Bracing for an Ugly Earnings Season

The slowdowns in Europe and China are hurting corporate profits

By Dan Burrows, InvestorPlace Feature Writer

Probably the best thing that can be said of the coming second-quarter earnings season — maybe the only good thing that can be said — is that expectations are so low companies can trip over them.

Dow component Alcoa (NYSE:AA) kicks off the reporting season after the market closes Monday, and one thing we’re certainly going to see is that the slowdown in the global economy has definitely caught up to U.S. corporate profits.

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For the market’s sake, the bad news had better be priced in and then some.

U.S. corporate profits fell in the first quarter of 2012 — the first such drop since 2008 — as a decline in earnings from overseas more than offset growth at home. Companies’ early warnings and analysts’ forecasts are saying we should expect more of the same as second-quarter results roll in.

Indeed, the only thing keeping S&P 500 earnings in growth territory for the most recent period is Bank of America (NYSE:BAC), according to data from FactSet, and that’s only due to preposterously easy year-over-year comparisons.

You may recall that BofA posted a deep year-ago loss because of its $8.5 billion mortgage lawsuit settlement. That’s going to make this year’s numbers look a heck of a lot better. So much better, in fact, that BofA is propping up not just financials, but the entire S&P 500.

Financials are forecast to be the best performing sector of the market with earnings growth of more than 51%. But strip BofA out of the results and the sector posts earnings growth of just 6.8%.

And although BofA is the biggest contributor, plenty of other firms are also helping the sector with easy year-over-year comparisons, FactSet notes. Morgan Stanley (NYSE:MS), Allstate (NYSE:ALL) and Travelers (NYSE:TRV) all reported losses in the year-ago quarter and are now predicted to be large contributors to earnings growth in the upcoming reporting season.

Kick those financial sector numbers out of the S&P 500’s bottom line and things get shaky. In the aggregate, second-quarter earnings are forecast to grow just 3%. Take just BofA out of the equation and the S&P 500 is set to see profits decline 1.7%.

What BofA and the financial sector are helping to paper over are higher costs, weaker overseas demand and the effects of a stronger dollar (which makes U.S. goods more expensive in foreign markets).

It all adds up to a wave of companies issuing profit warnings ahead of earnings season.

The ratio of companies cutting versus raising their earnings outlooks stands at 3.6, according to data from Thomson Reuters. If the alarm bells are ringing, then well they should: That’s the highest warning level since 2001.

The question for stocks, then, is whether companies have tempered expectations enough ahead of the season. Remember that the market doesn’t care about bad news nearly so much as it cares about nasty surprises.

Liz Ann Sonders, chief investment strategist at Charles Schwab (NYSE:SCHW), is expecting the earnings season to bring some disappointments, especially among companies most exposed to Europe and the slowdown in China. But it also helps that “companies have certainly lowered the bar, which could mitigate the disappointment,” Sonders writes.

As always, it all comes down to expectations. It’s no secret second-quarter earnings are going to be weak. The question is whether or not the ugliness has been sufficiently baked in to share prices.

As of this writing, Dan Burrows didn’t hold any of the securities mentioned here.

Article printed from InvestorPlace Media,

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