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June 25: Will Earnings Live Up to Expectations?

Zacks Equity Research

We seem to be on track for a positive start in the stock market today, with growing hope that the Chinese authorities know what they are doing in dealing with that country’s interbank funding issue. But a positive start doesn’t mean much in the current volatile backdrop, particularly given today’s data-heavy economic calendar.

The hope going forward is that the market will finally start reflecting real economic and corporate fundamentals in the post-QE world. Markets have to come around to the notion that less QE is not a sign of a hawkish Fed, but rather a vote of confidence in the economy’s vitals. This morning’s strong Durable Goods orders report confirms that the Fed is justified in taking a more sanguine view of the economy.

We have plenty of housing related on tap for release a little later. But if the Lennar (LEN) quarterly earnings report this morning is a sign of things to come, then we are likely in good shape on that front as well. There is some justifiable anxiety in the market that the rising bond yields could become a problem for the housing recovery. The Lennar earnings release quotes the company’s CEO that they are not seeing any negative signs on that front.

It is understandably unsettling for investors to envision a world without QE, but the prospect of a market without the Fed training wheels is a net positive, in my view. The adjustment process will be bumpy and some of the ground realities, like corporate earnings, may not be in-sync with where markets stand at present, causing stocks to lose further ground. The resultant volatility of this adjustment phase notwithstanding, this is a healthy process. Investors have been on an extended vacation from reality, in which the QE-inspired rising tide lifted all stock market boats.

The second quarter earnings season about to get underway in a couple of weeks will give the markets a good look at the true health of corporate profitability. Expectations for Q2 earnings are low enough that companies will easily come ahead of them. Current expectations are Q2 earnings to be up +0.5% on modestly lower revenues.

But consensus estimates for the second half of the year and next year reflect a strong rebound in earnings growth. Total earnings in 2013 Q3 are expected to reach a new all-time high, up +5.2% from the same period last year, while Q4 earnings are expected to up +13.2%. With margins already topped out and revenue gains hard to come by in a growth-constrained world, it is hard to envision these expectations holding up. Negative estimate revisions didn’t matter much in the QE world, but it is reasonable to expect that not to be the case without the Fed support.

Read the analyst report on LEN

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