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Corporate earnings may be stock market’s last hope

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Market Beat

After the economic and financial disasters brought to us over the last two years by big banks, big auto companies and, lately, Big Oil, it’s asking a lot of the general public to root for the success of the Fortune 500 crowd.

But for the sake of your 401(k), you’d better hope that corporate America reaped spectacular earnings in the second quarter just ended — and that the companies are willing to predict much more to come.

Because in the short run, an upbeat earnings season is pretty much the last hope left for the battered stock market, and maybe also for sustaining faith in the economy’s ability to extend its year-old rebound.

The government’s report Friday on June employment was another blow to confidence about the recovery. The private sector created a net 83,000 jobs last month. That was up from a revised 33,000 in May, but down from 241,000 in April.

Wall Street, which has turned morose over the last two weeks, fell for the ninth time in 10 sessions. The Dow industrial average lost 46.05 points, or 0.5%, to close at 9,686.48, its lowest finish since Oct. 5. It’s now down 13.6% from its April high, and that’s understating the damage done to the broader market since then.

The June private-jobs total confirms what other data have been telling us: U.S. economic growth isn’t collapsing, but it’s slowing. Although it isn’t unusual for the economy to hit rough patches as it’s emerging from recession, by now most analysts figured the private sector would be hiring much more aggressively.

We need that because public-sector support for the recovery clearly is winding down. The Europeans and Japanese are talking spending cuts or outright austerity to pare their debt loads. Even in Washington, as President Obama warns against pulling back on federal spending too quickly, the appetite for more deficit-financed stimulus seems to be fading in Congress.

In the U.S., debt reduction at the government and consumer level — the deleveraging process — will be a long-term drag on growth. That puts the onus on the global economy’s financially able players to lead the way up and out. They won’t do it out of charity, of course, but because they believe it will be to their benefit.

The financially able include many of America’s multinational companies. Collectively, the big firms in the Standard & Poor’s 500 index were sitting on a record $836 billion in cash at the beginning of April.

The disappointing June jobs figure notwithstanding, more of the corporate giants now sound as if they’re poised to spend some of their cash stash putting people to work.

In late June the Business Roundtable, an association of chief executives of major U.S. companies, said its quarterly survey of members found that 39% expected to boost domestic employment in the next six months, up from 29% in the first-quarter survey.

The survey also found a slight decrease in capital-spending expectations, but expenditures on equipment and software already had ramped up over the last few quarters, which is one reason the manufacturing sector has been so strong. Forty-three percent of CEOs said they expected to increase capital spending in the next six months, and 50% expected to keep spending at current levels.

Corporate spending is driven by growth expectations. And importantly, 79% of the Business Roundtable CEOs said they expected their sales to rise in the next six months, up from 73% in the first-quarter survey.

Many Americans would be happier if that optimism were more widespread, to the benefit of struggling smaller companies that have long been the economy’s main job generators.

But for now, the rich and powerful — the corporate titans — have the best shot at getting richer and more powerful. If U.S. consumer spending is likely to be restrained for years to come, the multinationals at least offer the chance to tap growth opportunities in the healthier emerging economies abroad.

What’s more, because they dominate the major stock indexes and are the most widely owned shares in mutual funds, the biggest companies’ fortunes are the fortunes of average investors. Your nest egg’s prospects ride with theirs.

This week, one of the most broadly diversified U.S. companies — 3M Co. — gave Wall Street a glowing assessment of its business. The firm, which makes tens of thousands of goods across industries including electronics, office products, healthcare and telecommunications, said it expected to post second-quarter sales growth of as much as 18% compared with a year ago. Earnings are expected to jump about 20%.

Given companies’ still-depressed results in the second quarter of last year, as the economy was just beginning to stabilize, investors already were expecting a significant rebound in last quarter’s corporate sales and profit. What they’ll want to hear is that momentum didn’t flag in the quarter, and that growth can continue in the second half.

For 3M, CEO George Buckley said the strong sales momentum was being driven by demand in Asia and Latin America. But he also said that U.S. sales were doing “surprisingly well.” As for the rest of the year worldwide, he said, “I think the second half is going to be OK. I’m not expecting any catastrophes.”

If that wasn’t exactly a ringing endorsement of the outlook for the next six months, it was enough to keep many 3M investors interested in sticking around. In a week when the average industrial stock in the S&P 500 slumped 6.5% on economic fears, 3M lost only 1.6%.

On the whole, Wall Street analysts think blue-chip companies will deliver robust second-quarter earnings gains when reports begin to roll out the week of July 12.

Keep in mind that the analysts tend to low-ball their earnings estimates, giving the companies a good chance of beating them.

Operating earnings of the S&P 500 companies overall are expected to rise 27% in the second quarter from a year earlier, according to analyst estimates tracked by data firm Thomson Reuters. They’re also predicting a 26% rise in third-quarter earnings and a 33% gain in fourth-quarter results.

“Estimates have come down very slightly since mid-May,” said John Butters, an analyst at Thomson Reuters in Boston. “Analysts definitely seem to be taking a wait-and-see approach.”

A caveat about those overall numbers is that they mask wide divergences in expectations for different sectors and individual companies.

A bigger caveat is that the numbers could turn out to be far too optimistic — and that analysts, and the companies they follow, are behind the curve in recognizing the risk of a sharp deceleration in the global economy in the second half.

If second-quarter results, and/or companies’ guidance for the rest of the year, don’t offer investors enough of an incentive to hang on to stocks even at their already marked-down prices, equities face the risk of falling into a new bear market just 16 months after exiting the last one.

The S&P 500 now is off 16% from its spring peak. The threshold of a new bear phase, using Wall Street’s classic yardstick, is a decline of 20%.

Skating this close to the edge, the market needs a reason to believe that the economic recovery isn’t headed for an early grave. If corporate America can’t deliver that message, it may be time to call the undertaker.

tom.petruno@latimes.com

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