07/12/10 — Earnings season is upon us once again, and it will be a critical time in helping to determine which way the stock markets head over the next few weeks and months. Second-quarter earnings are coming up, with Alcoa Inc. (NYSE/AA) reporting on Monday. I believe there will be a lot riding on the results. It will be crucial to see improvements in business activity and guidance. In my view, the key will be revenue growth
In the previous quarters, earnings were driven by cost-cutting and generally not by revenue growth. This is not what you want to see as the economy recovers. Earnings quality must be good and, for this to happen, it needs to be driven by a growth in business activity, namely revenues. If a company’s business activity is stagnant, it does not reflect much on the economy.
As you read a company’s results, take a glance at the revenue column to help determine if corporate activity is on the rise. Higher revenue growth would be positive and support earnings quality. Only if we see this would market gains be sustainable. Anything else would result in continued mixed trading.
For many U.S. companies, you also need to see improvements around the globe for the demand for U.S. goods and services. There was positive economic news last week after the International Monetary Fund (IMF) raised its GDP world forecast to 4.6% for 2011 from 4.2%. The IMF suggested that stronger growth in the U.S. would be partially offset by weaker growth in Europe. The news is encouraging for the domestic situation, but we need to see continued improving economic trends and corporate guidance in the upcoming weeks in order to drive sustainable gains.
This market needs leadership. In 2009, technology stocks provided this. In 2010, we have yet to see any sector take charge and drive buying. In tech, watch for Intel Corporation (NASDAQ/INTC), Advanced Micro Devices, Inc. (NYSE/AMD), and Google Inc. (NASDAQ/GO0G) this week.
Keep an eye on the banks during this earnings period. Increased business activity is generally reflected in the banks. The Bank of America Corporation (NYSE/BAC) and Citigroup Inc. (NYSE/C) report this week.
For overall business activity, listen to what diversified global conglomerate General Electric Company (NYSE/GE) has to say.
By the end of the earnings period, we will get a better sense on how corporate America is faring. Failure to generate decent revenue growth either in the second quarter or in the second half of this year could drive stocks lower.