Profit growth, the fuel that powers Wall Street, likely downshifted in the first quarter to its slowest pace in three years. Investor expectations, as a result, have also dipped a few notches.
The fact Wall Street has set the bar so low, however, might actually prove beneficial to stocks, as it makes it more likely that companies will be able to top projections.
When the first-quarter earnings season officially kicks off today, as aluminum giant Alcoa reports its results, investors will be bracing for a sharp slowdown in profit growth. Analysts expect growth of roughly 1 percent, vs. 20 percent a year ago, which would be the slowest since the third quarter of 2009, when the economy was just emerging from the Great Recession. "I would expect a higher than normal amount of companies to beat expectations," says Greg Harrison, corporate earnings research analyst at Thomson Reuters.
Still, a sizable contingent believes the sharp slowdown could turn the profit story from a market tailwind to a headwind.
Given that stocks just posted their best quarter since 1998, the earnings slowdown could cause "downward pressure" on stock prices, says Andrew Fitzpatrick, director of investments at Hinsdale Associates.
Stocks have been struggling lately, finishing down four sessions in a row, including the Dow Jones industrial average's 131-point drop Monday to 12,930. The selling has been driven by renewed fears surrounding Europe's debt crisis, slowing economic growth in China and concerns about U.S. profit margins.
But the trend of beating the Street has already begun. Of the 27 companies in the Standard & Poor's 500 index that have reported first-quarter earnings, 81 percent have topped forecasts, vs. an average of 62 percent, says Christine Short of S&P Capital IQ. That positive start is a good sign. Harrison says early results predict how the full earnings season will play out two-thirds of the time.
It is unlikely that the bull market will be killed off because of a shift to "boring yet steady earnings growth," says Rod Smyth at RiverFront Investment Group. The actual dollars-per-share earnings for the S&P 500 is expected to remain above $100 despite the slowdown. So if the market trades near its average price-earnings ratio of 14 or 15, the S&P 500 would be between 1400 and 1500. It closed Monday at 1382. "Six months ago profit projections were too high," he says. "But today they are at levels that companies should meet."
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