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Sep 25: Markets May Have Tough Times Ahead

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Stocks have been skittish since the 'No Taper' rally last Wednesday, with issues like the future of QE, a possible government shutdown and the debt ceiling dominating market discourse. Since none of these weighty issues are going away any time soon, we should likely brace ourselves for a relatively extended period of weakness in the market.

Another issue that has remained under the radar for some time, but will take center stage in the coming days with the start of the 2013 Q3 earnings season, is the underwhelming corporate earnings picture. Total earnings growth in Q3 is expected to be up +1.1%, down from +5.1% growth expected in early July. This downward revision isn’t unusual, as we have been seeing this trend play out repeatedly in recent quarters. Estimates for each quarter start out high, but come down materially as the calendar quarter progresses.

The actual quarterly results, in the end, come ahead of these lowered expectations and we will most likely see something similar play out this coming earnings season as well. But more than how companies perform relative to the lowered Q3 earnings expectations, it is the quality of guidance for Q4 that will determine how successful or otherwise the coming reporting season is deemed.

The reason for the above-average significance of guidance this time around is the elevated expectations for Q4. Total earnings growth in Q4 at this stage (up +11.1%) is the highest that we have seen for any quarter at this stage. Recent history tells us that these elevated Q4 expectations will start coming down as companies provide guidance in the coming days.

But how much will those estimates be cut? And more important, will investors continue to disregard this lack of earnings confirmation for the market’s strong gains this year?

The Fed and Washington DC may be in the spotlight at present, but discussion about earnings will likely add another negative to the conversation soon enough.

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