US company revenue shortfalls fuel slowdown fears

This earnings season, good profits are not enough. Investors have been punishing companies with disappointing revenues in a sign of growing trepidation about the health of the US economy.

 

Some investors are concerned that falling revenues at some bellwether companies are consistent with data showing that the economy began slowing in the second quarter and is starting to become a drag on corporations.

 

The bottom lines of US corporations haven't been all bad. About a tenth of S&P 500 have reported so far and of those, over 70% have beat earnings estimates, while 65%  have trumped revenue expectations, according to data from Thomson Reuters through early Tuesday.

 

But the S&P 500 has struggled to make progress since reporting season got into full swing a little over a week ago with a strong set of numbers from Alcoa Inc, as revenue misses at some big corporations grabbed the headlines.

 

"I think it's a real worry," said Christian Thwaites, chief executive at Sentinel Asset Management in New York. "The real story is that underlying final end real demand is weak here, which is what we've been seeing in the macroeconomic numbers for some time."

 

After stocks soared in 2009 as corporate management beat earnings forecast by cutting costs, investors are now demanding their pound of flesh in the form of top-line revenue growth. Shares of companies that don't oblige are getting hit hard.

 

Results from banks have been a concern. Two of the nation's largest banks, Citigroup and Bank of America, reported a sequential fall in revenues along with a declining demand for loans, a sign that economic activity is sluggish.

 

Bank of America's shares plummeted more than 9% after its results on Friday while Citigroup shed 6%. Since then, the BKW Bank index, which tracks the performance of 24 leading US banks, has dropped 6%.

 

The problem is not limited to the financial sector. Shares in General Electric Co, a huge industrial conglomerate, fell nearly 5% after revenues dropped, even as it posted its first quarterly profit increase in more than two years.

 

The prospect of an uneven recovery at best, and a double-dip recession at worst, is likely to favor careful stock pickers. Last year almost any buy-and-hold strategy worked as markets rallied off their lows.

 

This year it's not so easy. Tom Forester, a portfolio manager at the Forester Value Fund in Lake Forest, Illinois, has been protecting his portfolio by buying S&P 500 put options and selling stocks in economically sensitive sectors such as materials and energy.

 

"People are a little concerned that growth is slowing and you can't (cost-) cut your way to prosperity," said Forester, who said he liked stocks in the healthcare sector as well as stable revenue companies that pay a dividend.

 

The S&P 500 is down 2.8% since the beginning of the year and is now trading at about 12 times earnings, according to the smart estimate from Thomson Reuters Starmine. Investors who pick the right stocks at those kinds of valuations could end up taking home bargains.

 

David Joy, chief market strategist at Columbia Management in Minneapolis, said that certain finance and technology companies are still good buys and, barring a double-dip recession, cheap valuations should keep investors interested.

 

"We're upgrading the quality of our portfolios across the board, looking for sustainable earnings growers over time, companies that really take advantage of the environment and distance themselves from the competition," said Joy.

 

Examples of those are Intel Corp, whose margin and revenue forecasts breezed past forecasts, sending its shares up around 2%, and Apple Inc, which gained around 3% after handily topping expectations on both revenue and earnings.

 

Despite the occasional bright spots, Joy says earnings estimates for the next year will have to be lowered as the economy slows and corporations struggle.

 

"Maybe now you have to start rethinking what had been optimistic earnings forecasts for the second half of this year and for 2011. By and large, we think 2011 forecasts are just not realistic, and they need to come down," Joy said.

 

Early indicators suggest both the US manufacturing and services sectors started to slow down in the second quarter. Signs of a slowdown while employment is still anaemic are a concern to the investors, worried that consumer spending won't be able to sustain the recovery.

 

Government stimulus and inventory rebuilding by companies, which helped fire an initial bounce, are coming to an end. That combined with the prospect of slowing growth in the euro zone and monetary tightening in China is also worrying investors.

 

Trading volume in the equity market continues to be anaemic during the summer and investors have had a rough ride in the last few months, with fears over the economy, financial regulation and BP Plc's oil spill hitting sentiment.

 

With the US mid-term elections in November, many are taking a wait-and-watch approach until later in the year, with tax policy representing another wild card for markets.

 

That could make for a frenetic finish to 2010, especially with some prominent sell side analysts maintaining year-end S&P 500 forecasts that imply a 20% rally by year end.