All streaks must come to an end. Investors accustomed to double-digit earnings growth should prepare for more earthbound numbers as Wall Street heads into the midpoint of the fourth-quarter reporting season.
As of Friday, 197 stocks in the widely watched Standard & Poor’s 500 index achieved a growth rate of about 9 percent, according to Thomson Financial. Without any unexpectedly strong reports in the offing, it means the 18 consecutive quarters calculated by S&P to have double-digit earnings growth will come to an end.
Stock analysts believe this is all part of a cycle that helps bring the stock market down from lofty levels, and hopefully sets it up again for another run.
“Investors need to get used to this and realize that it is not necessarily a bad thing,” said Howard Silverblatt, Standard & Poor’s senior analyst. “This is a retrenchment and consolidation after four years of growth. We had a nice run.”
The last time Wall Street saw a surge in the S&P 500 index like that of recent years was 1992 to 1995. The markets, particularly the Nasdaq composite index, later bounced back with the dot- com boom of the late 1990s.
Still, the fourth quarter isn’t turning out all that bad. Of the S&P 500 components that have already reported, 68 percent beat expectations and 15 percent matched them. Earnings are also coming in about 5 percent above estimates, which tops the average surprise factor of 4.2 percent seen over the past eight quarters, according to Thomson Financial.
There is a slim chance the U.S. can realize double-digit growth for the quarter, though most analysts admit this would probably be by a narrow margin and with a few unexpected results.
At this point, it doesn’t look in the cards with about 40 percent of the S&P 500 reporting,” Silverblatt said. “There will have to be some significant results, a couple of knockouts from companies. If not, investors need to get comfortable with single digits.” Debate continues about if it’s now the right time to shift focus to large-cap stocks like those in the S&P 500. The group is considered to be more defensive in nature, and can withstand a slowing economy because they are typically more diversified around the world.
Indeed, the Russell 2000 index of smaller companies posted a gain of 18.4 percent last year. It has outperformed the large-cap Russell 1000 index for seven of the past eight years. A resurgent Russell 1000 beat the Russell 2000 in the second half of 2006 – though small caps won out for the year overall. Other widely followed large-cap indexes showed strong performances.
Portfolio managers have been telling clients to diversify more of their assets into large-cap companies. As corporate earnings begin to show signs of weakening – especially stacked up to the third quarter’s 23.2 percent growth rate – this could be the tipping point.
“We’ve been saying large-cap multinationals that pay dividends for about six months now,” said Hugh Moore, partner at Guerite Advisors. “The more diversification you have in the international arena the better so that you aren’t left being driven by exactly what’s going on here in the U.S.” He said large-cap stocks – whose market value exceeds $5 billion – usually lag behind small caps and technology issues. But, “now their has now come.” However, economists are still trying to determine exactly how fast the economy is slowing, especially after recent data suggested it might be expanding at a better-than-expected rate. Speculation about a possible interest rate cut by the Federal Reserve has now led to talk central bankers might need to hike.
“Based on guidance from corporate America and the upcoming economic data, investors will begin to seek direction as far as the market is concerned,” said Peter Cardillo, chief market economist for Avalon Partners. “Traditionally, going into large caps would be the case if we were headed toward higher interest rates along with a stronger economy. But, I think it’s a little too early to make that a decision.” He’s waiting for a little more economic data before making “any real switches within the marketplace.” AP-WS-01-26-07 1714EST
