Don't Put Any Stock In April's Rally
Mark Lewis, Forbes.com, 04.30.01, 2:30 PM ET
NEW YORK - Investors dreaded the current earnings season. Now that it's winding
down, they're buying stocks on the theory the worst is finally over. Is this a
sucker's rally? Many firms are hinting at more bad news ahead, so the party may
be premature.
As of the end of last week, 85% of large-cap
companies had reported first-quarter earnings
that met or exceeded the Wall Street
consensus estimate, while 15% have fallen
short. But those were estimates that already had been guided sharply lower. Yet,
when Dell Computer (nasdaq: DELL - news - people) announced it would make
the already-lowered earnings number for its current quarter, investors broke out
the champagne. If a company lowers the bar to the floor and then steps over it, is
that such a triumph?
More ominously, many first-quarter reports contain warnings for the second
quarter. Technology companies in particular are offering little evidence that the
worst is behind them. Cisco Systems (nasdaq: CSCO - news - people) said
revenue for its third quarter will be sharply lower than its second quarter, and that
the fourth quarter will be flat, at best, from the third. "There is still no sign of any
slowdown in warnings or downward revisions in the tech sector," says Charles
Hill, director of research for Thomson Financial/First Call.
First-quarter earnings for the overall S&P 500 will come in about 6% lower than the
year-ago quarter, Hill estimates. Judging from their forecasts, Wall Street analysts
expect earnings to decline 10.7% in the second quarter and 2.1% in the third,
before rising 9.7% in the fourth when comparisons with 2000 become more
favorable. But Hill says those forecasts are too optimistic. He expects earnings to
decline 11% to 13% in both the second and third quarters. "And I think there's a
reasonable chance that the fourth-quarter numbers are going to be flat or down a
bit," he adds.
April's equities surge reminds Hill of January, when the market perused the
fourth-quarter earnings reports and decided they were not as bad as feared. When
the Federal Reserve issued a surprise interest-rate cut on Jan. 3, it touched off a
huge rally. Alas, those gains melted away when companies began issuing
warnings for the first quarter.
Three months later, it's déjà vu all over again. Investors are looking at bad
first-quarter numbers and deciding that the worst is over. Meanwhile, the Fed again
has issued a surprise intermeeting rate cut. But Hill thinks investors are jumping the
gun. "You still don't know if it's sustainable," he says of the current rally. "I think you
should sit tight until you have a better sense of whether the fourth quarter is going
to reflect a recovery."
Granted, there is some evidence to justify a positive outlook. People are still buying
houses and cars. "You're starting to see some signs that the economy is stabilizing
here," says Steve Goldman, a market strategist for Weeden & Co. Corporate
earnings will remain weak this year, Goldman says, but it doesn't matter because
investors see stronger economic growth ahead, supported by a very aggressive
Fed.
The technology sector remains under a cloud, Goldman concedes, but the rest of
the economy seems to be doing all right. However, to Hill, tech is especially
significant because it is a proxy for capital investment, which has been declining
even as consumer spending holds steady. "We're kind of teetering on a tightrope
here," he says, with capital spending pulling the economy down while consumer
spending holds it level.
Nor is tech the only sector under a cloud. Hill points out that analysts are lowering
their fourth-quarter expectations for companies that make basic materials, such as
paper, metals and chemicals. These are cyclical stocks that are supposed to turn
up before the rest of the economy does. If they turn down instead, that would be
bad news indeed.
Consider what DuPont (nyse: DD - news - people) had to say last week when
reporting its results: "Based on demand signals observed in the first quarter in key
markets, the company now anticipates that the global economic slowdown will
similarly impact the manufacturing sector through the second quarter and perhaps
into the second half of 2001."
The worst may be to come, says Hill: "We have a hurdle to get over here in a
couple of weeks when the retailers start reporting." If such bellwethers as
Wal-Mart (nyse: WMT - news - people) offer negative guidance, the market may
give back April's gains. |
