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Sluggish Wall St. Seeks Earnings Boost

Sun February 22, 2004 09:14 AM ET
By Dick Satran

NEW YORK (Reuters) - Wall Street likes a surprise party -- and over the past year there's been no shortage of earnings that jump from behind the couch to delight stunned investors.

But after a year in which better-than-expected results played a big role in lifting stocks, some are worried that the next year could see just the opposite. Some market strategists are particularly worried that results in 2004's second half could disappoint.

"We expect pretty good year-on-year comparisons for the first and second quarters this year, but a deteriorating picture in the third and fourth quarters," said Tim Connors, chief investment officer at Delaware Investments in Philadelphia.

Profit soared in the second half of 2003, with Standard & Poor's 500 earnings reaching a 24.1 percent rise in the final period, according to Reuters Research. That lifted stocks this week to their highest level in more than two years.

The earnings results were much better than most analysts had expected going into the year, and even continuous upgrades failed to keep up with the dramatic rebound. More than half of all companies reporting results beat their estimates. Earnings on average were more than 5 percent above forecasts.

But now there is a risk of failure going forward, said Chuck Hill, director of research at First Call/Thomson Research. Wall Street could end up getting blindsided since earnings forecasts remain optimistically high through the entire year. Overall profit is seen in the solid double-digit growth range for the entire year, according to Reuters Research, and failing to meet those lofty expectations could trip up the market.


"When you have a big trend toward positive surprises it definitely helps the market -- and when you have negative surprises it has a drag on the market," said Hill of First Call.

To some extent, there is a normal pattern to the expectations, said Peter Boockvar, equity strategist for Miller Tabak & Co. "It's simple: The more expectations are raised, the more difficult it is to exceed them."

But so far analysts' expectations haven't backed off much at all, said Hill. Their optimistic earnings forecast are based on a supposition that the present economic recovery will follow the script of past rebounds, and that's a reasonable assumption, he said. "But there are risks out there," he added. "We don't really know how this recovery is going to play out."

Delaware Investments' Connors said there will be a continuing strong focus on the pace of jobs growth because it's been a missing link in the recovery. An extended period of sluggishness would crimp consumer demand and lead to lowered earnings.

"We're going to be a prisoner to the jobs numbers for some time to come," said Connors. "They're a pretty good indication of what's happening in the economy as a whole. And if job growth fails to materialize, earnings won't be as good as we think."

The leading sectors of the past year -- technology, finance and energy -- will make a particularly tough case in the second half of the year, said Hill. In those sectors "the comparisons will get tougher and tougher.

"I don't think the market is overvalued by much right now. But it might not be taking into account the risk factors, with so much uncertainty about where the economy and earnings growth will be down the road," he said.


Miller Tabak's Boockvar agrees that there are risks -- but he sees them on the other side of the equation. There is no doubt that jobs and earnings will rise with the economic recovery, he said. "But the real risk for stocks is rising interest rates," Boockvar said. "Even if we have healthy earnings this year, they will be overwhelmed by higher interest rates."

Hill's view is that there will be little or no rise in interest rates. The bigger risk comes in the form of unexpectedly low demand.

Connors said that the jobs figures provide enough uncertainty that it's difficult to chose between the two poles. The best course now, he said, is probably to choose solid dividend-paying companies to take advantage of the new law that cuts the tax on payouts by more than 50 percent.

"Until we get a better sense of what is the level of the economy and job growth," he said, "it makes sense right now to be more defensive."


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