Inside major Wall Street firms and across their trading floors, concerns about corporate earnings are getting difficult to ignore.
America's blue chip companies — big business stalwarts like Merrill Lynch & Co. and IBM Corp. — will release third-quarter results in the coming weeks. After a quarter marked by tightening credit conditions and concerns about a slowing economy, profit reports are expected to be the worst since 2001.
And early signs this past week seemed to confirm what many on Wall Street feared — that results will show no growth from the year-ago period. Investors got a pair of profit warnings from International Paper Co. and Chevron Corp., while results from General Electric Co. and aluminum producer Alcoa Inc. failed to impress.
Money managers in charge of multi-million dollar portfolios believe much more weight will be put on performance this quarter. Not only will individual results be a good indication of the health of corporate profits, but what companies say about the future will be the best indication yet about the economy.
"Right now people are flailing around trying to find out what the economy really is doing," said Kim Caughey, equity research analyst at Fort Pitt Capital Group. "I am really looking forward to getting on the conference calls that companies have with investors — that is what is going to bring us clarity."
While most economic data released is backward looking, outlooks by major companies give investors a glimpse of what might lie ahead. Some analysts believe companies are trying to get bad news out in the open, take their lumps during the third quarter and return to double-digit profit growth in the fourth quarter and beyond.
"When you're going to take a hit, take it," said Howard Silverblatt, senior index analyst at Standard & Poor's. "This shows that they are cleansing themselves and will probably get a tail wind next year."
For instance, Merrill Lynch — which reports results on Wednesday — already warned it will take a $5 billion write-down for the third quarter. Earlier this month, Citigroup Inc. said it lost $3.3 billion in the credit market turmoil, and a similar warning is expected out of rival JPMorgan Chase & Co. in the coming days.
That's important because financial stocks — which were the hardest hit during the summer's volatility — represent about 25% of the S&P 500's overall earnings. The reduction in their results could shave about $7 billion from the index's overall profit number, which is usually about $200 billion, according to the rating agency.
While financial stocks are expected to have fared poorly, that could be somewhat offset from strength in health care and technology companies. But cyclical consumer companies such as electronics retailer Best Buy Co. are also expected to have had a tough quarter as consumers, mindful of falling home values and the summer's turbulence on Wall Street, watched their spending.
It would also not be a complete surprise if earnings came in stronger than analysts expect. In fact, earnings growth has exceeded expectations by about 4% since 2004, according to a report from Deutsche Bank.
That might not be hard to do for the third quarter as forecasts put out by analysts have been slashed during the past three months — the latest downward revisions coming this past week.
David Dropsey, senior research analyst at Thomson Financial, said analysts' project S&P 500 members will have had a 0.10% growth rate during the quarter. That number was cut from the 6.2% forecast on July 1 and 3.9% on Oct. 1 as Wall Street analysts began to trim their expectations.
But, he also cautions that the big focus for most market players will be what they say about the future. Right now, both S&P and Thomson project about a 13% growth rate for 2008.
"Looking forward is the nature of the business," he said. "And, it is a good thing if the credit crisis was contained and we only took one quarter to get over it."