Investors have likely already discounted good Q2 earnings

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By Palash R. Ghosh | June 30, 2010 8:49 AM EST

Second-quarter earnings -- which will be launched by Alcoa's (NYSE AA) profit report next week -- are expected to beat analysts' estimates across the board, but they are unlikely to match the huge year-over-year gains witnessed in the first quarter.

Regardless, investors have probably already assumed that second-quarter profits will come in fairly good – and are casting a wary eye onto the third and fourth quarters and beyond, as macroeconomic problems increasingly darken the investment landscape.

But first, the good news.

 According to Sam Stovall, chief investment strategist at Standard & Poor's, companies in the S&P 500 index posted aggregate earnings of $19.41 per share in the first quarter, far better than S&P Equity analysts' own $17.16 estimate.Overall, first quarter 2010 earnings enjoyed a huge 92% year-over-year jump.

The robust profit picture was attributed to the “modest recovery of the global economy, the extended first-time home-buying credit, a slightly lower value in the U.S. dollar, a doubling in consumer confidence readings, and general cost-cutting,” which partially offset headwinds like “substantially higher oil prices and a stubbornly high unemployment rate.”

Easy comparisons to a dreadful first-quarter of 2009 also helped boost the first quarter earnings figures on a relative basis.

In fact, nine of the 10 sectors in the S&P 500 posted earnings improvements; with only Telecom Services enduring a decrease in quarterly profits.

Earnings for the second quarter are expected to show a more modest – but still impressive -- 42% year-over-year rise, Stovall noted though the breadth of participation should be wider.

He anticipates that all ten S&P sectors will enjoy year-over-year profit gains, with Financials leading the pack – surging by more than 250%. Materials (+91%,), Energy (+80%), Information Technology (+62%), and Consumer Discretionary (+44%) are also expected to post above-market earnings improvements in the second quarter.

The remaining broad sectors -- Consumer Staples, Industrials, Telecommunications Services and Utilities – are expected to show year-over-year profit gains of below 10%. The other S&P sector, Health care, is positioned for a 12% earnings improvement.

Quite a bifurcated market indeed.

For example, the Consumer Staples sector is expected to show the lowest projected growth (+2%) in second quarter operation earnings among the ten S&P sectors.

“We expect no more than modest sales growth in 2010’s second quarter for major U.S. Consumer Staples companies, including the prospect that currency exchange rates will have a negative near-term impact on reported results, especially for companies with a sizable presence in Europe,” said S&P analyst Tom Graves.

On the other side of the fence, Energy is among the anticipated big profit-gaining sectors for the second quarter.

“For the super-major [oil companies], which account for roughly 60% of the market value of the group, our projected earnings growth is tied to economic expansion, higher price realizations, widened refining & chemical margins, as well as a boost from upstream oil and gas volumes reflecting recent project start-ups and ramp-ups,” said analyst Stewark Glickman.

However, some dark clouds loom over the energy sector for the longer-term, namely the ongoing BP oil spill disaster and the deepwater Gulf moratorium.

“Companies will likely start talking about taking charges if they move a lot of people/equipment out of the region,” Glick added. “The offshore drillers will likely show deteriorating results in the second quarter; day-rates were already edging lower even before the BP spill, and the spill will certainly make for a gloomy outlook.”

In general, Stovall noted, S&P 500 earnings gains will be driven “by both increased volume and rising prices, as a result of our outlook for ongoing economic improvement, despite growing uncertainties related to U.S. housing markets and sovereign debt issues in Europe.”

Now, some of the bad news.

Howard Kornblue, senior portfolio manager at Alpha Fiduciary Wealth Management in Phoenix, contends that most investors have already discounted a good second-quarter earnings season – and that they're more likely to scrutinize what companies say about their near-term outlooks, given the multitude of macroeconomic headwinds on the horizon.

“On a relative basis, second-quarter profits will be pretty good, but I think everyone already knows that,” he said.

“Part of that is because last year's profits were so dismal. What investors are more interested in now is the guidance and near-term prospects not only for individual companies, but also for their industries. The market will also keenly listen to what the Federal Reserve has to say about global economic trends.”

Consensus earnings expectations guidance for the second quarter seem overly bullish, given all the economic woes weighing on sentiment right now, said Tom Samuels, portfolio manager for the Palantir Funds in Houston.

“The first and second quarters of this year have benefited from easy comps from last year,” he noted. “Going forward, comparisons will be much, much tougher.”

Samuels said that one of the key issues that may impact earnings in the second half will be the tension between rising costs of basic materials -- agricultural products, iron ore, etc. – and the difficulty of passing those pricing pressures onto the consumer.

“We are looking at a whole host of companies that are facing rising costs as well as a lack of pricing power,” he said. “This could really
impose some margin squeezes on corporations in many industries.”

Kornblue also cautions that many corporations are still padding their bottom line through cost-cutting measure and workforce reductions – though probably not to the extent witnessed last year.

Indeed, investors are wary, but they have good reasons to feel that way.

“Investor psychology has been beaten down by a stubbornly high unemployment rate, tepid consumer spending, a still-fragile housing market, as well by the mammoth credit/debt crisis in Europe and now new worries about a potential second-half slowdown in China,” Kornblue added.

The questions is: has the market accurately priced in all these near-term risks? And if second-quarter earnings come in spectacular, would that provide just a short-term stock price spike, or would it serve as the base of a solid uptrend?

As far as investors are concerned, they're already looking well past the second quarter.

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