Q2 Earnings Outlook

Despite the latest developments of IndyMac’s meltdown and the ongoing viability issues facing Fannie May (FNM) and Freddie Mac (FRE), we shouldn’t lose focus on the fact that our credit system, though currently under significant pressure, it’s not broken. The distinction is important.

While share prices are suffering as investors remain concerned how the persisting credit crisis may affect the fragile state of the economy, the truth is: economic growth is far stronger than generally perceived. The economic reality is that most of the damage is concentrated only in one single sector – that of financials, which is down almost 35% on a y/y basis, and continues to be the biggest drag on earnings (particularly in the financial sector) and the market in general.

Since on the subject of earnings. The first wave of second-quarter earnings reports will be released over the next few weeks. Including reports of seven components of Dow Jones industrial average and 53 members of the Standard & Poor’s 500 index.

According to AP – earnings for all the companies in the S&P 500 index are forecast by the rating agency to be down 10 percent from a year earlier.

Thomson Financial, which compiles forecasts from analysts at banks and brokerages, estimates the decline at 13.5 percent.

Regardless of these number, all is not expected negative. The Tech and Health Care sector are projected to report growth in the mid 15% and 12% level, respectively. Excluding financials, with a significant majority of the firms posting EPS’s drops of more than 10% – earnings are expected to rise 9%. Much of that gain as you guessed it – is attributable to strength in the energy sector expected to post 21% y/y growth.

If we strip energy and financials ; earnings are expected to rise more than 3.4%. The following quotation also supports these estimates.

If you remove the financials, Thomson forecasts the companies in the index would post an average earnings growth rate of about 9 percent; and if you remove financials and oil, the rest of the S&P 500 would have a 4 percent profit growth rate.

Considering what the market has endured over the past three quarters, from the sub-prime crisis, talk of recession/depression, a housing market dragging the consumer into the abyss and the prospects of a financial market ready at any time of seizing up – having a 3% floor projection earnings’ growth, with a real GDP expansion annual rate of more than 3.1% ; objectively speaking as opposed to euphorically – merits compliments to the resiliency of the U.S. economy. It may be down at times, but always finds a way to fight back.

On a separate note: the market seems currently due for bounce as it is significantly oversold. During the past month and a half, the NYSE Advance/Decline Ratio has averaged a mere 0.35.

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