updated 7/21/2004 4:03:34 PM ET 2004-07-21T20:03:34

With second-quarter earnings season underway, Wall Street is expecting a fourth straight blowout quarter of 20 percent-plus growth. But how long can the hype last?

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Investors had hoped this quarter’s earnings would live up to, or even surpass, the impressive growth in the first quarter, when earnings for companies in the Standard & Poor’s 500-stock index rose 27.5 percent from the first quarter a year earlier. But a rather shaky start to this reporting season may be taking a toll on investors' long-term optimism.

The reason is the less-than-stellar profit outlooks provided in recent weeks by companies in a variety of sectors — most notably technology. Analysts say that guidance, combined with lower consumer spending, uncertainty about inflation, terrorism and the presidential election could mean a lackluster third quarter.

"What’s murky is the third and fourth quarters," said Larry Wachtel, an equity strategist at Wachovia Securities. "The good second quarter is already known, but the guidance going forward is unknown. Valuation isn't cheap, so that's why we are left in this void."

With that in mind, companies that fail to deliver decent second-half guidance are already getting the cold shoulder. Investors are firmly focused on the rest of 2004, and are worried that profit prospects will dim even as interest rates rise and consumer spending drops off.

A case in point is 3M. The manufacturer of Scotch tape and Post-It notes saw its share price fall 5.5 percent on the New York Stock Exchange Monday after reporting quarterly revenue that was lower than analysts had expected, while the company's 2004 earnings outlook of $3.72 to $3.75 a share only matched Wall Street's existing estimates. Video: Market outlook

Wall Street's cool reaction to 3M’s news highlights a trend in the markets in recent weeks according to Brian Pears, head of equity trading at Victory Capital Management.

“3M’s earnings report is an example of how investors are being very picky about earnings,” Pears told CNBC Monday. “We all know the revenue numbers are going to be pretty good, but we all want to see the quality of earnings before getting bullish on stocks.”

Indeed, over the last few weeks, Wall Street has punished a handful of technology firms, including software makers PeopleSoft, Computer Associates and Veritas, and microchip maker Intel, for their profit warnings. Intel, the number-one semiconductor firm, surprised Wall Street by lowering its profit outlook for 2004, saying internal miscalculations led to an unexpected surge in the company's chip inventory. Its share price fell to an 11-month low on the day it issued its profit warning.

Still, the rash of high-tech warnings hasn’t left too large a dent in the overall earnings estimates for the technology sector, leading some analysts to opine that the bad news is limited to a few technology companies, and so the worries about quarterly earnings coming in short of expectations are somewhat exaggerated.

The technology sector is still expected to show year-over-year earnings growth of 59 percent, a number that is virtually unchanged from the start of the quarterly earnings season despite the spate of high-tech warnings according to earnings research firm Thomson Financial/First Call. At the same time, the ratio of positive to negative earnings warnings coming from the tech sector point to a slightly more negative third-quarter outlook, although the ratio is well below the long-term average, he notes.

Financial services boost
With only a third of the universe of S&P 500 companies having reported earnings, it’s too early to draw a meaningful conclusion about the outlook for the overall earnings season according to John Butters, research analyst at Thomson/First Call.

But if earnings from the financial services sector are anything to go by, there may be a positive surprise this season. Like technology, the sector tends to report earnings early and has seen its year-over-year growth expectations rise from 8 percent at the start of the quarter to 11 percent on the back of strong earnings from sector heavyweights like Citigroup and Bank of America, Butters says.

The commercial banking sector is the place to be according to Mark Fitzgibbon, director of research and partner at Sandler O'Neill & Partners. Banks like North Fork Bank, Wachovia, J.P. Morgan and others have reported signs of small business and middle-market loan growth, he said. This is a bullish sign, he said, because it implies that companies and individuals are becoming more bullish about the economic outlook.

“We have been hearing from banks that their customers are more bullish about the economic outlook, but this hasn’t been matched with much more demand for loans,” Fitzgibbon said. “But this quarter we are seeing some early signs of this, and I think it will accelerate in coming quarters. So more businesses and feeling more comfortable with the economic trends and they are beginning to make investments.”

Good banking earnings could spell good news for the overall economy, Fitzgibbon noted.

“We think that the banking sector will be a leading economic indicator at this time,” he said. “You’ve had pent-up demand for some time; businesses have wanted to grow and expand, but have waited for signs that the economy is growing. My sense is we have reached that point now. The stars are aligned and there is potential for the economy to grow over the next three or four quarters, but beyond that, my crystal ball gets fuzzy.”

Reuters contributed to this report.


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