalupnik says. September U.S. retail sales fell 1.2%, twice the decline economists were expecting. Earnings are due from Coach (COH) on Oct. 21, from Amazon.com (AMZN) on Oct. 22, and from RadioShack Corporation (RSH) on Oct. 23.
Eyeing Export Sales

It's not just the U.S. economy and American consumers that are raising concerns. Investors are scrutinizing earnings releases for clues as to the direction of the world economy.

For years, industrial firms like Caterpillar (CAT), which reports Oct. 21, and Ingersoll Rand (IR), due Oct. 24, have profited from brisk product sales abroad. "People are going to be looking for signs of how much international is really slowing," Thornton says.

Everywhere investors turn, they seem to find big uncertainties. "It's going to be rough for the next two quarters," says Peter Cardillo, chief market economist at Avalon Partners. "The economy is under pressure."

How are profits being affected by the credit crunch, falling commodity prices, weak business and consumer spending, and a slowing world economy? Third-quarter results may only provide the faintest of clues. But those clues will still be seized upon by investors desperate for answers.