Corporate Profit Engines May Be Out of Steam

S&P 500 earningsFor the first time since June 2009, the Street has finally acknowledged that forecasts for S&P 500 earnings should be cut for the third quarter of 2010. This should certainly cast a deep shadow over the stock market, because there is simply no way to keep the engines going when the country’s GDP cannot pick itself off the floor. But then the estimate for S&P 500 companies’ aggregate profit for 2011 has only been reduced from $96.16 a share forecasted as of June 30, 2010, to $95.21 a share as of September 30, 2010. Considering what has been going on lately, it does not seem to be much of a reduction, don’t you think?

Sure, there are a few shy voices out there who believe this reduction is still too optimistic. To achieve a substantially better performance in 2011 versus 2010, the U.S. GDP would have to be pretty robust next year, they say. Having in mind that the recovery has effectively stalled, it does not make too much sense to see the S&P 500 pull another record year in 2011. Then again, considering that Wall Street has managed somehow to decouple itself from the rest of the economy, perhaps there is reason behind such madness, I really can’t tell anymore.

In any event, even the most optimistic among analysts had to acknowledge that, to realize an average price of $95.00 a share in earnings, the U.S. economy would have to pull – well — quite a rabbit out of the hat. Don’t know about you, but I have been disillusioned enough in the past two years to believe what approximately 8,500 analyst tracked by Bloomberg have to say. The optimism card has been played one time too many, despite the odds of 8,500 versus one.

What do I think about the third-quarter reporting season? I think that the stalled recovery in the U.S. will show up in Q3 corporate earnings big time and it will not grease the kind of liftoff that Wall Street analysts are predicting in 2011. Now analysts have estimated that the S&P 500 companies will report Q3 earnings 23% higher quarter-over-quarter. This is significantly lower from the 49% increase during the second quarter and the 52% increase for the first quarter of 2010. If this reduction in earnings actually pans out, it will be in stark contrast to the S&P 500 Index’s performance (in relative terms) during the month of September, an 8.8% increase — something not seen during any month of September since 1939.

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The way I read this, it is just another example of the decoupling of Wall Street from Main Street. My only question is, then, how are the S&P 500 companies supposed to achieve $95.00 per share in 2011 when most of the engines are not online anymore?

Talking to a couple of my trader friends may provide some insight. First, they have long stopped relying on analysts’ forecasts. And, second, they believe the market has already priced the lower earnings forecasts. Currently, the S&P 500 is trading at 12 times its 2011 earnings, which, in their language, means that equities are cheap.

My trader friends worry about one thing, though. They know the market will be doing its thing as long as investors believe the economy is slowly, but surely recovering. But even stuck in their own little bubble, they are beginning to realize that may not be the message for very much longer.