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Going gets tougher
Unlucky 13: after 12 quarters of double-digit growth, S&P profits look set to slow in 2nd quarter.
June 30, 2005: 8:22 AM EDT
By Alexandra Twin, CNN/Money Staff Writer

NEW YORK (CNN/Money) - Don't look now, but second-quarter earnings growth is expected to be the slowest in three years.

And while that's not exactly a secret on Wall Street, the harsh reality of slower earnings growth could hit home in the weeks ahead -- giving already edgy investors another reason to worry.

According to a Standard & Poor's report released this week, the run of double-digit percentage earnings growth that has spanned 12 quarters is in danger of ending with the second quarter, when earnings are expected to grow just 7.8 percent from a year earlier. Second-quarter reports start trickling in next week and the reporting period gets into full gear in mid-July.

Howard Silverblatt, equity market analyst at Standard & Poor's, noted that the 20 and 30 percent year-over-year earnings growth posted back in 2002 and 2003 was neither typical nor sustainable.

Earnings have been growing since then, but at a slower pace. S&P had initially forecast 9 percent growth in first-quarter profit for the companies in the S&P 500. Earnings came in a bit better than expected and ended up rising 13 percent.

"It would be nice if it turned out we were wrong again, that our forecasts for the second quarter were also too pessimistic, but unfortunately, I don't think that's going to be the case," Silverblatt said. "With the ongoing currency situation, higher oil prices, and the more difficult comparisons year-over-year, a slowdown is to be expected."

Earnings tracker Thomson Financial/First Call is even less upbeat than S&P, forecasting growth of just 7 percent compared with a year ago.

Nonetheless, even at 7 or 8 percent, the earnings growth "is still very good," Silverblatt added.

No surprise, but nothing to shrug off

Granted, a period of slower earnings growth is not exactly a news flash to many investors.

"The expectation for earnings growth to slow down is pretty widespread on Wall Street," said Subodh Kumar, chief U.S. strategist at CIBC World markets.

But with everything else investors have been worried about -- including record oil prices and rising interest rates, to name two -- slowing profit growth may have gotten lost in the shuffle.

Oil prices closed at a record high above $60 a barrel this week, and the Federal Reserve is all but certain to boost short-term rates another quarter-point when its policy-makers end their two-day meeting Thursday, which would be the ninth straight increase.

At the same time, concerns are widespread on Wall Street that economic growth is slowing, which presents its own set of problems.

Solid first-quarter earnings helped mask worries about how slower earnings growth could hit the economy. Such concerns were also tempered by a brief drop in oil prices last spring, and a bout of improved economic reports, all of which coincided with a six-week rally in the stock market.

But that period was short lived, and oil prices jumped again, and are now up more than 30 percent this year. The stock market has been struggling of late, and slower earnings growth is only likely to add to that struggle.

According to a recent Thomson Financial/First Call report, the early ratio of negative earnings pre-announcements to positive pre-announcements is the worst its been in about eight quarters.

"I think we're in a situation where some earnings will miss (forecasts), but not as much as some bearish people expect," Kumar added. "If this is the case, the S&P 500 is likely to remain in the trading range it's been in."

Early winners and losers

Unsurprisingly, energy and basic materials are expected to lead the pack again in earnings growth in the quarter.

First-quarter earnings fell for automakers and some other consumer goods companies -- a trend likely to continue, Kumar said.

S&P estimates that the consumer discretionary sector's earnings will fall 16 percent in the second quarter.

Financials also saw a challenging quarter, Kumar added, noting the sector tends to suffer as rates rise and with capital markets sluggish at best.

But financials could bounce back in the second half, even given higher rates, S&P said.

A significant difference between this quarter and previous ones, Kumar said, is that the earnings delivery is going to be less unified -- meaning that if a bellwether issues a warning, that doesn't necessarily mean the whole group it's a part of is having problems.

"In the first quarter, people made the mistake of looking at how a few groups did as indicative of the whole sector," Silverblatt agreed. "For this period, you really can't do that."

One good reason to be upbeat: third- and fourth-quarter earnings growth looks more encouraging, and could push up above 10 percent again, the analysts said.

"If the Fed is right and the economy continues to expand, we'll see that happen and see it reflected in the earnings for the second half," said William Hummer, principal at Wayne Hummer, a Chicago money manager.

S&P currently expects 2005 earnings to grow nearly 11 percent versus 2004, and 2006 earnings to grow another 10.2 percent over this year.

That's a far cry from the 23.7 percent growth seen in 2004, but it's nothing to sniff at either.

Click here for our Earnings Scorecard.  Top of page


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