Reporting season begins this week in the United States, with Alcoa Inc. , Chevron Corp. , Google Inc. and JP Morgan Chase & Co. providing the first glimpse into how companies are faring so far this year.
Members of the S&P 500 index are expected to deliver a tenth consecutive quarterly increase in operating profit. But investors who are hoping the first-quarter results will drive further stock gains may be disappointed.
Sam Stovall, chief equity strategist at S&P Capital IQ, warns that the S&P 500 "may have borrowed a bit too much from the future, and could now be in the early stages of a widely anticipated pullback." He notes that in the last six months, the U.S. benchmark has racked up gains nearly on par with the average 12-month recovery that has followed every other downturn since the Second World War.
Mr. Stovall adds that expectations are low and leave ample room for companies to deliver positive surprises. Among the factors expected to have weighed on corporate performance last quarter are higher input costs, weakening demand from European and emerging markets, a strong U.S. dollar and tough year-over-year comparisons coming off robust corporate growth in 2011.
The analyst consensus calls for share profit for companies on the S&P 500 to inch ahead less than 1 per cent from a year earlier. That compares with annual gains of between 18 per cent and 20 per cent in each of last year's quarters. Only three of the 10 sectors represented in the index are expected to show any growth, according to S&P Capital IQ.
Analysts are counting on corporate results improving during the year, with consensus calling for share profit growth of 16 per cent in the fourth quarter. "However, until confidence in [fourth-quarter]results is more widespread, we think recent share price gains will remain vulnerable," Mr. Stovall said.
Some money managers have been selling stocks in recent weeks, believing that there is now more downside risk than upside potential.
Within the last two months, Fidelity Tactical Strategies Fund has reduced holdings in equities to 52 per cent, down from 60 per cent, and increased its positions in government bonds and cash, says Jurrien Timmer, co-manager of the fund and director of global macro for Fidelity Investments.
"U.S. economic improvement explains only so much of the advance since October," he cautions. "There's more to this market than just fundamentals."
Stock prices have been lifted by the liquidity pumped into the European and U.S. economies by their respective central banks and by hedge fund managers getting squeezed on short positions, he said.
Looking forward, slowing growth in China and the next phase of the European sovereign debt crisis could exert more influence on investors than corporate earnings, he says.
Last week, for example, it became clear that although Greece's crisis is temporarily at bay, buyers aren't stepping up for Spanish debt and even domestic banks aren't interested in buying their government's bonds.
In China, there is a growing possibility that the economy will suffer a "hard landing," which Mr. Timmer describes as growth falling to less than 6 per cent. That figure may sound like a robust number, but it represents a significant drop in China's growth rate compared with its pace over the last decade.
Aggravating matters, there is so much excess in China's economy today, from property values to embedded inflation, that the government will be less willing, or able, to intervene, Mr. Timmer says.
"There is not enough concern in the markets today about a possible hard landing. Chinese policy makers will be unprepared for any hard landing and unwilling to act in the way that the market will demand."