Lame Expectations: Can Stocks Withstand Weak Earnings?

Jeff Macke

Earnings reports for the third quarter get cranked up tonight, and the picture isn't pretty. Consensus estimates are for a decline of anywhere from 1% to 3% year-over-year — the first such decline in nearly three years. Combined with GDP expectations dropping both here and abroad and the already bleak economic picture growing darker, investors are asking themselves if the U.S. is on the cusp of a recession and whether or not stocks can hold up to what looks like a full month of bad tidings.

The Reformed Broker Josh Brown doesn't trust pundits who are claiming bad news is in the tape. "We don't know how this market's going to react to its first down earnings quarter since 2009," Brown says in the attached video. As for a recession itself, Brown says anything below 3% GDP growth suggests economic contraction.

On average stocks fall 25% to 35% during economic contractions; making The Recession Call a cottage industry all of it's own. Sadly these calls seldom add trading value since: a) economists are usually wrong; and b) recessions are defined six months after the fact, by which time your portfolio is already apt to be trashed.

So if you think earnings season is going to be a wreck and a recession is coming should you run screaming from the market? "For most people the answer is no," says Brown. If you plan to make any tweaks, he suggests moving out of sectors subject to the darkest downside revisions and into non-cyclical names — that means out of tech and into health care.

Brown's taking his cues for the rest of the year from the guidance in the conference calls. With China slowing much faster than the soft-landing camp had expected and Europe at least as bad as feared, the numbers still seem too high, even after the lowered guidance.

If past is prelude, weak reports for Q3 are already understood, but the stocks aren't going to have an easy time shaking off warnings for the Q4. The fun starts tomorrow after the bell with Alcoa (AA). Buckle up, things are going to get a little bumpy.

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