Stocks' growth may hinge on much better earnings, economy

The stock market shined last year with an epic rally. Now it's time for corporate America — and the economy — to catch up.

Stocks ballooned 30% last year, as measured by the Standard & Poor's 500 index. But the average company in the broad index only increased annual earnings — the key driver of stock values — an estimated 5.2% as the economy grew sluggishly.


For stocks to maintain their gains, market observers say, American companies will need to eke out solid, if not better, earnings growth this year. That's no easy task with corporate profit margins already at record highs after executives slashed expenses to please Wall Street.

"It's a squeeze," said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. "Nobody's happy about the growth, but the bottom line is these companies are finding a way to do it. Now it's getting harder. How do you squeeze it more?"

The stock market hasn't seemed too impressed this year.

The Dow Jones industrial average is down 0.7% since Jan. 1, while the S&P 500 index is off 0.5%. The technology-focused Nasdaq composite index, however, has gained 0.5%.

Wall Street, meanwhile, is losing one major fuel source starting this month: The Federal Reserve is scaling back its massive stimulus program that's credited with helping juice the rally by luring investors out of perceived havens such as bonds. By keeping interest rates low, the Fed has encouraged investors to chase returns in riskier assets such as stocks.

While few analysts have sounded alarms about a possible stock market bubble, there have been increasing signs that equities are becoming a bit overheated.

"We need 2014 to justify the run-up that we saw last year," said Stephen Wood, chief market strategist at Russell Investments in New York.

So far, the results aren't so great.

Company earnings reports for the final quarter of 2013 began trickling in this week, and they've been mixed.

Shares of Intel Corp., often considered a bellwether for the tech industry, fell 69 cents, or 2.6%, to $25.85 on Friday after the computer chip maker disappointed investors with its growth prospects for the year.

Meanwhile, General Electric Co. shares dropped 2.3% to $26.58 after the conglomerate reported disappointing profit margins Friday.

"I don't think anyone's been wowed" with the start of earnings season, said Daniel Morris, a managing director and global investment strategist for TIAA-CREF in New York.

Not all corporate news was bleak.

Morgan Stanley, the last of the major Wall Street banks to report results this week, beat analysts' estimates when it posted strong growth in its wealth-management business Friday. The investment bank's stock jumped $1.40, or 4.4%, to $33.40 despite steep legal expenses last quarter.


Even though a surge in quarterly profit at Bank of America Corp. this week helped lift the S&P 500 index to a new all-time high Wednesday, stocks have since retreated.


Stocks ended Friday mixed. The Dow rose 41.55 points, or 0.3%, to 16,458.56. The S&P 500 index fell 7.19 points, or 0.4%, to 1,838.70 and the Nasdaq slid 21.11 points, or 0.5%, to 4,197.58.

Wall Street watchers generally do not expect the stock market to replicate 2013's stellar leap this year. Many forecasters predict only modest single-digit increases for the S&P 500.

"There is that lingering doubt and worry that we got really too much, too soon in 2013, that it was too much relative to what the economy or corporate profits could warrant," Morris said.

As the Fed begins pulling back its stimulus, the stock market could lose ground.

Many on Wall Street have predicted a correction, or a decline in stock prices of 10% or more. To many, such a drop seems long overdue.

Since World War II, the S&P 500 index has suffered such a sharp pullback every 12 months, said Sam Stovall, chief equity strategist at S&P Capital IQ. But the market has gone 27 months without falling as much.

Even without a correction, the Fed's gradual tapering of its bond-buying program — or quantitative easing — may lead to a "blase" first half of the year for stocks, Morris said. Then corporate America should take it from there, he said.

Wall Street analysts estimate the average company in the S&P 500 will post about 10% profit growth in 2014, according to S&P Capital IQ.

"The reason that the Fed did decide to remove the stimulus is because they expect the economy to grow," Stovall said. "And they expect corporate earnings to rise on their own."