Caution: Falling profits

[notiCIas]

Caution: Falling profits

Earnings growth in the first quarter should be fairly tame, prompting some worries on Wall Street.


February 23, 2005: 1:22 PM EST
By Paul R. La Monica, CNN/Money senior writer


The broader markets have been choppy this year. And with earnings growth expected to be tame, there may be more volatility.

 
Little to get excited about
Analysts expect sluggish growth for most sectors in the first half of '05.

 S&P Sector   Est. 1Q EPS Gr.   Est. 2Q EPS Gr.  
Consumer discretionary  -5%  8%  
Consumer staples  6%  7%  
Energy  28%  4%  
Financial  0%  6%  
Healthcare  3%  6%  
Industrials  12%  14%  
Materials  42%  24%  
Technology  12%  12%  
Telecom  6%  6%  
Utilities  5%  11%  
 

Source:  Thomson/First Call

NEW YORK (CNN/Money) - Investors have had a lot to worry about, including rising oil prices, broad inflationary pressures and the weak dollar. Still, the stock market has held up reasonably well.

But there's another, perhaps even bigger, concern that Wall Street will likely have to contend with: uninspiring corporate earnings for the first quarter. And that could keep a lid on stocks during the spring.

"You know how you're driving along a road in the mountains and you see a sign that says 'Caution: Falling Rocks?' We're seeing 'Caution: Falling Profits.' I'm really nervous about the market," said Todd Campbell, president of E.B. Capital Markets, an independent research firm catering to institutional clients.

Profits slowing, warnings rising

According to Thomson/First Call, first-quarter earnings growth for S&P 500 companies is expected to be just 7.1 percent from a year ago, compared to 20 percent annual growth in the fourth quarter.

"Earnings growth is now on a down trend," said Ozan Akcin, chief market strategist with Puglisi & Co. "This doesn't mean fundamentals are bad, but we are going to have some softness."

Basic materials and energy companies and, to a lesser extent, tech and industrial firms, should be the earnings stars of the quarter, with analysts predicting profit growth of 42 percent in the materials sector, 28 percent in energy and 12 percent in both the tech and industrial sectors.

But elsewhere the outlook is tame, with analysts predicting earnings increases between zero and 6 percent for the consumer staples, financial, healthcare, telecom and utility sectors.

And the consumer discretionary sector, which includes retailers, should really take it on the chin: analysts are predicting a 5 percent decline in profits.

What's more, there's been a disturbing trend of companies saying they would miss forecasts. Through Feb. 18, 63 percent of all earnings preannouncements from S&P 500 companies were warnings while just 24 percent were from companies raising their numbers.

At the same time a year ago, 47 percent were warnings and 33 percent guided higher.

"This is something to be concerned about," said Akcin. "I don't think investors have been particularly cautious just yet." He adds that the market has been surprisingly resilient given the spate of earnings warnings.

Investors need to be selective and wary

The rest of the year isn't shaping up to be much prettier. Jeffrey Kleintop, chief investment strategist for PNC Advisors, said that he's expecting S&P 500 earnings growth of about 6 percent for the second quarter and about 7 percent for all of 2005.

Because of this sluggish earnings environment, Kleintop said he thinks investors would be wise to stick with companies in sectors that should be able to post decent profit gains for the full year, such as materials, industrials and tech. He adds that it won't be a smooth ride for these groups though.

"Market leadership will be driven by earnings this year. But there will be a return of volatility. It will be choppy," said Kleintop.

Campbell said that more defensive oriented sectors like commodities and industrials should do well this year. He also thinks that earnings for consumer staples firms could rebound at the end of the year.

"Investors have to spend a lot of time thinking about areas of the market that will be insulated from declines in profitability," said Campbell.

Still, there is at least one positive upshot from a relatively weak earnings backdrop for the overall market. It appears that estimates are no longer out of whack with reality.

So there should be a better chance for companies to report results that, at the very least, won't miss forecasts. And those that don't wind up disappointing the Street could be given a boost.

"Expectations are pretty much in line," said Subodh Kumar, chief investment strategist with CIBC World Markets. "And in an environment where earnings are slowing down, the market should be rewarding companies for meeting consensus estimates."