Warning! Warning! Weak profits ahead

Few companies will avoid reporting disappointing fourth-quarter results as investors brace for the worst round of earnings in a long time.

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By Paul R. La Monica, CNNMoney.com editor at large

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Earnings bloodbath
Only three sectors are expected to post higher profits in the fourth quarter.
Sector 4Q '08 Earnings change
Basic materials -67%
Consumer discretionary -55%
Consumer staples +5%
Energy -17%
Financials -7%
Healthcare +6%
Industrials -18%
Technology -15%
Telecom -14%
Utilities +4%
Source:Thomson Reuters

NEW YORK (CNNMoney.com) -- If you're looking for some theme music for the upcoming wave of earnings reports, a funeral dirge is probably most appropriate.

Aluminum giant Alcoa (AA, Fortune 500) unofficially kicks off the deluge of corporate reports when it releases its results on Monday. We already know that the numbers will be awful: analysts are forecasting a loss of 5 cents per share.

What's more, Alcoa announced Tuesday that it is cutting 13% of its global workforce and will take a $900 million to $950 million charge in the quarter as a result.

It's only fitting that Alcoa will be the first major company to release fourth-quarter results. That's because it is not an exception but the rule in what's shaping up to be one of the worst quarters for corporate profits in recent memory.

Several retailers, including Wal-Mart (WMT, Fortune 500), Macy's (M, Fortune 500) and American Eagle Outfitters (AEO), all slashed their fourth-quarter profit forecasts Thursday. And those warnings come on the heels of semiconductor kingpin Intel's (INTC, Fortune 500) reduced sales outlook Wednesday.

How bad will fourth-quarter numbers be? According to Thomson Reuters, earnings for the S&P 500 are expected to fall 14.4% from the same period last year.

And that projection may turn out to be too optimistic since estimates continue to play a game of limbo -- how low can you go?

Last week, analysts were expecting just a 1.2% decrease in earnings. And at the beginning of the fourth quarter, analysts were actually expecting a profit increase for the S&P 500 of 46.7%, largely due to hopes that the financial sector would bounce back after a dismal fourth quarter of 2007.

In addition, seven of the ten sectors in the S&P 500 are expected to post lower profits than a year ago. Back on October 1, only one sector -- telecom -- was forecast to report a decline in earnings.

"The weakness has spread to a number of sectors. The last four or five quarters, most of the weakness was concentrated in the financial and consumer discretionary sectors," said John Butters, director of U.S. earnings research with Thomson Reuters.

This should not come as a huge surprise. Even though the economy officially entered a recession in December 2007, the slowdown was largely confined to a pocket of industries (banks, autos, homebuilders, for example) until the credit markets unraveled last September. Once that happened, the entire economy went into a tailspin in a frighteningly quick period of time.

As such, profits for companies in the energy and technology sectors, two areas of the economy that had been doing reasonably well earlier last year, are now expected to decrease in the fourth quarter.

Some bright spots remain...

The pockets of strength in this economy are few and far between. But there are some.

"Earnings are under pressure for anything economically sensitive. But two primary areas going to hold up are consumer staples and healthcare so we have our biggest weightings there," said Hank Smith, chief investment officer with Haverford Trust, a Radnor, Pa.-based investment firm with $5 billion in assets under management.

In fact, earnings for consumer staples firms, companies that make stuff like food, alcohol and household products, are expected to increase by 5% in the fourth quarter, according to Thomson Reuters. And healthcare profits are expected to rise by 6%.

And even in a sector like energy, which has been hit hard in the past few months as the price of oil has plummeted, there are some bright spots. Take coal, for example. A lump of coal in your stocking may be a punishment on Christmas...but maybe not this year.

Bob Auer, manager of the Auer Growth fund, said he owns several top coal producers, including Peabody Energy (BTU, Fortune 500), Massey Energy (MEE) and CONSOL Energy (CNX), largely because they are all expected to post strong gains in revenue and earnings in the fourth quarter.

Even though coal prices have also come down, Auer argues that there should still be healthy demand for coal despite the recession. That's because a lot of the coal that is produced is used for electricity. And as cost-conscious as consumers are these days, Auer doesn't believe that will extend to people's electricity consumption.

"You may not drive as much to Grandma's house because of the weak economy. But are people really going to turn off their laptop computers and televisions and not watch a movie because of worries about their electric bill?" Auer said.

Perhaps not coincidentally, the utilities sector is the only other sector that analysts believe will show an increase in earnings in the fourth quarter.

...but overall estimates probably too high

Still, the bad corporate news far outweighs the good. And the earnings outlook is likely to deteriorate further.

"I think that earnings will continue to get worse before we finally could start to see easier comparisons later in the year," Smith said.

Butters added that profits for the S&P 500 are now expected to fall 12.8% in the first quarter and another 11.8% in the second quarter before finally posting a 2.4% increase in the third quarter.

If those forecasts prove true, earnings would be down year-over-year for eight consecutive quarters before finally taking an upturn in the third quarter.

And based on the recent track record of analysts, it may not be a huge surprise if profits dip again in the third quarter. After all, the fourth quarter of 2008 was supposed to be the one when the streak of quarterly profit declines ended.

"The problem with using consensus estimates is the tendency for a perma-positive perspective to emanate from both strategists and analysts," wrote Jack Ablin, chief investment officer with Harris Private Bank in a note to clients earlier this week.

Ablin's earnings target for the S&P 500 calls for a nearly 15% decrease in profits for 2009 and is about 11% lower than analysts' consensus target. But he thinks that the consensus will eventually move closer to his estimate.

"We are concerned that the woeful economic environment is still being underestimated. In 2009, the Street will snap out of its dream world and cut estimates," Ablin wrote.  To top of page

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