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Wary investors turn focus to corporate profits

Will corporate profits save the stock rally — or kill it?
/ Source: The Associated Press

Will corporate profits save the stock rally — or kill it?

Most companies won't announce second-quarter earnings for a few weeks yet. But already Wall Street is buzzing about what might lie ahead. One worry: With investors on edge from bad economic news, the market is riding more than ever on these upcoming reports.

"It's too early to tell if growth is tapering off," but people are concerned, said Mark Luschini, chief market strategist at Janney Montgomery Scott. "If companies disappoint, stocks could retrace their recent lows."

Stock analysts expect companies in the Standard & Poor's 500 stock index to post $184 billion in profits in the second quarter, up 27 percent from the year-ago period, then continue to rocket higher. Under their bullish scenario, profits will peak next year.

Can Corporate America do it? The Dow Jones industrial average closed at 10,450 Friday, capping two weeks of gains. But the Dow is still 7 percent off its high of April 26, and investors are jittery.

On Wednesday, shares in FedEx Corp. fell sharply although the company reported profit last quarter that met analysts' expectations. The problem was, the shipping company lowered its target for earnings in the coming year. That followed a disappointing profit report from Best Buy Co. that sent the electronics retailer's stock down 6 percent.

The coming week offers clues as to whether the two reports are part of a trend. Among companies announcing earnings: drugstore chain Walgreen Co., software maker Adobe Systems Inc., Nike Inc., homebuilder Lennar Corp. and ConAgra Foods Inc.

If recent history is any guide, analysts may be right to be bullish. Last quarter, corporate earnings rose 31 percent, the biggest increase since 1984. What's more, those profits came from selling more goods, not just from cutting expenses. With people spending again, the recovery looked like it was gaining steam. Now that's not so clear.

The Commerce Department reported Wednesday that construction of homes and apartments slumped 10 percent in May from the month earlier. Adding to the gloom, mortgage applications for new homes have fallen 40 percent in the past five weeks, a 13-week low.

To be sure, there's been hopeful news, too. The Fed reported earlier this month that all 12 regions of the nation it tracks are growing, a first since 2007. But then came reports that retail sales plunged in May. Worse, the government reported that private employers added a mere 41,000 workers to their payrolls last month. So much for the V-shaped recovery.

Anyone looking for hints in the coming week that things are perking up may be disappointed. The Federal Reserve meets to decide whether to keep benchmark interest rates near zero. But with the economy struggling, no one is expecting any big moves or statements.

Reports on home sales, both previously owned and new, come out Tuesday and Wednesday. But aside from that and the Labor Department's June jobs report, there's a relative vacuum of data until profit reports next month. And that's almost a relief.

"We have Greece, we have BP — but you can't anticipate these things," said money manager George V. Reis of Two Rivers, Wisconsin, referring to Greece's part in the European debt crisis and the Gulf oil spill. "You can estimate earnings."

"Everyone is hoping the next news will be earnings, and not some big, macro situation," said Mike Shea, managing partner at Direct Access Partners LLC. Earnings are something we're "comfortable with."

The S&P 500 is valued now at 13.1 times expected earnings in the year through March 2011. Some investors consider that cheap, given that the index usually trades at 19 times expected profits.

But analyst estimates are often too optimistic and so some investors prefer looking at other measures to gauge stock market value. One favorite: the cyclically adjusted earnings ratio. This divides stock prices by their average earnings over 10 years to smooth out troughs and peaks in those earnings.

According to Yale professor Robert Shiller, S&P 500 stocks are now valued at 20 times those earnings. The average going back over a century is 16.

In other words, stocks are pricey.