Be Afraid of the Third-quarter Numbers

Afraid of the Third-quarter NumbersIt’s that time again, and I can tell you that I’m more nervous for third-quarter earnings season than I was the previous two quarters. You should be, too.

Alcoa, Inc. (NYSE/AA) will be the first Dow stock to report in the third-quarter earnings season, as it kicks off with its results on Tuesday. The company is one of the world’s top aluminum makers. It is also a good barometer for the global economy, as the metal is applied in many industrial uses, including aircraft, automobiles, commercial transportation, packaging, building and construction, oil and gas, defense, and consumer electronics.

In the second-quarter earnings season, Alcoa beat slightly on earnings; but what was concerning was the lack of revenue growth, an emerging issue that will likely be the situation with many U.S. companies. Alcoa’s revenues are estimated to fall 12.7% in the third-quarter earnings season, followed by a five percent decline in the fourth-quarter earnings season. These are not good metrics, and they clearly indicate that global demand for raw materials has declined.

Revenue growth is estimated to be flat, down from the projected 1.9% growth at the start of the third quarter, according to FactSet. This is not what you would expect if the economy was healthy and expanding—but the economy is neither. And while there is some hope and guarded optimism for the third-quarter earnings season, I expect disappointment across the board.

Based on the current estimates, earnings for the S&P 500 are expected to fall 2.6% in the third quarter, which would end the 11 straight months of earnings growth, according to FactSet. So far for the third quarter, 82 S&P 500 companies have issued negative earnings-per-share (EPS) guidance, while only 21 companies are reporting positive guidance.

The top performing earnings growth predicted for the third-quarter earnings season is the financials sector at 10.4%, according to FactSet. The two weakest areas of earnings growth in the third-quarter earnings season are predicted to be the energy and materials sectors.

As in past quarters, companies need to be growing their revenues to drive earnings and earnings growth being generated by cost cuts—this is critical and could give us a good indication on how well corporate America is actually doing. Based on the soft GDP growth, I’m not expecting any major upside surprises.

The reality is that many companies cut costs during hard times and should be in a better condition now. If the economy was truly healthy, we would see earnings growth driven by revenues. In addition, what the company says about the future is important.

The key is to monitor the companies that are global in nature, especially those that produce the raw materials essential to economic renewal, such as copper, energy, iron, forestry, and concrete. (Read “What Multinationals Are Telling Us About the Global Economy.”)

As I have said, revenues going forward, especially organic growth, will be key. We want to see growing revenues, instead of cost cuts, drive earnings. It is difficult to imagine a healthy economy without revenues growing, and this is my concern that could hamper growth.