The resolution – for now – of ongoing political hostilities in the U.S. sent stocks soaring to multi-year highs. Now, will the next batch of corporate earnings reinforce the giddiness, or send share prices several steps back?
This is the question as the fourth-quarter earnings season starts in earnest this week, with Alcoa Inc. releasing its numbers Tuesday. A host of major corporations follow with their earnings in the days and weeks after.
Analysts expect fourth-quarter earnings for the Standard & Poor's 500 index to increase 3.28 per cent, said Christine Short, a senior manager at S&P Global Markets Intelligence. That's an improvement from essentially flat profits in the third quarter.
By now, analysts have figured in all of the economic disruptions of the fourth quarter, including Hurricane Sandy, winter storms in the Midwest, and the post-election consumer dismay. "There was a widespread trimming of estimates and maybe a little bit of concern due to the fact retail sales growth was soft, with the holiday season the weakest in about three years," said Fred H. Dickson, chief investment strategist at D.A. Davidson & Co.
But while these are "general headwinds" to fourth-quarter earnings, Mr. Dickson suggests companies may follow the typical pattern wherein about 60 per cent to 65 per cent beat their earnings expectations. (So far, 22 companies have reported earnings for the fourth quarter, with 14 beating, six missing, and two meeting, Ms. Short says.)
The key driver for stocks, then, is whether companies' guidance for 2013 will be more upbeat than would have been expected just a week or so ago, when the United States was poised to go over its "fiscal cliff."
"I think we'll see an uplift in first-quarter guidance that might be a little more robust than what we expected a couple of weeks ago," Mr. Dickson said. "And investors usually react more to the tone of forward earnings guidance than to the number of positive or negative surprises."
So far, just 11 companies in the S&P 500 have issued guidance for 2013's first quarter, Ms. Short says, with nine "negative" – or below existing analyst consensus – zero in-line and two positive, or above. While this negative-to-positive ratio of 4.5 is much higher than the 10-year average of 2.0, Ms. Short says, it's also a small sample size, and the guidance was mostly issued prior to the "fiscal cliff" resolution.
Paul Larson, chief equities strategist at Morningstar Inc., thinks guidance may remain conservative since the U.S. political caste will resume their struggles shortly over the federal debt ceiling. "Washington D.C. is not going to fade into the background, like they could have … there will still be a lot of attention in the stock market and in corporate cultures focused on what is going on there," he said.
If companies remain cautious with guidance until more fiscal matters get settled in the first half of the year, the best news for corporate earnings and guidance may occur in the reporting for the first and second quarters of 2013 – not now.
In the meantime, the expected low-single-digit earnings growth ("It's not going to burn up any barns," Mr. Larson said), coupled with a market that Morningstar sees as close to "fairly valued" – limits the potential for earnings news that can drive share prices up.
"Think of it as a coiled spring: The further stock prices fall, the spring coils harder, so when good news comes, the returns are that much greater," Mr. Larson said. "But we've had four straight years of gains in the stock market, and a lot of the good things that have happened like coming out of the recession and modest job gains are already priced in."
Robert Kavcic, a senior economist and vice president of economic research at BMO Nesbitt Burns, said that while his group remains "bullish overall on equities" for 2013, "stocks could still face a bumpy ride, and offer some buying opportunities" in the first quarter.