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The Great Disconnect: Awful Earnings vs. a Hot Stock Market


A week from today, when Alcoa (AA) officially kicks off third-quarter earnings season, analysts who know the company best are expecting the aluminum producer to report a penny per share in earnings on $5.6 billion in sales. That's down sharply from $0.15 per share and over $6.4 billion in revenues that it delivered in the Q3 last year.

Given that Alcoa — the smallest and second worst performing stock in the Dow Industrials over the past year — has already been punished for its lackluster results, some might argue that it is poised for a pop. The bad news, so to speak, is already in.

But there's only one problem: Alcoa's projected plunge is not an island of strife, it's part of a bigger crisis. All totaled, more than 80% of Q3 earnings pre-announcements have been negative, a rate that Jeff Kleintop, chief market strategist at LPL Financial, says is not only running at more than double the historic norm, but is a key factor in why he thinks we're looking at the start of a "global profit recession" that is going to see estimates come down.

As we discuss in the attached video, Kleintop cites three reasons why he thinks we're about to see the worst quarter for earnings in three years. Chief among them is his call that manufacturing is stalling, despite Monday's better-than-expected ISM Manufacturing report.

"Everywhere you look we're seeing declines now for the first time in three or four years, back to a recession in profits," Kleintop says, pointing out the negative profit outlooks that exist for markets in Europe, Asia, and the U.S. While we have gone into earnings seasons with negative expectations more recently, the tendency for companies to post better-than-expected results (a.k.a. to beat the street) helped avert that situation in recent quarters.

* Related: Is The Manufacturing Snap-Back For Real or a False Positive?

Kleintop is also on watch for any erosion in profit margins, pointing out that "companies have already cut costs to the bone." As he sees it, there is a limit to the amount of time that corporate America can deliver double-digit profit growth while revenues are barely moving.

Finally, Kleintop says he's looking out for the unspoken side of share buybacks or repurchase programs. Of particular interest to him are companies and industries that are able to come through with positive earnings growth, via a few pennies of better-than-expected EPS, at a time when their net income is shrinking.

As he sees it, traders may be focused on policy events like the easing authorized by the Federal Reserve and ECB, but "what matters most to investors" is long-term earnings growth.