Earnings Warnings & EPS Season Threatens Shares

Alcoa (NYSE: AA) officially started earnings season Tuesday afternoon, but earnings warning season is at full stride. I see stocks at risk broadly speaking, as it is put up or shut up time now. With the SPDR S&P 500 (NYSE: SPY) up 16.7% year-to-date after adjustment for dividends and splits, and given that earnings estimates are moving in the opposite direction, the pressure is weighing against stocks to prove their worth. Of course, valuations might still benefit from improved investor expectations which could coincide with a Romney rise in the election polls. However, the weight of earnings and EPS warnings should prove meaningful.

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Earnings Warnings & EPS Season

Tensions are high for good reason, including high profile warnings already booked by the likes of Caterpillar (NYSE: CAT), McDonald’s (NYSE: MCD), Applied Materials (Nasdaq: AMAT), FedEx (NYSE: FDX), Hewlett-Packard (NYSE: HPQ) and Express (Nasdaq: EXPR). Indeed, concern about Apple’s (Nasdaq: AAPL) outlook after an analyst’s downgrade drove it down 2.3% intraday Tuesday before it recovered to close just 0.4% underwater. The SPY collapsed a full point Tuesday as tensions rose ahead of reports from Alcoa and Yum! Brands (NYSE: YUM). The week’s reporting schedule is light overall, but it’ll close with high profile (and impact) news from J.P. Morgan Chase (NYSE: JPM) and Wells Fargo (NYSE: WFC).

Earnings expectations do not match up well against stock performance. According to a Zack’s report, total earnings are expected to decline by 3.2%, marking the first drop since 2009. You recall 2009, when the market reached rock bottom. When I was an analyst, I tracked analysts’ expectations and was not surprised to find that they really were late in catching up with reality. They tended to follow results, even quarter to quarter, and so I’m not surprised to discover that expectations for the fourth quarter are still for EPS growth of 7.9%. I expect that after this quarter’s reports, growth for Q4 will be severely altered.

Much of the more recent earnings growth has been on cost cuts, as revenues have proven soft. As you might expect, there’s only so far you can cut and continue to function somewhat efficiently. It looks to me like the fat is all gone now, and only muscle attrition can follow, or EPS attrition. Another issue has been stealth price increases, meant to keep customers from noticing. I plan to report on some of the creative ways companies have passed off price increases to their customers in a near-term article at the blog and at Seeking Alpha, so stay tuned.

The SPY is down fractionally in morning trading Wednesday, after mixed news from Alcoa (-3.8%), Yum! Brands (+8.9%), Chevron (NYSE: CVX) (-3.6%) and Costco (Nasdaq: COST) (+4.7%) on their individual earnings reports. As the season continues to test stocks, I expect pressure to increasingly weigh against them. Though, as we pass warnings season, the outperformers will increase in number and begin to balance the message against the companies reporting bad news or outlooks. Still, in my opinion, on net, earnings season threatens stocks this quarter.

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