By Nick Godt
With the third-quarter earnings season just about to kick off,
the market is looking to some sectors, such as financials, where
revenue growth might actually improve.
In the previous quarter, investors were satisfied with seeing
improvement in firms' net income, the so-called bottom line, which
was mostly the result of heavy cost-cutting to adapt to a slumping
global economy.
"Companies have undergone a fantastic run of cost-cutting, which
will surely benefit the bottom line to a larger than normal degree
when top-line growth returns," Dan Greenhaus, chief economist
strategist at Miller Tabak, wrote in a note. "Given the improvement
in the economy as well as the equity market, perhaps a
wealth-effect flow-through, this could very well be the quarter in
which revenue growth returns."
Financials, which suffered the brunt of the credit crisis of the
past two years, might be among the sectors where surprises start to
emerge.
On Monday, Goldman Sachs upgraded its view of large banks,
highlighting an improvement in Wells Fargo's & Co. (WFC)
capital position as well as its takeover of Wachovia. Goldman also
added Capital One Financial Corp. (COF) to its conviction buy list,
saying it expects a positive revenue surprise from the bank, citing
moderating consumer-credit problems.
The financials sector, freed from the write-downs that crippled
results last year, is expected to be the best performer this
quarter, with earnings on average expected to be up by 59% from the
year earlier, according to Thomson Reuters.
On Monday, the Dow Jones Industrial Average (DJI) rose 112.08
points, or 1.2%, to finish at 9,599. The S&P 500 Index (SPX)
rose 15.25 points, or 1.5%, to 1,040.46, while the Nasdaq Composite
Index (RIXF) added 20.04 points, or 1%, to 2,068.15.
Greenhaus also takes heart from the big 2.7% surge in U.S.
retail sales in August. While the government's "cash for clunkers"
program largely helped spike sales at the likes of Ford Motor Co.
(F), sales excluding autos also rose a hefty 1.1%.
Sales at clothing stores, department stores, sporting-goods
stores and bookstores were up more than 2%; electronics retailers
also saw a 1.1% increase.
"We don't have the September sales yet, but based on [August]
perhaps the consumer-discretionary sector did better [this
quarter]," according to Greenhaus. "It's tough to predict a
consumer-based recovery, which is the main determinant of top-line
growth."
Among consumer-discretionary firms slated to report this week
are Yum Brands Inc. (YUM) on Tuesday as well as Costco Wholesale
Corp. (COST) and Family Dollar Stores Inc. (FDO) on Wednesday;
Marriott International (MAR) and PepsiCo (PEP) are due to issue
their results on Thursday.
Earnings in the consumer-discretionary sector of the S&P 500
are expected to be up by 17% year on year, according to
Thomson.
The overseas play
The market slumped last week as concerns about the U.S. economy
resurfaced after several weak economic reports, especially a
worse-than-expected September jobs survey.
Now, "it all boils down to earnings," said Ed Yardeni, chief
investment strategist at Yardeni Research, in written comments.
"Can they recover even if employment remains weak?"
Yardeni answers in the affirmative. "U.S. companies are
scrambling to decouple from the U.S. economy, and are finding more
revenues and earnings overseas, especially among emerging
economies."
The weak dollar, which lost roughly 5% during the third quarter,
is also expected to have helped boost the overseas revenue of U.S.
multinationals.
Further, "even a subpar recovery in domestic revenues could
morph into significant earnings growth given all the cost-cutting
that has been going on during the recession," Yardeni added.
Some strategists also are increasingly leaning toward
information technology as one of the best plays of a global
recovery. Rising income for consumers in emerging economies, it is
hoped, leads to more purchases of cell phones, laptops and other
gadgets.
The tech sector could provide some upbeat surprises, said Owen
Fitzpatrick, head of U.S. equities at Deutsche Bank. Overall
earnings in the information-technology sector are expected to be
down 15% in the third quarter from the year earlier quarter.
"I expect this earnings season to be like previous quarters,
with companies beating expectations," he commented. "But now we do
want to see more visibility and some improvements in [revenue], not
just the bottom line."
Ready for disappointment?
On Monday, an upbeat survey of the service sector of the U.S.
economy in September helped assuage some concerns about the shape
of the recovery, which might also help investors once again look
beyond this quarter's results and pay more attention to future
guidance.
"Our work, both for the U.S. and globally, suggests the economic
recovery continues to spread," said Ken Tower, market strategist at
Quantitative Analysis Service. "As we see more evidence of that
going forward, even if we don't see top-line growth this quarter, I
think investors will continue to be patient and look beyond the
current season."