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Upbeat earnings season expected

As 2nd-quarter earnings season moves into view, analysts are becoming more optimistic about the corporate profit landscape. But companies’ earnings outlooks may have greater meaning for Wall Street.
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As the second-quarter earnings season moves into view, analysts are becoming more optimistic about the corporate profit landscape. And with stock prices riding high, the pictures companies paint about their results in future quarters may have greater meaning for Wall Street.

Most analysts expect a relatively upbeat second-quarter earnings season, something they say is already reflected in stock prices.

The market’s main indices are up over 20 percent from their mid-March lows, as investors have bet on an economic recovery in the second half of the year — a longed-for event that has failed to materialize over the last two years. The broad Standard & Poor’s 500-stock index rose 15 percent in the second quarter, which ended Monday, posting its best quarter since the fourth quarter of 1998.

With these gains in mind, investors will be scrutinizing not only companies’ second-quarter results, but also their outlooks for coming quarters. The thinking among analysts is that with the market’s main averages now at their highest levels in a year, investors are unlikely to push share prices much higher unless there is evidence of improvement in the corporate sector to justify the 15-week bull run.

“July is the fulcrum; it’s critical,” said Joseph Cooper, a research analyst at Thomson First Call.

The earnings season unofficially begins with Dow component Alcoa’s earnings report due July 8. Until then, firms will continue to issue pre-announcements — the jargon Wall Street uses when companies raise or lower earnings estimates.

Early indications for second-quarter results have been encouraging, with relatively few companies warning of shortfalls.

Analysts polled by Thomson First Call forecast earnings for the nation’s 500 biggest companies to grow by an average 5.3 percent in the second quarter. The research firm expects companies will beat that forecast by three and five percentage points on average due to the beneficial impact of the weak U.S. dollar.

In any case earnings are expected to be somewhat softer than last quarter, when earnings rose 11.6 percent on the back of soaring energy industry results.

Looking further out, things get cloudier. First Call expects earnings for the S&P 500 index to be up 12.7 percent and 21.3 percent, respectively, in the third and fourth quarters of 2003. But those estimates may be lowered in coming weeks by any earnings warnings.

Fewer negative surprises
One positive for earnings season is a decline in the number of negative pre-announcements from corporations that think their earnings will fall short of Wall Street’s forecasts.

“Even though I’m still dogged by the weak shape of the overall economy, I think [this earnings season’s] going to be good,” Cooper said. “So far this earnings season, the ratio of negative pre-announcements to positive announcements has been pretty good, and that gives me confidence.”

Thus far, there have been two negative announcements for every positive report, slightly lower than the long-term historical average of 2.5 negative reports for every positive announcement, according to Cooper. In the first quarter, there were three negatives for every positive.

Another positive sign, Cooper said, is the trimming of analysts’ estimates, which has been less severe than in previous quarters. On April 1, the analysts expected a 7 percent rise in quarterly earnings, which has now been reduced to 5.3 percent. This decline compares favorably with previous quarters, when estimates were nearly halved.

As in the first quarter, the second quarter’s best performing sectors are expected to be energy and technology, the former posting 36 percent growth and the latter recording 20 percent growth. A rise in commodity prices — including oil and natural gas — has helped energy stocks, Cooper said.

“Investors have felt they have to be in technology because when the market turns the technology sector will turn very quickly,” said Sam Stovall, an investment strategist at Standard & Poor’s. “They’ll buy even though valuations are high, but I think the expectations are based more on faith than fundamentals.”

But tech sector earnings may be trimmed in coming weeks.

“We’re not hearing anything from the techs that suggests there has been anything more than a seasonal pickup in demand,” said Cooper. “Analysts haven’t brought their forecasts down, but I think they will,” he said, adding that earnings pre-announcements in coming weeks may soften the outlook for the sector.