2011 Earnings Off to a Strong Start, but Will it Last?

Earnings season is well underway and the trend so far has been mostly positive. But as 2011 progresses, companies will be less and less likely to meet - much less surpass - Wall Street's lofty expectations.

That's because high unemployment, tight credit, an inability to further reduce cost structure and less favorable comparisons to 2010 will conspire to trip up the less nimble corporations.

Indeed, any sustained improvement in spending will depend largely on a significant reduction in the unemployment rate. And even the U.S. Federal Reserve doesn't believe the jobless rate will fall below 8% within the next two years.

And then there's inflation. Although not a concern for quite some time, rising prices in commodities such as oil, grains and cotton could put upward pressure on prices as we get deeper into the year.

"Inflation will be front and center in the eyes of analysts and policy makers," said retired hedge fund manager and Money Morning Contributing Editor Shah Gilani. "Interest rates are low. How long they can remain subdued, especially if inflation rears its ugly head, is another key issue we're facing."

Another challenge for 2011 is that, after two years of cost cutting, the ability of companies to boost earnings by streamlining operations is just about tapped out. The most successful businesses, says Gilani, will be those that grow revenue, particularly revenue on a diversified basis.

Gilani says there will be some earnings growth, but only for the toughest and leanest companies.

Consider JPMorgan Chase & Co. (NYSE: JPM), Intel Corp. (Nasdaq: INTC) and General Electric Co. (NYSE: GE). These companies serve as barometers for the economy's health, and all three beat analyst expectations. Their collective success suggests the recovery has indeed become more tangible, and that earnings growth is there for the taking.

Both GE and Intel anticipate further improvement to the brighter business climate that contributed to their impressive fourth quarters.

"What you saw on the fourth quarter is a pretty good precursor to what you're going to see in 2011," Jeffrey Immelt, chairman and chief executive officer of GE, said on his company's Jan. 21 earnings conference call.

Immelt said he saw more tailwinds than headwinds heading into 2011 - and, for that matter, 2012.

Immelt attributed GE's 51% increase in fourth-quarter profit to an environment that "continues to improve," citing a 12% increase in infrastructure orders with equipment up 20% and services up 5%. He expects components such as transportation, healthcare and financial arm GE Capital to come on strong in 2011, helping to carry earnings higher throughout the year.

Meanwhile, Intel said it spent a whopping $9 billion on capital expenses after seeing a 48% rise in fourth-quarter profit.

"It shows me that management is serious about expanding leading edge manufacturing capacity and confident regarding demand and the ability to fill that newfound capacity," Wedbush analyst Patrick Wang told MarketWatch.

And JPMorgan's 47% pop in fourth-quarter earnings was good news for the financial sector - even with the other big banks delivering mixed results. JPMorgan reduced by 66% the amount it set aside for future losses. Another positive sign was the drop in customers late in paying on their credit cards, which fell to 3.6% from 5.52%. Perhaps most promising was the hint from Chief Executive Officer Jamie Dimon earlier this month that JPMorgan soon could raise its annual dividend to as much as $1 per share.

And while other major banks did not fare as well as JPMorgan, their reports provided some insight into the state of the U.S. consumer, which drives some 70% of the economy.

Indeed, just about every other bank mirrored the decline JPMorgan saw in late credit card payments, which means the U.S. consumer is coping better with debt. Likewise, the big banks reported fewer homeowners behind on their mortgage payments.

"I like technology and commodities, both with tight stops," said Money Morning's Gilani. "Financials have been laggards. They could be the New Year's bellwether. But play them cautiously; they still have skeletons in their closets."

Look for companies that cut enough to survive the recession without "cannibalizing themselves," Gilani says.

Companies that reinvest in their core businesses will be strong contenders. That shouldn't be too much of a stretch considering non-financial U.S. companies had $1.93 trillion in cash as of Sept. 2010, according to the Federal Reserve. That equates to 7.4% of assets - the largest share since 1959.

But the catch here is that the cash-hoarding strategy that has helped many companies weather the recession could backfire. The corporations that wait until they're certain the recovery is underway before cracking open their piggy bank will cede ground to quicker-acting competitors.

As for winning sectors in 2011, some clues may be found in 2010's strong performers. Last year's top performers were industrial materials (up 31%) and energy (up 13.8%). Both showed noteworthy strength in the fourth quarter, with industrial materials up 16.4% and energy gaining 15.5%.

[Editor's Note: For a more in-depth look at the stocks that will top the charts in 2011, check out the Money Map Report's "2011 Investor's Forecast Issue." This report is free for Money Map subscribers and contains all of the best prospects for the upcoming year - including an industrial-equipment maker whose stock is expected to surge more than 110% by the end of March. Click here to get the report.]

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About the Author

David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.

Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.

Dave has a BA in English and Mass Communications from Loyola University Maryland.

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