For stock market investors, everything outside of what companies earn is pretty much noise.
Profit reports for the January-March quarter will start to trickle in this week and they are sure to look good. That's because business is improving, but also because the economy was so bad last year that it won't take much for companies to post better numbers. What investors want to know now is whether companies can keep the good news coming.
The early recovery in earnings came from heavy cost-cutting. By shearing away expenses, companies could generate profits on far less business than before the recession began at the end of 2007. Then, the newly slimmed down companies got a boost from heavy government stimulus spending and record-low interest rates. Investors will be looking for signs that companies can continue to do better even after the government removes emergency supports and businesses do more than just replace depleted inventories.
"A major question on a lot of people's minds is, 'Well, what's the next act?'" said Stu Schweitzer, global markets strategist at J.P. Morgan's Private Bank in New York.
The forecasts that companies provide often are far more important than the earnings they report because investors are paying for stocks to get a slice of a company's future profits. Last week, the Standard & Poor's 500 index rose to an 18-month high on expectations that companies are getting stronger.
The estimated first-quarter earnings growth rate for companies that make up the S&P 500 index is 37 percent, according to analysts polled by Thomson Reuters. Investors will get their first taste of first-quarter profits when bellwether companies like Alcoa Inc., Intel Corp. and JPMorgan Chase & Co. report their results this week.
"How are we making the money?" said Mike Shea, managing partner at Direct Access Partners LLC in New York. "If we continue to improve productivity that's all well and good, but I think what we're looking for is are we making more things? Are we selling more things? Are more people working?"
Even if the news is encouraging, investors could still see a drop in stocks, at least at first. The stock market has tended to fall as earnings arrived in the past two quarters. Once most profits came in as well as expected, some investors figured stocks had run far enough.
In October, the S&P 500 index fell 5.6 percent after third-quarter earnings came out. In January, when results from the last three months of 2009 rolled in, the S&P 500 index lost 8.1 percent. The market resumed its climb once most of the earnings were released.
There are reasons to be optimistic that the coming quarters will show an important gain in revenue and higher profits. The best sign is that the government reported the economy added jobs in March at the fastest pace in three years.
Retailers have also been doing better than expected. The government reported last month that retail sales for February rose, even though analysts had expected bad weather in large parts of the country to keep shoppers away. And last week, retailers reported sales at stores open at least a year climbed more than expected in March.
Consumer spending is the biggest driver of the economy, and so an improvement there would spill over to a huge range of businesses.
Tim Speiss, chairman of the personal wealth advisers practice at Eisner LLP in New York, cautioned that consumers still will only be able to spend a bit more because it's harder to borrow money and because unemployment remains stubbornly high at 9.7 percent.
The pace of recovery in earnings all comes down to jobs, Speiss said, because without gains in employment consumers won't spend, and that means companies will find it hard to keep improving their bottom line — the most important thing that stock investors care about.
"It's all about how quickly we put a meaningful dent in the unemployment rate," Speiss said. "Where is the revenue growth going to come from when you know the American consumer has had a glass ceiling put on top of them?"
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