It's not just third-quarter earnings spooking investors. The bleak profit outlooks that CEOs are serving up have Wall Street on the defensive, prompting investors to sell and lock in profits.
That's a big reason the market has hit a rough patch. A three-session slide has dropped the Dow Jones industrial average 449 points, or 3.3%, including Tuesday's 243-point tumble to 13,103. The Nasdaq composite index on Tuesday closed below the psychologically important 3000 level for the first time since Aug. 6.
Though it's still early in the reporting season, third-quarter results are clearly shaping up poorly. Only 57% of the 145 companies in the Standard & Poor's 500 that have reported earnings have topped forecasts, well below the normal rate of 62%, Thomson Reuters says. In a sign of weak demand in the global economy, only 37% of companies have topped revenue expectations.
But what is really creating concern: the negative profit outlooks. So far, 22 companies have issued profit warnings for the fourth quarter, while just two said earnings would be better than expected. So for every 11 profit warnings there is only one upbeat forecast. That 11-to-1 ratio dwarfs the long-term average of 2.4 profit warnings for every better-than-expected forecast.
"The negative guidance is a cause of investor discomfort," says Greg Harrison, earnings analyst at Thomson Reuters. It "suggests that their profit estimates for the fourth quarter may still be too high, which throws doubt on the strength of the anticipated recovery in earnings."
Currently, analysts expect year-over-year earnings growth of 9.7% in the October-December quarter.
Another worry is the fact that earnings are expected to be down in the third quarter for the first time in three years. And history shows that very seldom are profits down for just one quarter.
Since 1953, earnings have fallen 18 times and the downturn lasted longer 15 times, or an average of 3.4 quarters, before growth resumed, Strategas Research Partners data show.
If CEOs keep flooding the airwaves with lower rather than higher earnings projections, it could spell even deeper trouble for a stock market already facing plenty of uncertainty in the November elections and looming "fiscal cliff" of potential higher taxes and spending cuts.
'If you get a continuation of those kind of negative-to-positive ratios, then that is a whole new ballgame," says Craig Hodges, a portfolio manager at the Hodges Funds. "It could take the market down and lower the price-to-earnings multiple investors are willing to pay for stocks."
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