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S&P 500 Q3 Earnings Outlook: Optimism in ‘Unprecedented High-Risk Environment’

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Equity analysts for Standard & Poor’s on Wednesday presented a third-quarter earnings outlook that took note of a vast gap between their expectations for record double-digit earnings versus investors’ loss of faith in analysts’ optimistic earnings forecasts.

While S&P 500 corporations are expected to report healthy aggregate third-quarter earnings per share, for the eighth consecutive quarter of double-digit earnings growth, the theme for Q3 will be earnings in “an unprecedented high-risk environment,” said Robert Keiser, vice president with S&P Capital IQ Valuation and Risk Strategies Research, during an earnings outlook webinar.

The U.S. economy is not yet in recession, Keiser said, “but we’re getting a lot of mixed signals. Investors will often take the view that ‘this time things are different,’ but you have to admit that since 2008, many things about the economy are truly quite different. The performance of S&P 500 companies will tell us in aggregate whether the economy is entrenched in a recession.”

Sovereign credit contagion in Europe is feeding investors’ fear of a global run on banks, which government leaders must short circuit—both at home and abroad, said Keiser, who pointed to S&P’s downgrade this summer of U.S. debt.  “So long as Europe’s debt problems are unresolved, this uncertainty is not going to go away.”

Keiser’s other concerns for the U.S. economy include a lack of job creation, a weak housing market and a massive dilution of the money supply due to the Federal Reserve’s two rounds of quantitative easing.

That said, the analysts on the webinar pointed to S&P Capital IQ’s expectations for yet another banner quarter for U.S. stocks, thanks in part to surprisingly strong consumer retail sales, which have grown every month in 2011 except for May.

“We want to keep an eye on how the consumer contributes to GDP going forward,” Keiser said, adding that his economic outlook calls for 1.5% to 2% annual growth in gross domestic product. “We believe the market is fundamentally cheap right now,” he said.

Equity analyst Christine Short said earnings results have been a positive this year for the economy, but noted that S&P Capital IQ’s expectations on Tuesday of 13.47% average Q3 growth dropped to 13.02% overnight.

“This is still a robust number and our eighth consecutive quarter of double-digit growth in earnings,” Short said.

Financial companies are responsible for the lowered expectations, Short said, with a 12% drop in earnings anticipated since July 1 to 15% from 3%. The two primary culprits in the downgraded expectations for the sector are capital markets and insurance companies, with Goldman Sachs seen declining significantly since July. Bright spots for the sector include consumer finance companies such as American Express and commercial banks such as PNC.

Nevertheless, the analysts expect earnings of $24.95 per share in Q3 versus $25.44 per share  in Q2—which was an all-time record earnings season. Barring a massive global crisis, S&P Capital IQ predicts earnings will hit $30 per share by the end of 2012.

The problem, though, is that the stock market is not tracking those optimistic earnings expectations, Keiser conceded.

“Investors who don’t believe in the future are voting with their pocketbooks and exiting the stock market,” he said. “So we’re seeing record earnings, yet investors lack confidence in this environment and are seeking safe havens out of stocks. Clearly, investors are pricing in something closer to recession.”

Separately, S&P Indices announced Wednesday that dividend increases rose 17.1% during Q3 2011, with 350 issues increasing dividends versus the 299 that did so during the third quarter of 2010. Of the approximately 7,000 publicly owned companies that report dividend information, only 23 decreased their dividend payment during the third quarter of 2011 versus 35 this time last year.

“Dividends continue to battle back, adding 14.5% to their indicated rate this year, but still 6.8% shy of their all-time June 2008 high,” said Howard Silverblatt, senior index analyst at S&P Indices, in a statement. “Payout rates, which historically average 52%, remain near their lows at under 30%, with strong cash flow giving companies considerable room to increase payments. Part of the reason for the low payouts appears to be the uncertainty over the economy, which prevents companies from making long-term dividend commitments.”


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