Under the surface, corporate earnings aren't quite as impressive as the headlines suggest

For the fourth quarter, expected earnings growth

drops from 32% to just 11%

if financials are excluded.

(U.S. Stock Market Built on Financials' Mark-to-Model)

By Kelly Evans
The Wall Street Journal
10/26/10
The third-quarter earnings season has helped the stock market find its footing again. But a solid foundation still is lacking.

About a third of S and P 500-stock index companies have turned in earnings, and the results once again look impressive. As of Friday, 83% of companies topped consensus earnings-per-share estimates, according to Thomson Reuters, which, if it holds, will be the highest proportion since 1994. Overall earnings are on track to rise 28% from a year ago, the fourth straight gain after nine prior quarters of decline.

While earnings activity peaks this week with results due from some 177 companies, only major misses from blue-chip companies at this point are likely to break the market's upward momentum. The S and P 500 has gained nearly 3% since Alcoa unofficially kicked off the season Oct. 7, extending its run since late August to an impressive 13.5%.

But that surge isn't really about this quarter's earnings. Recent economic data also have improved, and the Federal Reserve is expected to announce additional bond-buying measures at its Nov. 2-3 meeting to stimulate the U.S. economy. Bulls are further salivating over the fact that the S and P 500 last week formed a "golden cross," the 50-day moving average punched above the 200-day moving average, usually a bullish sign.

Skeptics, however, can be forgiven for not breaking out the champagne. The market's recent behavior looks eerily similar to its prior 15% run-up from February through April. That episode didn't end well. This one may not either.

Under the surface, corporate earnings aren't quite as impressive as the headlines suggest. Much of the overall growth has come from the financial sector, helped by its weak performance a year ago. Yet the foreclosure problems and concerns over future profitability recently have roiled those shares.

Exclude financials, and year-on-year earnings growth falls below 21%. The average "surprise" margin, by which earnings beat estimates, falls from 9% to 6.5%. Meanwhile, for the fourth quarter, expected earnings growth drops from 32% to just 11% if financials are excluded. Revenues for that period are seen up just 6.3%, excluding financials. That is hardly disastrous. But given growth is likely to slow further, it weakens the basis for a more lasting rally.

Thanks to Kelly Evans for a realistic delivery of data as it is a refreshing change!