Stocks shift focus as earnings growth stalls

NEW YORK (MarketWatch) � As an era of double-digit growth in corporate earnings draws to a close, analysts say investors need to start looking beyond quarterly profits if the market is to sustain, let alone advance, its recent gains.

First-quarter earnings for S&P 500 SPX �companies, which start rolling out with Alcoa Inc.�s AA �report on April 10, are expected to show a 0.2% decline from overall results a year ago, according to analysts polled by FactSet.

If the estimates prove accurate, it will mean snapping an exceptionally strong string of earnings seasons, extending from a 119.2% jump in the fourth quarter of 2009 to 6.1% growth in the final quarter of 2011.

Analysts polled by FactSet expect a decline in first-quarter earnings for seven of the S&P 500 index�s 10 sectors, led by materials and telecommunications. Only the industrial, financial, and technology sectors are expected to see overall earnings growth for the quarter.

Given a dearth of positive macroeconomic data, corporate earnings have been the primary driver behind the rebound in equities these past two years.

�Earnings are the gas fueling the market�s engine,� said Marc Pado, U.S. market strategist at DowBull.

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The impact is evident across the board. Wrapping up the first three months of 2012, the S&P 500�is up 12%, the Dow Jones Industrial Average DJIA �is up 8% and the Nasdaq Composite COMP �is up 19%.

So how will markets cope with a slowdown in corporate profits?

While the trend could be a source of disappointment, Paul J. Nolte, managing director of Dearborn Partners, said it would not be enough to derail the market.

�Earnings estimates that came in under expectations spoke to a general lack of growth, not weakness,� Nolte said. �There has been a big jump in [profits] the last few years. We expect it to start to moderate.�

Many of the recent gains in earnings stem from companies aggressively cutting production and labor costs, analysts said. At the same time, greater efficiency was achieved by squeezing more work out of fewer employees and extending their overtime hours. That trend is waning, however, as companies start rehiring.

�Companies realized that if they are going to compete, they can�t keep cutting costs,� said Jerry Webman, chief economist at OppenheimerFunds.

�New jobs mean paychecks and expenses. It diminishes earnings, but in the long term my expense is my revenue,� he said.

Other factors at play

As corporate-profit growth slows down, other catalysts may boost investors� enthusiasm. Improvements in the U.S. job market have spurred optimism about the economy. The unemployment rate fell to 8.3% in February from 9% last fall. By the beginning of March, first-time unemployment claims had hit a four-year low.

Bill Ryder, director of quantitative strategy at Riverfront Investment Group in Richmond, Va., said that with more people getting jobs, consumer demand should be strong enough to sustain modest GDP growth.