Pessimism will engulf US corporate earnings

EARNINGS season is underway. This week, investors will learn about the health of some of the biggest US companies.

There is an air of pessimism. According to analyst surveys, earnings last quarter are expected to drop 2.4 per cent, and we may see more losses reported than profits for the first time in four years.

But some have found reasons to be sanguine: US unemployment fell below the stubborn 8 per cent barrier in September, and July and August readings were revised significantly. On the back of that, the Dow Jones Industrial Average index and S&P 500 both approached highs not seen since 2007, and are up around 25 per cent in the last 12 months. However, this rally may be short-lived.

Investors are nervous about industry bellwether Alcoa, which reports after today’s closing bell. The leading producer of aluminium has a lot of exposure to China, where the slowdown has reduced demand for industrial metals. Shares have shed 8 per cent over the last 12 months, and there may be further downside.

The price of aluminium has been steadily declining over the last two years and this will inevitably hit the company’s earnings. Stephen Briggs of BNP Paribas feels that the growth outlook is “quite painful, and they’ll struggle to make money”.

Yum! Brands, the owner of Pizza Hut and KFC, is the world’s largest chain of restaurants with over 38,000 restaurants in 120 countries, and it also reports today. Like Alcoa, it has plenty of exposure to China, where it earns half of its revenues.

Yum has bucked the trend and grown phenomenally since the start of the crisis. Shares have doubled since the beginning of the 2009 as the company positioned itself more towards emerging markets. This year alone, shares have risen by 30 per cent, although they are off highs seen in April. The company is expected to post a profit, so any dips in the share price may represent a good entry point for traders.

Banks are expected to be a bright spot during this earnings season, and analysts predict a 5.5 per cent growth in earnings, according to FactSet. Two banking titans will report on Friday.

Wells Fargo provides one-third of all new mortgages in the US and has seen strong mortgage refinancing recently. Richard Straite of Atlantic Equities says it is “a relatively safe play” for those betting that US housing has bottomed out.

There is more uncertainty around JP Morgan: a lawsuit brought by the New York attorney general over alleged mortgage security fraud by Bear Stearns (now owned by JP Morgan), and potential fines for Libor manipulation bring legal and regulatory risk. But Straite thinks that “overall, they are pretty safe, and can deal with these issues”. Traders will want guidance regarding share buybacks, which were suspended in the wake of the London Whale trading scandal, which resulted in losses of $2bn (£1.25bn). A resumption of that programme may boost shares.

Banks may be a bright spot, but generally it looks like a season of gloom for US equities. By the quarter end, we might also see just how reliant American muscle is on Chinese steroids.