Are You Ready for Earnings Season?

Equities are coming off one of their best quarters in years. Fundamentals took a back seat in the third quarter as central banks around the world increased monetary easing efforts to boost liquidity and pump up asset prices. All three major indices rallied and are currently sitting on double digit gains. However, company specifics are about to come back into focus as earnings season begins.

After Tuesday’s closing bell, Alcoa (NYSE:AA) unofficially kicked off earnings season for the third quarter. The global aluminum giant is often seen as an early indicator of health for the manufacturing industry and the rest of earnings season, because it has exposure to a wide variety of products. This year though, the average analyst estimate was for net income of only one cent per share, a 92.9 percent plunge from its earnings last year in the same period. During the past three months, the average estimate has moved down from 12 cents. In fact, Alcoa reported a loss of $143 million (13 cents per diluted share) in the quarter. Meanwhile, Alcoa’s revenue fell 9.1% to $5.83 billion from the year-earlier quarter.

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The overall forecast for other companies this earnings season is not looking too optimistic either. According to FactSet, the estimated earnings growth rate for the third quarter is expected to decline 2.7 percent, compared to expectations of a positive 2 percent growth rate just a few months ago. It is the first time in three years that analysts expect S&P 500 companies to report a year-over-year profit decline. Half of the sectors in the index are projected to report decreases in earnings, led by the Materials sector with an almost 22 percent pullback. In recent weeks, economic bellwethers such as Caterpillar (NYSE:CAT) and FedEx (NYSE:FDX) have issued guidance warnings, echoing global slowdown fears.

On Monday, the World Bank reduced its economic growth forecasts for the East Asia and Pacific region. It also warned that China’s slowdown could worsen and drop the nation’s growth to an estimated 11-year low. The announcement was followed by the International Monetary Fund also cutting its outlook on the global economy. The organization now expects the world economy to grow by 3.3 percent in 2012, down from its forecast of 3.5 percent in July. It also predicts 3.6 percent growth next year, compared to its prior estimate of 3.9 percent.

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On the positive, investors should be well aware of the gloomy outlook. Negative pre-announcements outnumber positive pre-announcements more than 4 to 1, the highest level for the ratio in over a decade, according to Zero Hedge. Downward earnings per share revisions have also outnumbered upward revisions for the past 22 weeks. “People are certainly aware that earnings are going to be poor in the quarter,” said Dan Greenhaus, chief global strategist at brokerage firm BTIG LLC. However, there is still no telling how the algorithms on Wall Street will react.

Although Alcoa is considered an early indicator of earnings season, statistics suggest otherwise. Since 2009, when Alcoa missed Wall Street’s earnings forecast, 72.4 percent of the companies in the S&P 500 went on to beat the profit estimate. “It appears that Alcoa’s earnings performance relative to estimates has little predictive value in determining the earnings performance of the remaining companies in the index,” said FactSet senior earnings analyst John Butters in his analysis.

Despite the lowered outlook for third quarter earnings and global growth, banks are expected to come out on top. Wall Street firms expect financial institutions to grow earnings by 21 percent in the third quarter, and 32 percent in the fourth quarter, the most out of all S&P 500 industries, according to Bloomberg. Banking giants such as Wells Fargo (NYSE:WFC) and JPMorgan Chase (NYSE:JPM) both report earnings this Friday.

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