Wall Street may be heading for a pullback as earnings season starts

WALL Street may be bracing for a pullback as US earnings season begins this week – if the clouds of profit warnings from bellwethers ranging from FedEx to Hewlett-Packard lead to a downpour of lower profits, or even losses.

Thanks to aggressive stimulus plans from central banks around the world, the Standard & Poor’s 500 index gained 5.8 per cent over the third quarter. That sharp rally occurred even as companies were struggling. Earnings for that period are forecast to fall 2.4 per cent from the year-ago quarter. If that happens, this would be the first earnings decline in three years, according to Thomson Reuters data.

Market strategists and investors say US stock valuations are broadly out of sync with earnings estimates. They forecast a pullback in stocks in coming weeks as more companies report and reduce expectations for the fourth quarter and beyond.

Fourth-quarter estimates for S&P 500 companies show a 9.5 per cent gain in profits from a year ago, according to Thomson Reuters data. Analysts say that outlook is too high, given what investors are already hearing from the corporate world.

“It’s a divergence right now where the valuations as far as equity prices (are concerned) have soared, and are really putting in place a stronger economy and stronger fundamentals,” said Alan Lancz, president of Alan B. Lancz & Associates Inc, an investment advisory firm in Toledo, Ohio.

“But earnings will be the telltale sign,” Lancz added. “And if the guidance isn’t particularly strong, the market might be setting itself up for a little disappointment. I don’t see a major correction, but I do see a pullback.”

On Friday, the Standard & Poor’s 500 Index broke a four-day string of gains and ended down about half a point at 1,460.93. For the week, though, the S&P 500 rose 1.4 percent, and for the year, the benchmark index is still up 16.2 per cent.

The earnings season will kick off tomorrow with results from Dow component Alcoa after the bell. Analysts expect Alcoa’s third-quarter results to show it broke even, down from a profit of 15 cents per share a year earlier.

JPMorgan Chase & Co and Wells Fargo, the first big financial names to report, are also on tap in the coming week.

Nearly half of the S&P 500 companies guiding lower for third-quarter earnings blamed weakness in Europe, according to a Thomson Reuters survey. Another 11 per cent blamed the weak global economy. Eight per cent cited strength in the US dollar, and six per cent blamed the slowdown in China, the survey showed.

Weakness in the US economy has not helped. The final read on US second-quarter gross domestic product last month showed growth of just 1.3 per cent, weaker than an expected 1.7 per cent.

On Thursday, software maker Informatica Corp issued a profit warning and said business conditions were worsening in Europe. The software company is considered to be a bellwether because its products are used alongside those made by larger software companies.

“Parts of Europe aren’t just in recession, they’re in depression,” said Jeff Kleintop, of LPL Financial in Boston. “I think (analysts) underestimated the extent of the global slowdown, and maybe are still underestimating it.”

While estimates have come down sharply in all 10 S&P 500 sectors since the start of the year, technology is one area where the lower expectations are most notable. Slower growth in China is a big factor in that trend.

Earnings growth in the tech sector is expected to be just 2.3 per cent for the quarter, compared with a 1 July forecast of 13.1 per cent. Apple is a big driver of gains.

Technology’s profit growth has been crucial for the S&P 500. Minus technology, S&P 500 earnings are expected to be down 3.4 per cent.

The tech sector is where the slowdown in China’s economy is having the biggest impact.

Recent data shows that the pace of growth in China, the world’s second-largest economy, may slow for a seventh quarter, straining earnings in the tech and materials sectors.