In the first test of corporate profits since the Federal Reserve hinted it's preparing to start removing the training wheels from the economy, investors are expected to be keenly tuned to corporate earnings outlooks over the next few weeks.
The stock market often gyrates amid earnings announcements as stock investors gain insight into whether they have paid too much, or too little, for the profits companies will deliver in the future. But now that investors realize the Fed won't be babying the markets forever, attention to this earnings season will be particularly intense. The assumption is that investors finally are giving up their fixation on the Fed and will start focusing on what typically matters most when people invest — the strength of the economy plus corporate profits and sales.
If companies provide the profits investors are expecting for the second quarter that ended June 30, and executives see good times ahead, the second-guessing that caused stocks to plunge in June should relax and stocks should continue to rally. Yet, if executives sound hesitant about the global economy — as many did during earnings season in the spring — the hesitancy may not sit well with investors. With the Dow Jones industrial average up almost 17 percent for the year, investors are well aware that many of them have been buying stocks on a knee-jerk basis this year simply because they figured the Fed would keep throwing money into the system.
As investors begin a period of less Fed dependence, fundamentals such as whether a company can sell more products will likely take on more significance. Investors have been responding to economic news lately in the healthy way they tended to before the Fed's maneuvers. For example, the stronger employment report Friday triggered a rally, which is the way investors typically respond to good news. In the topsy-turvy world of Fed stimulus the past few years, investors sometimes dreaded good economic news because they were afraid it would signal that the Fed would be ending stimulus.
As companies report profits during the next few weeks, "keep an eye on how they are guiding for the third quarter," said John Butters, earnings analyst for FactSet. While investors have subdued expectations for the profits that companies accumulated in the second quarter, "analysts are expecting lofty earnings growth" for the second half of the year.
For the third quarter, which started in July, earnings are expected to grow 7 percent, and sales 3 percent, Butters said. That's a high hurdle.
Earnings for the second quarter are expected to grow just 0.7 percent and sales just 0.9 percent, Butters said.
Further, even though analysts have been cutting earnings expectations since the end of March, a record number of companies have told investors to be prepared for lower-than-anticipated profits.
Although the U.S. economy has been slowly recovering, large companies that depend on foreign countries to buy their products face a particularly difficult environment. China's economy has slowed substantially, and emerging market countries in Asia and Latin America are in a slump.
The International Monetary Fund reported Tuesday that it expects global growth to remain "subdued" for the rest of 2013, with "weaker domestic demand and slower growth in several key emerging market economies" and "a protracted recession" in the eurozone.
For companies that depend on selling products abroad, this could be a tough environment to maneuver. McDonald's mentioned the challenge in April when it reported that sales in Asia-Pacific, Middle East and Africa declined primarily because of weakness in Japan and negative results in China.
Other companies referring to emerging market weakness included Coca-Cola and IBM.
Analysts expect the slowdown outside the U.S. to take the largest toll on U.S. companies that sell commodities, technology and industrial products. Demand for everything from copper to agricultural products has been affected. Companies that sell basic materials are expected to have an 8 percent decline in earnings this quarter, and analysts estimate that information technology companies will face a 6.5 percent decline, according to FactSet.
Some analysts think expectations are so low now for the quarter that companies will have an easy time exceeding forecasts and that will set stocks up to climb. Yet, analysts are still lowering some growth projections.
Piper Jaffray analyst Michael Cox this week said that although concerns over Deere & Co. are already embedded in the company's stock price, "We are growing increasingly concerned that North American large ag equipment sales could finally slow in 2014." On Monday, he lowered sales expectations for agricultural and construction equipment.
As foreign markets have slowed this quarter, investors have been favoring U.S.-centric companies and small-company stocks — which tend to depend less on exports than multinationals. Analysts also are expecting the strongest earnings growth from U.S. financial companies, which are expected to benefit from higher interest rates.
Yet, Ned Davis strategist Joseph Kalish noted, "If banks want to generate earnings growth, they will have to make more loans. If not, bank stocks may deserve a lower-than-historical multiple."