1st-Quarter Earnings May Show How Stock Winds Blow

From Reuters

Stock market investors beware. It may all come down to corporate earnings.

Many analysts say stocks are at a major crossroads, and the greatest bull market in history could be in for another gut-wrenching drop if the upcoming round of first-quarter earnings disappoint Wall Street.

The Dow Jones industrial average plunged 148.36 points on Friday, a 2.3% loss, to end the week at 6,391.69--the lowest since Dec. 18.

The latest sell-off was provoked by government data released Friday that show the nation’s economic growth accelerated in the final three months of 1996 and that underlying inflation was showing some unwanted vitality, a likely prescription for the Federal Reserve Board to push interest rates higher again.


The Fed on March 25 raised its benchmark short-term interest rate by a quarter of a percentage point, the first such credit-tightening move in more than two years. Now another increase seems all but certain when the Fed meets May 20.

Meanwhile, a major concern on Wall Street is that 1997 may be the year of corporate earnings accidents now that the Fed has changed its monetary course and is stepping on the interest rate accelerator.

“I think this is going to be the year of earnings shortfalls and accidents,” said Michael Metz, chief investment strategist at Oppenheimer & Co.

“The market faces significant roadblocks and a double problem because there’s pressure on stock valuation due to higher interest rates and there’s also a question of whether earnings will meet expectations.”

The strong dollar is also giving foreign companies a pricing advantage, helping them cut prices to get a bigger U.S. market share, which could hurt the profit margins of American firms, he said.

“Even though the economy is steaming along at a very vigorous pace, I think we are in for a period of contracting profit margins and disappointing earnings,” Metz said.


Yet Wall Street is betting that first-quarter earnings will show an increase of nearly 12% overall from the first quarter of 1996, according to earnings-estimate tracker First Call.

But that strong number, if it is achieved, will owe partly to the relative weakness in earnings in the first quarter of 1996.

“The first quarter of last year was the second-weakest quarter of this six-year earnings recovery . . . and it’s important to point out that the comparisons with last year’s first quarter will not be a tough one,” said Chuck Hill, research chief at First Call.

The first three months of 1996 reflected the damage from a strike at General Motors Corp. and one of the worse winters on record, which severely crippled the auto, home construction, entertainment, trucking and airlines industries.

More important, there is a consensus that the first-quarter 1997 numbers will be as good as it gets for earnings and that profit growth might slow during the rest of the year. That could be bad news for stocks, which have gotten accustomed to a steady stream of earnings improvements.

“The issue now is that the first quarter might be the best that we’ll have for the next quarter or two because higher interest rates may start to impact corporate profits the rest of the year,” said Alan Ackerman, market strategist at Fahnestock & Co.


“The strong dollar raises a caution flag for U.S. multinational companies, which get a great deal of their earnings from overseas,” he said.

Indeed, the dollar has been flying high, soaring last week to 127.16 Japanese yen, its highest level since August 1992, before drifting down to 126.03 yen by week’s end.

Many companies will also have a tough time repeating past successes as they start to lose the benefits of mergers and restructurings, which have brought huge job cuts and plant closings in past quarters.