Originally created 09/15/03

Are investor expectations for earnings too high?



NEW YORK -- Investors' appetite for stocks slowed this past week amid a spate of bad news, including weak retail sales, a brokerage downgrade of Texas Instruments Inc. and a downbeat revenue outlook from Nokia Corp.

While some retreat was to be expected given Wall Street's six-month runup, analysts fear stocks could be in for a deeper correction if increasingly demanding investors are disappointed by third-quarter profits. Investors are intently scrutinizing earnings reports and outlooks, and details like a drop in handset sales or software licenses can be enough to send the entire market lower.

"It is tough to be priced for perfection in a less-than-perfect world ... and the earnings preannouncement season looms," said Bryan Piskorowski, market commentator at Wachovia Securities.

Analysts say that with investors paying line-by-line attention to company reports, the market will be able to sustain its current high levels only if the quality of earnings - not just the numbers themselves - also improves.

For example, investors will look for earnings growth based on higher revenues - consumers and companies buying goods and services - not because of cost-cutting or favorable currency conversions. They'll also want outlooks for the fourth quarter and beyond to remain strong, especially with an expected rise in interest rates that could threaten to dampen consumer spending.

"It depends entirely on economic growth and corporate profits rebounding on a sustained basis," said Joseph Keating, chief investment officer at AmSouth Asset Management.

Investors' uncompromising attitude this past week led to a lower finish for the three main gauges. The drop ended the Dow Jones industrials' five-week winning streak, and a four-week advance for the Nasdaq composite and Standard & Poor's 500 indexes.

On Tuesday, stocks fell on a disappointing revenue outlook from Nokia Corp. although the company also reported strong earnings. Analysts said investors were examining revenues more closely to see if handset sales were picking up.

On Wednesday, a lower revenue estimate from Texas Instruments Inc. added to investor fears about the strength of the third-quarter earnings season.

Friday brought a similar story, with stocks falling for much of the session on disappointing retail sales as well as sales of new software licenses by Oracle Corp.

"So much of the market has been driven by the technology companies and there has been the expectations built into stocks for a recovery as well as comments by senior management that it looks like business is improving," said Janet Engels, director of Private Client research group at RBC Dain Rauscher.

"The fact that the Oracle numbers were disappointing were not a huge negative, but a setback," she said. "It all leads to the bottom line that this economic recovery is uneven. That is what's causing the weakness."

But analysts note that the past week's declines were modest and might reflect more of a natural pullback than deepening investor concern about corporate profits. By and large, they say, the third-quarter earnings season should be strong - the only question is how much so.

Indeed, Wall Street has priced in a robust rebound in the economy and earnings with the major stock gauges standing well above the lows for the year that they hit March 11. The Dow is now up 26 percent, the Nasdaq has surged about 46 percent and the S&P 500 index has climbed 27 percent.

But Russ Koesterich, U.S. equity strategist at State Street Corp. in Boston, said given investors' high expectations, the earnings season will likely need to impress.

"The market is pricey, but rallies don't come to an end simply because too they're pricey. It will if earnings disappoint," he said.