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Will stronger profits drive stocks higher?

Expectations for profit growth are high as Canadian companies begin their third-quarter earnings parade, but the ability of strong numbers to drive stocks higher remains in question.

In the U.S., a relatively strong bag of quarterly reports over the last week has failed to propel markets the way results had three months earlier.

The S&P 500 has inched up a little more than 1 per cent since bellwethers Intel Corp. and JPMorgan Chase & Co. kicked off the steady flow of corporate reporting Oct. 13. with better-than-expected results.

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In comparison, the index climbed more than 4 per cent in a similar time frame after the start of second quarter reporting season.

Part of investors' concern appears to be the quality of corporate earnings at a time when a lot of businesses have reported higher results by cutting costs, but not actually improving revenue. This underlying sentiment flared late Wednesday, when banking analyst Richard Bove, of Rochdale Securities, put a "sell" rating on Wells Fargo & Co. even as it topped expectations with a $3.2-billion (U.S.) profit. The bank's stock and the broader market fell on his interpretation that the results were poor quality and unsustainable, built on returns from hedging rather than improved performance.

Earnings under a microscope

In Canada, companies have generally not attacked their costs as vigorously as U.S. businesses, but analysts say many of them are benefiting from a stronger economy recovery here.

The same day that the U.S. Labor Department took some air out of the market by reporting a higher than expected jump in initial applications for jobless benefits, for example, Statistics Canada provided positive economic news, announcing Thursday that retail sales here rose 0.8 per cent in August, offsetting a decline in July.

Analysts are expecting 55 per cent of S&P/TSX companies to report that their profits were up in the third quarter, according to data from Bloomberg. That would represent the highest proportion of companies this year reporting sequential growth.

But as Precision Drilling Trust showed on Thursday, earnings season will be a rocky ride. Canada's largest oil and gas drilling contractor reported a 13 per cent fall in profit and 11 per cent decline in sales, as lower oil and natural gas prices caused drilling activity to slump.

"While we have experienced a seasonal pick-up in Canada and are encouraged by customer demand ... it is far too early to make the call for a meaningful recovery," Kevin Neveu, Precision's chief executive officer, said in a statement.

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Potash Corp. , the world's largest producer, said its sales tumbled to $1-billion from $3.1-billion a year earlier and profit fell 80 per cent to $248.8 million, as fertilizer sales fell from their pre-recession heights.

Shaw Communications Inc. and Transforce Inc. are scheduled to post results on Friday.

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