Will the Stock-Market Recovery Continue?

Will the Stock-Market Recovery Continue?

All eyes are on corporate earnings these days as investors shift from a hopeful mode to one more demanding of real improvement. And in the business headlines, at least, they are seeing it. After the close of trading on Monday Apple reported that quarterly earnings were up a stunning 47% on strong sales of iPhones and Mac computers. Investors were also cheered by the prospects that Caterpillar would deliver a bullish profit report. On Tuesday morning Caterpillar did just that, reporting earnings that were down 53% but were well ahead of analysts expectations.

But the news from most other companies for the just-ended third quarter will be decidedly mixed. “The overall picture for the third quarter is very similar to the second quarter, with most firms beating expectations while the top and bottom lines [i.e., revenues and profits] are still lower than a year ago,” says Dirk Van Dijk, chief equity strategist for Zacks Investment Research. Overall, Zacks’ analyst surveys suggest that earnings for the S&P 500 will be down 23.8% from last year’s third quarter.

That would spell trouble for stocks were it not for high investor confidence that a blockbuster fourth quarter is about to unfold. “Earnings on a year-over-year basis are expected to more than double in the fourth quarter,” says Van Dijk, thanks largely to big recovery in the financial sector. In the final quarter of 2008 AIG imploded, losing $38 billion. With that ball of lead no longer weighing down the financial group average, earnings will surge.

Calculating the financial group’s improvement can be a bit tricky since going from a loss to a profit isn’t truly a percentage improvement. “When you cross over zero, comparisons get weird,” says Van Dijk. Even so, the financial group’s turnaround — it should log $15 billion or more in fourth-quarter profit — will give a strong boost to the S&P 500 composite earnings. The S&P will also be boosted by a famous departure: “GM was losing billions last year, but it’s no longer in the S&P,” observes Van Dijk.

Those accounting tweaks make the 2009 fourth quarter’s huge expected gain a bit less meaningful, but it’s still a factor in the market’s future. “Even though a child can figure out that the year-over-year numbers are going to surge from a depressed base of a year ago, the fact that some market makers feel it is important must make it important,” noted strategist David Rosenberg at wealth manager Gluskin Sheff in a Monday report to clients. Such is the power of market psychology.

Investors will be getting some tangible good news on earnings too. According to Zacks, companies currently in their fourth quarter are expected to show a modest 7.7% gain over the third quarter of 2009. That’s not spectacular, but it’s progress and it’s real. Says Van Dijk, “It’s positive news for the stock market.”

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