New quarter...same fears
A brutal first quarter is almost over and pros say the third and fourth quarters could be better. But investors need to get through the second quarter first.
NEW YORK (CNNMoney.com) -- Investors burned during this wretched first quarter can take comfort in this fact: many pros think stocks could do very well in the third and fourth quarters.
But there's the matter of that quarter in-between. The one that starts next week? That one doesn't look too good.
The awkward teenager of this year's market, the second quarter is likely to be one of transition, analysts argue.
Investors will be keeping an eye on the housing and credit market crises to see if there are any signs the worst may finally soon be over. Record oil and gas prices, a weak dollar and sluggish economic growth will keep the inflation versus recession debate going. In other words, the second quarter is shaping up to be a lot like the first.
Plus, many companies will report their latest quarterly results in April and early May. These numbers, in addition to forecasts for the rest of the year, will give investors a better sense of whether the presumed recession is taking its toll on corporate profits.
Yet, if there's one bright side to how stocks may do in the second quarter, it's that expectations may finally be low enough so that investors may not be that disappointed by weak first-quarter results.
"The second quarter is probably going to be mixed, but better than the first," said Dan Genter, president and CEO at RNC Genter Capital Management. "I don't think people are expecting much from it and that could limit any losses."
Genter said the first quarter would have been a tough one for earnings even if the economy merely slowed a bit from the pace of early 2007.
When you add in the credit crisis, the collapse of Bear Stearns and record oil prices, the odds of first quarter results being strong became "pretty insurmountable" according to Genter.
But he added investors are beginning to put the worst behind them. The major stock barometers have twice fallen to a level close to 20% off their October highs. Both times -- in late January and mid-March -- stocks have bounced back a bit since then.
Genter even suggested that investors may not be as upset about huge subprime-related writedowns from banks as they were earlier this year because they are expected.
And in a strange way, the collapse of Bear Stearns and its subsequent salvaging with the Fed's and JPMorgan Chase's help has been positive for stock market sentiment.
"What happened with Bear Stearns was basically the realization of everyone's worst fears, but yet we seem to be getting through it," he said.
Investors have assumed that the economy is in recession and that this will eventually hurt profits. So it will be important to see if the first-quarter earnings actually confirm this, said John Forelli, portfolio manager at Independence Investments.
So far, the earnings-recession connection hasn't really emerged outside of the financial sector. If that trend continues, that will be good news.
"The earnings, but especially the guidance will be the next real test of where the market is going," said Dave Hinnenkamp, CEO of KDV Wealth Management.
Hinnenkamp said that outside the financial sector, a lot of the fourth-quarter earnings reported in January weren't bad, but the guidance wasn't great and that's what sent stocks lower.
Since then, expectations for earnings have been lowered so much that there's the possibility companies could surpass diminished expectations and that investors may reward companies for doing so.
Financial sector earnings in the first quarter are set to slump 53% and again drag overall S&P 500 earnings into negative territory, as they did in the fourth quarter. S&P 500 earnings are currently on track to fall 9% from a year ago, with that number likely to be revised lower over the next few weeks, Thomson Financial reports.
But just like in the fourth quarter, when you strip out financial earnings, overall earnings turn positive, with profits for the S&P 500 otherwise set to rise 8%.
That's because many corporations, especially technology, consumer and energy companies, are generally continuing to see enough demand overseas to temper the weaker demand stemming from a U.S. slowdown.
"If you look at the earnings U.S. companies are seeing overseas, it makes the argument that the U.S. recession, if we're in one, is not at this point a global recession," said David Dropsey, Thomson Financial's senior research analyst.
The expected strength from multinational companies also adds fuel to the idea that a so-called earnings recession will be over by the second half of the year. Third-quarter earnings for the S&P 500 are currently expected to grow 17.2% and fourth-quarter earnings are primed to rise 60.5%, according to Thomson estimates.
By the third and fourth quarters, the effect of recent fiscal and monetary policy could start to be felt. Rebate checks start going out in May, as a result of the government's $170 billion fiscal stimulus plan.
Plus, the Federal Reserve's campaign to loosen up credit markets through rate cuts and cash infusions hits its 9-month anniversary in June. Six months into the campaign, stocks hadn't shown much reaction, but 9 months should bring better results.
"The impact from the [rate cuts] is going to coincide with the fiscal stimulus at the same time that year-over-year earnings comparisons will start getting better," said Phil Orlando, chief equity market strategist at Federated Investors.
At some point, the anticipation of all this is going to provide a psychological impetus to investors to get back in to the market.
"The issue is when is that inflection point where the sentiment shifts from fear of recession to assumption of future growth?" Orlando said.
But there's no getting around how bad the first quarter was. As of Thursday's close, the Dow was down over 7%, the Nasdaq was down over 14% and the S&P 500 was down nearly 10%.
Financial stocks led the list of losers in the first quarter, surprising no one. Bear Stearns (BSC, Fortune 500) is the S&P 500's biggest loser, down more than 87% Five of the ten biggest laggards are in the financial sector.
There was no clear sector theme with the winners though as retailer Big Lots (BIG, Fortune 500), energy company EOG Resources (EOG), homebuilder Pulte Homes (PHM, Fortune 500), trucker Ryder System (R, Fortune 500) and biotech Celgene (CELG) are the biggest winners in the S&P 500 so far this year. 
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