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Earnings Season Kicks Off OK

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The third quarter earnings season has gotten underway and we are off to a decent enough start, with both Alcoa (AA - Free Report) and Yum! Brands (YUM - Free Report) coming ahead of expectations after the close on Tuesday. This morning’s result from Costco (COST - Free Report) is also along the same lines.

But as important as beating consensus earnings expectations for the third quarter are, it is even more important to provide reassuring enough guidance for the fourth quarter and beyond. And on the outlook front, we saw Alcoa lower its aluminum demand outlook. And while Yum guided higher, the growth trend in its all-important Chinese operation appears to be slowing, though the company seems to be doing a good job on the home front.

The overall earnings scorecard for the third quarter is that we have 28 companies from the S&P 500 already report results as of this morning (October 10), with total earnings down 4.9% from the same period last year and fewer than half of the companies beating earnings expectations. It is admittedly very early going at this stage, but the performance so far is weaker than what these same 28 companies did in the previous quarter.

That said, given how low expectations are at present, I would expect the final scorecard for the third quarter to be not materially different from what we saw in the second quarter. And while overall earnings growth and guidance were on the weak side in the second quarter reporting season, we still saw roughly two-thirds of the companies beat earnings expectations.

But if the quality of guidance remains weak, then estimates for the fourth quarter will have to come down from current expectations of a strong ramp up in the final quarter of the year. The same is true for full-year 2013 when current expectations are for earnings growth of about 12%, roughly double the pace of 2012. The key ‘known unknown’ at this stage is what this process of downward earnings adjustment will mean for the recent stock market rally that has pushed stocks close to all-time highs. I am of the view that the market will lose its momentum as this trend unfolds, but we will find out in the coming days as the reporting season gets into high gear.

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