The 'sale-less' recovery
Companies are about to start reporting third-quarter results. Cost cutting may once again drive profits, but when will revenues make a comeback?
NEW YORK (CNNMoney.com) -- More and more economists are talking about how they think the economy actually grew in the third quarter. Unfortunately, it might be hard to find evidence of that once companies start reporting their latest quarterly results.
There's only a trickle of significant third- quarter reports due out this week, but investors will be keeping a close eye on them to see how Corporate America is faring during what might really be the waning days of this brutal recession.
Wall Street is hopeful that blue-chip companies will generate better-than-expected profits. If so, that could help rekindle some confidence in the economy after the disappointing September jobs report and get the market rally, which has stalled for the past two weeks, back on track.
But it's going to take more than good earnings news to get people excited. A parade of positive earnings surprises should only be considered encouraging if the better earnings are a result of increased consumer demand as opposed to more cost cutting (i.e. layoffs and reduced spending on new production).
At first blush though, sales aren't looking promising.
"Everybody thinks that earnings are going to be better than expected, but people still don't expect revenue growth for another six months. So we've got that tug-of-war going on," said Phil Dow, director of equity strategy with RBC Wealth Management in Minneapolis. "You're going to have decent sales growth from the technology, materials and energy sectors but that's probably going to be about it."
None of the major companies that will be announcing results this week are expected to report substantial revenue growth from the same period last year.
Agricultural giant Monsanto (MON, Fortune 500) and retailer Costco (COST, Fortune 500) will both report numbers for their most recent quarter, which ended in August, on Wednesday morning. Analysts are predicting a 2% decline for Monsanto and 3% decline for Costco. Dow component Alcoa (AA, Fortune 500) is set to announce its third-quarter results on Wednesday afternoon and the consensus estimate is for a 38% drop in sales.
PepsiCo (PEP, Fortune 500) and Marriott (MAR, Fortune 500) are the only other two companies of note to report this week, with each of their results due out Thursday morning. Pepsi's sales are expected to be as flat as an opened can of soda left in the fridge for too long, with forecasts of a meager 0.1% increase in revenue. And analysts are predicting a nearly 20% decline in Marriott's sales.
To be fair, it's unreasonable to expect a major surge in sales for companies. It's no secret that while many Wall Street traders, market strategists and other financial experts are tripping over themselves to declare that the recession is over, it doesn't feel that way for most consumers.
And since consumer spending is still the main growth engine of the economy, it will be nearly impossible for companies to generate sizeable increases in their top lines until consumers are willing to spend more freely.
"The economy has probably just reached a trough and we're still at the low end of the valley. So we are in a gray area," said Mike O'Rourke, chief market strategist with BTIG, an institutional brokerage firm in New York. "There will people complaining about the lack of revenue growth, but it's asking too much for big sales growth at this time."
O'Rourke added that because many companies have slashed their expenses in recent quarters, it won't take a huge increase in sales to have a meaningful impact on profits.
"We had massive layoffs and companies stopped investing in their businesses. I expect some type of revenue bump, but not a big one. But since companies cut to the bone, a little bump should help earnings nicely," he said.
That's a good point. But there's a flip side to it. Once you've cut to the bone, there's little, if anything, left to slice off. That means that, sooner or later, companies will need bigger increases in sales to lift their profits.
And the more that people talk about an economic recovery, the more demanding investors are going to become as well.
"Investors are going to be looking for evidence of sales improvement. Most importantly, they'll be looking at the guidance going forward," said John Stoltzfus, director and senior market strategist with Ticonderoga Securities in New York. "As the market develops more of this show-me-the-money attitude, investors are going to be less forgiving."
So the fact that sales don't appear to be picking up yet is troubling for several reasons. You could argue that companies should be able to have an easier time reporting sales growth in the third quarter because they are facing comparisons to a dismal period this time a year ago.
It shouldn't be too challenging to have a better quarter this year considering that the third quarter of 2008 was when we had to live through the meltdowns of Fannie Mae, Freddie Mac, Lehman Brothers and AIG.
But if companies can't report growth compared to one of the tumultuous economic periods in the nation's history, is it really safe to claim that a recovery is in full swing?
And with unemployment steadily rising, that's another reason to think that sales growth may not be in the cards just yet. What's more, times are getting tougher for people with jobs as well. The size of the weekly paycheck shrunk in September because employers continued to cut back on hours.
If these disturbing trends in the labor market continue, it may be a blue Christmas for retailers and investors.
"You need to see hours go up and actual job improvement for consumers to spend. It's hard to envision sales growth without that," Dow said.
Hopefully, companies will back up all the talk of an economic rebound by being more bullish about their sales outlook for the fourth quarter. If they aren't, it's worth wondering just how strong the recovery really is -- or if there is one at all.