The second quarter was a "soft patch" for the U.S. economy, but corporate earnings likely remained strong.
Analysts are projecting 14% growth in S&P 500 earnings, led in part by energy and materials, says John Butters, senior earnings analyst at FactSet Research Systems.
But over the past six quarters, 70% of companies have beaten those estimates. Analysts could be setting themselves up for another upside surprise.
"Up until now, expectations haven't been too high," Butters said. "They've actually probably been a little bit too low."
This past quarter was rough. Investors had to grapple with massive disruption from the earthquake and tsunami in Japan, the ending of the second round of quantitative easing, and fears over a default in Greece. Unemployment crept higher. Real consumer spending dipped in April and May. But some recent data suggest some momentum as Q2 ended.
"As we hear these companies tell us how they did, we'll really be listening to their outlooks," said Linda Duessel, equity markets strategist with Federated Investors. "We always do, but this time could be more interesting because of the severity of what's been out there."
No S&P 500 company is slated to report this holiday-shortened week. Aluminum giant Alcoa (NYSE:AA - News) will kick off the earnings season unofficially on Monday.
But 26 S&P 500 firms that had reported through Friday showed a 20.1% hike in median earnings vs. a year earlier, according to Zacks Investment Research.
"We're off to a very strong start," Dirk van Dijk, Zacks' chief equities strategist, wrote in a note.
Analysts bumped up their earnings and revenue estimates early in Q2 for the commodity-fueled energy and materials sectors. They've largely left those projections alone, even as commodity prices tapered off in May and June, Butters said.
"Are the analysts seeing this as just kind of a soft patch and they think there's going to be continued demand for commodities going forward, or have they been a little slow in revising their estimates?" he asked.
Oil and other commodity prices did rebound Tuesday.
With the domestic economy sluggish, much of the strong earnings in the past few quarters have come from Asia and other emerging markets.
"Companies are going to really need to continue seeing that growth overseas to sustain the current expectations for earnings and sales growth," Butters said.
But Duessel says expectations grow more modest as the year progresses, even though there's some bright news. Early indications are that supply chains have bounced back quickly from the Japanese disaster. And fuel prices, which weigh heavily on consumers, have eased considerably.
"We're vulnerable to an upside surprise," Duessel said.
Stocks Cheap?
That would suggest a "strong patch" for corporate results in Q3, she said.
Butters says the market also seems skeptical to even the muted forward earnings estimates. Stocks are trading at 12.6 times forward price-to-earnings ratio, vs. a more normal historical average of over 15 times.
"We've sort of had a disconnect between the market's expectations of earnings, and what the analysts' expectations of earnings have been over the last year or so. And until this point, the analysts have been proven correct," he said.
Friday capped the S&P 500's best week in almost two years, fueled by relief that Greece should avoid a near-term default and some brighter U.S. economic data.
Investors will be watching this Friday's jobs report closely.
