Another Sharp Market Drop? Not Likely

The midsummer stream of earnings reports from major companies is refreshing, and so is the market's reaction to them. So far, July's quarterly results are sweet enough to reassure you that neither the economy nor the indexes are on the verge of backsliding, and they've helped push the Dow above 9,000. Some 61% of the companies in Standard & Poor's 500-stock index to report for the quarter beat analysts' forecasts.

Some reports even point to a revival of retail spending. Apple sold a slew of iPhones, and even shares of Starbucks, that erstwhile symbol of excess consumption, soared 18% July 21 after the coffee company announced it had beaten analyst profit predictions by a nickel. We'll get a better handle on consumer spending when key retailers, such as Target and Wal-Mart, report in mid August.

Investors have been anxious since May about the quarterly reports -- not so much about profits (which are easily massaged), but sales. A bunch of big companies, however, such as Apple, IBM, Intel, Johnson Controls, M&T Bank and Merck, have reported strong sales and improved outlooks for this year and next. That, says Fred Fraenkel, chairman of investment policy for Beacon Trust Company, is more significant than profits. When companies' sales are strong, management won't be so quick to lay off people or cut overhead, and that bodes well for the economy. Healthy sales are also generally a prerequisite for analysts to issue an upgrade.

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Some other earnings reports show that another key segment, manufacturing, is doing okay. "The industrial sector is doing fairly well now, given the speed that the economy went down," says David Francis, head of the stocks team at Thrivent Asset Management, in Appleton, Wis. "In fact, in the first couple of weeks, most of the surprises are to the upside."

Rough spots do remain. Housing and construction-related companies, such as Sherwin-Williams and Whirlpool, are suffering. Both issued poor results for the most recent quarter, and they aren't optimistic about a turnaround. Banks are still confessing that more of their loans to homebuilders and developers are going sour.

Still, the news is good enough to rule out a 2009 echo of that "end of the world" market crash during the last few months of 2008. It's beginning to look as though Standard & Poor's 500-stock index, which closed July 24 at 979, could be above 1,000 points by year-end. A finish at 1,000 would work out to a 11% gain for the S&P in 2009, not counting dividends, and a 50% recovery from the low of 667 on March 6. Here's a quick review of the summer's earnings so far, by sector:

Banks and financials. They did start the fire, to borrow from Billy Joel, so they need to extinguish it. However, so far the earnings reports from banks are decidedly mixed. Here's one way to think about banks and their impact on the economy: When banks' ratio of delinquent loans starts to fall, or at least stops getting worse, that will signal an end to the bleeding.

So far, according to the Federal Reserve Board, the rate of charge-offs for bad loans at the 100 largest U.S. banks is still rising, but not as fast as it did in 2007 and 2008. That rate has to drop before the world will fall in love again with bank stocks -- especially after so many have cut their dividends. Fortunately, financial stocks are only 12% of the overall stock market now, down from more than one-fourth before the collapse.

Technology. IBM (symbol IBM) and Intel (INTC) are as responsible as anyone for July's blue-chip rally. On July 16, IBM crushed analyst earnings estimates of $2.02 a share when it announced $2.32 for its second quarter. Intel's July 14 announcement was more of a mixed bag, but it did point to a growing demand for laptop computers. The market needs the two companies to keep up the good work for the rest of the year.

Energy. In this earnings season, energy is a sideshow. Low natural-gas prices and low demand for oil and coal mean that for all their enormous profits, ExxonMobil (XOM) and Chevron (CVX) aren't going to lead the entire stock market higher -- or lower -- for a while. Eventually, if energy prices go up to reflect a recovering world economy, you'll see these stocks boom.

Manufacturing. Military contractors, such as Lockheed Martin (LMT) and United Technologies (UTX), aren't doing well, but there are some stars in the manufacturing sector. 3M (MMM) said on July 23 that sales revenues won't decline as badly in 2009 as it previously thought. 3M's wide range of businesses makes its results always worth watching, even if you don't own the stock. While 3M's earnings were down 17% in the second quarter, it beat analyst expectations and raised earnings guidance for 2009.

Consumer. Reports from retail chains generally come last in the earnings season because stores run on a January-April-July-October quarterly schedule. This allows them to account for Christmas shopping as well as the subsequent returns and clearance sales in a single quarter. But even when reports do come in, don't look to retail sales as a major bellwether for the recovery.

Consumers have other priorities right now. For instance, many Americans plan to save more, rebuild their retirement accounts and pay off debts. It will be up to technology and manufacturing, with an assist from finance, to lead the market from here. For now, you could say they're warming up.