After a rough second quarter, corporate financial results will be weak. Investors will be listening closely to executives for signs of hope in the future
Entering the crucial midyear earnings season, investors are a befuddled bunch.
Financial markets—much improved from four months ago—suggest the economy is stabilizing and could recover soon. But corporate profits continue to fall, and more and more Americans are losing their jobs.
That's why, investors say, they'll be listening very closely as companies unveil second-quarter results—and not just to the results themselves, but to what executives say about the future.
"What the market wants to hear out of Corporate America is that perhaps things are getting better," says Peter Cardillo, chief market economist at Avalon Partners. "Is the mood shifting toward a more positive outlook?"
Not a Great Start
Alcoa (AA), traditionally the first major U.S. concern to release results each quarter, said July 8 that earnings fell from 67¢ per share a year ago to a loss of 32¢ last quarter. Revenue dropped 41%.
There's certainly nothing to celebrate in those results, but attentive investors could detect a slight shift in tone.
In a July 8 call with analysts, Alcoa Chief Executive Klaus Kleinfeld described how the giant aluminum producer is first in the supply chain of a number of industries. "So, we see some changes … at an early point in time," he said.
Thus, Alcoa sees "early signs of a cyclical downturn" in aerospace, he said. But there is some hope in the automotive, heavy trucks and trailers, and beverage cans industries.
"So overall, the global environment for 2009 clearly remains challenging, but I believe we do see some pockets of growth—like in China—and signs of stabilization in the U.S. in automotive and beverage cans in general," Kleinfeld said.
It's not just big companies that can be economic barometers.
Another early reporter is WD-40 (WDFC), the maker of a wide variety of lubricants and cleaning products. Talking to analysts on July 8, WD-40 Chief Executive Garry Ridge gave his view: "We … anticipate that the U.S. economy will recover slowly as many international markets experience a continued economic slowdown," he said.
Reports Add Up to Data
One by one, these reports may help investors settle the debate about whether, and how quickly, the economy can recover.
"Each one of these reports is a data point that tells you what at least that executive in that industry sees in the near term," says William Rutherford, president of Rutherford Investment Management. "If you add up enough of them, you can get some sense of where things are headed."
But, obviously, different companies will offer different views of the future. Rutherford says he'll be closely examining the outlook for financial firms. "Are they cleaning up their mess?" he asks.
Some executives are popular bellwethers for investors because they speak plainly and have a reputation for honesty. Rutherford puts John Chambers, the chairman and chief executive of Cisco Systems (CSCO), in that category. "If he says things are looking up, I'll be happy," Rutherford says. Cisco reports results on Aug. 5.
Eye on the Service Sector
John Merrill, chief investment officer at Tanglewood Wealth Management, warns against reading too much into guidance and comments from industrial CEOs. After slashing production in late 2008, manufacturers may need to boost production in order to replenish inventories. "But it's really an inventory turn, not a turn in the whole economy," he says.
Instead, he's watching service-sector companies, like FedEx (FDX) or United Parcel Service (UPS), that don't have inventory. "They're probably our best eyes and ears on what's happening in the economy today," Merrill says.
UPS reports its earnings on July 23. FedEx reported results June 17 for its quarter ended May 31. At the time, FedEx Chairman and CEO Fred Smith said, "We do see signs of stability as the rate of decline appears to have leveled off."
One place where signs of stability haven't materialized is in the labor market. Companies continued to cut payrolls in June, as employment fell 374,000 and the jobless rate climbed to 9.5%.
"Corporate America is still on the skittish side in terms of employment," Cardillo says.
How Much More Job Cutting?
The tone of second-quarter earning season could reveal how much execs intend to continue cutting jobs in the third and fourth quarters. At companies focused on the U.S. consumer, results and the outlook of executives could give important clues to how job losses are affecting the mood of consumers, Rutherford says.
One early indicator was Ruby Tuesday (RT), which on July 7 reported mixed results. The rate of decline in same-restaurant sales slowed, to 3.2% in the quarter ended June 2, from a 6.8% drop the previous quarter. But Chairman and CEO Samuel Beall hardly sounded optimistic about the economy. "Without a doubt, the environment remains difficult and very uncertain," he told analysts.
Consumer moods can be volatile. Tanglewood's Merrill says he'll be watching "nondiscretionary" firms, like health care and utilities companies. "Those companies [provide] a more fundamental look at the underlying economy," he says.
The Importance of Looking Longer-Term
By overseeing their companies' day-to-day operations, executives have a closer look at economic trends than many investors or Wall Street analysts. That's what makes their insights valuable.
But trying to predict the immediate future can be a difficult game for investors, says Don Wordell, portfolio manager of the RidgeWorth Mid-Cap Value Equity Fund (SMVFX). From quarter to quarter, "It's noise," says Wordell, who tries to look out 18 months to two years in the future. "You've got to look out over a longer period of time."
Earnings season will provide investors with important clues to where the economy and corporate profits are headed. But, as the last two years have shown, the outlook can change very quickly.