U.S. Stocks 2012: Will Third-Quarter Earnings Kill Rally?

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When Alcoa Inc. (NYSE: AA) reports third quarter numbers after the close Tuesday, the Dow bellwether will unofficially kick-off the final earnings season of 2012, giving U.S. stocks a chance to continue their rally.

Numbers from Alcoa, which supplies the global economy with a plethora of materials used for everything from soda cans to airplane parts, are closely watched. A dismal report from the company is predicted to set the stage for rather glum spate of third quarter reports.

The world's largest aluminum maker is expected to report a profit of a penny a share, compared to 15 cents a share earned in the same quarter a year ago. Sales are expected to fall 14% to $5.6 billon.

A strong focus will be on its overseas growth. China's troubling slowing growth coupled with the Eurozone's recession is expected to be a notable drag on international revenue for global firms like Alcoa and Yum! Brands Inc. (NYSE: YUM), which also reports Tuesday after the bell.

"Any evidence they're expecting improvement globally would be good," Mark Luschini, chief investment strategist at Janney Montgomery Scott told MarketWatch.

Scores of economists have increasingly warned that earnings for the second to last quarter of 2012 will be weak at best. The big question is just how weak, and how big an impact the glum results will have on markets through the end of 2012.

Here's what to expect from third-quarter earnings reports.

Low Third-Quarter Earnings Expectations

Overall, companies in the Standard & Poor's 500 Index are expected to show a 1.34% decline in profits for the latest quarter, marking the first time in more than three years that returns have turned negative, according to data from S&P Capital IQ. That compares to a 0.81% growth rate in the previous quarter.

The current earnings consensus for S&P 500 companies is $25.01 a share, 4.5% lower from a read on June 30, according to FactSet Research System.

Over the last three months, earnings forecasts for the third quarter have been repeatedly slashed. Some 78% of S&P 500 companies that have provided an earnings outlook (80 out of 103) have cautioned they will miss Wall Street estimates.

Last month, global shipping giant FedEx Corp. (NYSE: FDX) cut its earning range to $6.20 to $6.60 per share from its June forecast of $6.90 to $7.40. Caterpillar Inc. (NYSE: CAT) also warned of tepid economic growth for the next several years.

As investors brace for the worst, they may be surprised since some companies have intentionally set the bar low.

"Companies are masterful at convincing analysts things are going to be terrible and that ends up not being the case. It's the quarterly game that everybody plays and pretends not to be playing," chief global strategist Dan Greenhaus at brokerage firm BTIG LLC told The Wall Street Journal.

Money Morning Chief Investment Strategist Keith Fitz-Gerald agreed.

"Companies very deliberately bring down earnings announcements on a pre-announcement basis on the theory that if they surprise later, they in fact induce a boost," said Fitz-Gerald. "It's like betting on a house after the race."

U.S. Stocks 2012 and Third-Quarter Earnings

But if earnings are down, how will markets react?

Investors may just turn a blind eye to poor results, owing declines to the looming fiscal cliff, the European debt crisis and Election 2012 uncertainty.

"People are certainly aware that earnings are going to be poor in the quarter. But in light of what's happening on the macro side of things earnings have gotten a lot less attention than they normally do," said Greenhaus,

An increasing sentiment among analysts and market participants is that companies' earnings for the third quarter, and guidance for the fourth, may not sway markets as much as in the past.

Stoked by a fresh round of quantitative easing in September, equity and commodity markets have enjoyed a robust rally that began in earnest in June. Year-to-date, the Dow is at a five-year high and the S&P 500 is very near the same landmark. Over the last week alone, the Dow jumped 1.3%, the S&P climbed 1.4% and the Nasdaq eked out a 0.6% gain.

And QE3 could keep the rally going. What investors should watch for is if the market reflects disappointing earnings or simply shrugs them off.

"If the analysts are right, and earnings stink, then we're going to find out once and for all whether this market is actually all about Ben Bernanke and Club Fed," said Fitz-Gerald.

The real earnings test will come at week's end when banking behemoths JPMorgan Chase & Co. (NYSE: JPM) and Wells Fargo & Co. (NYSE: WFC) both report Friday. Those reports should give a good read on consumer health with figures related to mortgage banking activity and reserve releases.

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