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The second-quarter earnings season that kicks off today may be the make-or-break test for a global recovery that suddenly looks to be sputtering.
The past several weeks have seen a string of disappointing economic data, as growth in the U.S. and elsewhere unexpectedly slowed. More bears came out of hibernation to argue the recovery that was once seen as V-shaped would look more like a W - an imminent double-dip recession.
Last week's market rally, in which the prior week's carnage was reversed, occurred without any major economic or market news and blunted that talk.
What will occur over the next several weeks, however, is a string of major earnings releases with little margin of error, owing to a consistent ratcheting up of expectations in 2010.
"You're going to need a lot of upside surprises to break the negative mentality," said Beata Caranci, the deputy chief economist at TD Bank. And the high expectations "tells you where the balance of risks are - it's much easier to disappoint than surprise."
Peter Buchanan, a CIBC economist, said "as economists are getting more cautious, analysts for companies in the S&P 500 have not cut their estimates. We'll see who's right in the weeks to come."
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Robert Kavcic, an economist at BMO Nesbitt Burns, notes that at the beginning of 2010, the consensus analyst estimate for 2010 earnings for S&P 500 companies was 8.6 per cent below 2009 levels. On the strength of the fourth-quarter 2009 and first-quarter 2010 earnings reports, 2010 estimates have been jacked up so much that the consensus numbers are now 34 per cent above 2009.
For the second quarter, consensus estimates are for earnings to grow 27 per cent over 2009's second quarter, according to Thomson Reuters.
"The last three quarters have been absolute blowouts with respect to earnings surprises," Mr. Kavcic said, as about 80 per cent of S&P 500 companies have beaten consensus, versus a historical norm of about 66 per cent. "But the market can only be fooled for so long … it won't be surprising if the impressive rate of earnings surprises seen in the past three quarters marks the high watermark of this cycle."
Mr. Buchanan, at CIBC, notes that Canadian analysts have actually tempered expectations recently, meaning there's more downside risk in the U.S. from missed numbers.
Investors will get samplings from several sectors this week. Alcoa Inc. kicks it off Monday with a look at industrial production.
Other companies reporting this week include Intel Corp., Advanced Micro Devices, Google Inc., JPMorgan Chase & Co., Bank of America Corp., Citigroup and General Electric.
"Cost-cutting is still the order of the day, so the earnings numbers probably won't disappoint like the economic numbers did," said TD's Ms. Caranci.
Of course, cost-cutting typically includes head count, and that's a big reason why the blowouts in corporate earnings haven't translated to an across-the-board economic recovery.
"We should have employment [head count gains]at a rate four to five times higher than it is, based on the health of corporate profits," Ms. Caranci said. Productivity is at its highest rate since the 1960s, unit labour costs are at their lowest point, and companies have very high liquidity, as measured by their ratio of current assets to current liabilities - yet companies haven't brought back workers to any large degree.
"The longer that persists, [a downturn]is self-prophesizing," Ms. Caranci said. Another quarter of healthy earnings, however, "might ignite some faith in the sustainability of this recovery, and that might feed into the labour market."
To that end, the real news of the earnings season may not come in the second-quarter numbers themselves, but in the second-half outlooks issued by management. "They're not necessarily going to be negative, but they may be somewhat cautious," said Mr. Buchanan.
Special to The Globe and Mail
David Milstead