Earnings stink, but...

Banks are expected to report another dismal third quarter despite decent results from JPMorgan and Wells. Still, some areas of the economy are holding up.

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

What should be at the top of the next president's economic agenda?
  • Solving the credit crunch
  • Creating new jobs
  • Reducing the deficit
  • Halting the housing meltdown
  • Cutting taxes

NEW YORK (CNNMoney.com) -- A handful of top companies actually reported decent third-quarter results Wednesday...but you wouldn't have guessed that from the way stocks sold off.

After a relatively calm day Tuesday, the three major U.S. market barometers all sank sharply Wednesday.

Investors clearly were spooked by disappointing retail sales figures for September and comments from San Francisco Federal Reserve President Janet Yellen late Tuesday night. Yellen said the economy "appears to be in a recession."

However, the fact that three big banks reported better-than-expected results is a slight cause for optimism. Emphasis on slight.

JPMorgan Chase (JPM, Fortune 500) posted a profit even though analysts were forecasting a loss. Wells Fargo (WFC, Fortune 500) and State Street (STT, Fortune 500) reported earnings that far exceeded analyst projections. (Hmm...maybe these three banks should just send back the $52 billion they are set to collectively receive from the Treasury Department.)

Still, profits fell at both JPMorgan Chase and Wells Fargo. What's more, JPMorgan Chase CEO Jamie Dimon cautioned that the bank expected "reduced earnings" ahead because of the credit crunch.

And even though State Street's profits jumped 33% in the third quarter, its stock plunged more than 10% Wednesday morning. Part of that sell-off shouldn't be a huge shock coming after the euphoric bailout-induced 17% jump in its stock price yesterday.

But the company also warned of a possible $400 million to $450 million charge in the fourth quarter because some of the portfolios its State Street Global Advisors unit manages are "under pressure" as a result of the volatility in the bond markets.

In addition investors now have to brace for more bad news from the rest of the struggling sector in the coming days.

Citigroup (C, Fortune 500) is expected to post a $2.7 billion loss and Merrill Lynch (KO, Fortune 500) is forecast to lose $6.8 billion in what might be its last quarterly report before it is acquired by Bank of America. Next week, Cleveland-based regional bank National City (NCC, Fortune 500) is also expected to report a third-quarter loss.

Overall, financial companies are expected to report a whopping 90% decline in profits during the third quarter, according to John Butters, director of U.S. earnings research for Thomson Reuters.

And that's a big reason why profits for the S&P 500 are projected to decline nearly 10% in the third quarter. That would mark the fifth consecutive time that profits fell on a year-over-year basis.

The last time that happened was in 2001 and the first quarter of 2002, Butter said. Not surprisingly, that was the last time the economy was in the midst of a recession.

Bright spots beyond banks

Nonetheless, even though Wall Street was not in a cheery mood Wednesday, there were some other encouraging signs in what continues to be a dismal market (Monday's historic rise notwithstanding.)

And it's further evidence that, contrary to popular belief, not every company is suffering and there are bright spots to be found even in the gloomiest of market and economic environments.

"The thing I know from past cycles is you spend so much time in markets like these shaking your head in disbelief, that sometimes you don't recognize the values sitting in front of you," said Joe Milano, the portfolio manager of T. Rowe Price New America Growth Fund.

Coca-Cola (KO, Fortune 500), which Milano does not own, reported a third-quarter profit increase of 14% thanks to strong sales overseas.

Whether or not this trend will continue in light of what is now definitively a global slowdown remains to be seen. But the stock was up about 3%, an impressive pop (pardon the pun) on a day when the S&P 500 fell nearly 6%.

Drug and medical equipment maker Abbott Laboratories (ABT, Fortune 500) reported a more than 50% jump in profits Wednesday thanks to strong sales of arthritis drug Humira, And it boosted its earnings outlook for the year.

Also in the healthcare arena, St. Jude Medical (STJ), a maker of defibrillators and pacemakers, posted a 20% increase in earnings. This just goes to show that quality healthcare companies may continue to hold up well even in a sour economy, a point some market strategists made to me earlier this week.

Butters said that profits for healthcare firms are expected to increase at a steady, if not spectacular, rate of 6% in the third quarter and 9% in the fourth quarter.

Technology is another area where there could be an oasis or two in this otherwise barren profit landscape. Tech earnings are expected to increase 7% in the third quarter and 6% in the fourth quarter, Butters said.

IBM (IBM, Fortune 500) already announced last week that its profits would come in better than forecast. And chipmaker Intel (INTC, Fortune 500) posted a 12% jump in earnings, ahead of estimates, Tuesday. More importantly, the company issued a sales forecast for the fourth quarter that was in line with analysts' targets.

So there are opportunities to be had in this market.

"The growth curve will be dampened for many companies by this credit squeeze but we're staying with the highest quality firms that will be able to keep growing," said Kent Mergler, chairman of Northstar Capital Management, an investment firm with about $400 million in assets based in Palm Beach Gardens, Fla.

Mergler said some of his top holdings are biotech Gilead Sciences (GILD), medical devices maker Stryker (SYK, Fortune 500) and tech giants Apple (AAPL, Fortune 500) and Oracle (ORCL, Fortune 500).

Milano also likes Apple and added that dental-equipment company Henry Schein (HSIC, Fortune 500) and video-game retailer GameStop (GME, Fortune 500) are also top holdings in his fund.

As I've stressed in this column time and time again, I'm neither an optimist or pessimist, bull nor bear. I am a realist who tries to look rationally, and not emotionally, at the market and economy. I talk to smart experts and then base my columns on what I learn from them.

Milano said that as bad as things seem right now, there is little sense in assuming that the markets will never recover.

"If we're in a full-blown credit seize up like what we've been in for the past few weeks, that's a tough environment for any company. But the government is throwing the phone book at this problem and at some point I think we will see some improvement in the credit markets," he said.

Don't mistake that as a denial of the obvious hardship many are going through. Yes, this economy is extremely lousy and it probably will remain so for some time. But that's no excuse to run away and hide. Good companies trading at reasonable prices can always be found if you bother to look for them.

"In almost 50 years I've never seen anything like this," Mergler said. "But it is insane to dump a stock if you still think the fundamentals are sound." To top of page

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