Second quarter earnings reports begin today with Alcoa’s report after the close. Most companies will post earnings higher than analysts' estimates, as happens every quarter. Aggregate earnings will post a solid increase. Yet, the overall earnings trend will be of a lackluster corporate performance. An earnings season rally is less likely than usual.

Expectations

Second quarter earnings for the S&P 500 in aggregate are expected to rise 6% compared to the same quarter last year. That would be similar to the 8% increase in the first quarter, but down from the 14% gain posted for all of 2011.

In itself, a 6% earnings gain is good. Over the long term, all else equal, that would produce an annual 6% gain for the S&P 500 index.

The problem this quarter is twofold. First, the vast majority of companies are going to post meager gains or losses. Second, the outlook for profits in upcoming quarters will be more uncertain and risky than it has been in years.

A Bias to Total Earnings

The decent 6% gain in total earnings expected for the S&P 500 is largely a function of a strong gain for Bank of America and the financial sector. A year ago, Bank of America and some other financial firms posted large losses. The absence of those losses this year produces an increase this year.

Here are the profit forecasts compiled by Thomson Reuters for the ten S&P 500 sectors.

As can be seen, most sectors are expected to post modest increases or declines. That means that a large number of companies will report lackluster earnings growth.

Analysts have lowered estimates sufficiently (as happens every quarter) so that over 60% of companies will come in ahead of the average earnings forecast, but that won’t hide the fact that earnings growth for most companies will be poor.

Here is a list of earnings forecasts compared to the same quarter last year for selected major firms:

Admittedly, this is a selective list. There are other companies that will post some large earnings gains. Google and Apple in the technology sector will post very strong gains, and IBM is likely to post 10% earnings growth. Wells Fargo in the financial sector will post a double-digit gain, as will some industrial firms.

But this list shows just how sluggish earnings growth is for numerous large companies.

Commodity-based firms, such as Alcoa and ExxonMobil, will post earnings declines.

International businesses with operations in Europe are suffering, as evidenced by weak trends for 3M and American Express. Even key technology companies such as Intel and Microsoft are forecast to post profit declines.

In good times, it isn’t just the select few that post earnings gains – the gains are broad-based by sector and the rising tide raises all large multinationals.

That isn’t going to be the case this quarter. The overall solid earnings growth will be the result of strong gains by a few select companies.

This will be the second quarter in a row that this has been the case. In the first quarter, overall earnings growth was due largely to Apple. This quarter, Apple will again be key, boosted by the accounting anomaly impacting the financial sector.

Earnings Guidance Will Be Extremely Cautious

Another factor that will dampen enthusiasm for any overall earnings gain will be that a lot of companies will express concern about the outlook for earnings.

There is simply too much uncertainty globally for many companies to present a confident, positive outlook for earnings for the rest of the year.

Europe is in recession. Economic growth in China is slowing. Now, it is clear that US economic growth has also slowed significantly.

The wide swath of companies with sluggish second quarter earnings will understandably be anxious about the near-term outlook. That anxiety will be evident on conference calls and the stock market is unlikely to get a boost from the typical hockey stick forecasting (flat now, shooting higher in a quarter or two) from CEOs and analysts.

Most CEOs will prefer, quite understandably, not to make promises that they can’t keep given the widespread uncertainty globally.

It is not difficult to predict that corporate guidance in the upcoming conference calls will be extremely cautious and hedged. Any whiff of anything worse could lead to a selloff in that company’s stock price.

A Digression

From an investor standpoint, there is also an additional concern that will weigh on sentiment in the months ahead:  political uncertainty is very high.

The US elections could well retain bi-partisan rule. That will produce an extremely difficult environment for addressing the fiscal cliff issues that hit January 1, 2013.

Tax rates for dividends, capital gains, and income are all set to rise at the start of next year, barring any action from Congress and the president. It is highly uncertain how this will be dealt with by a new government after the elections. There are also higher capital gains and dividend taxes for high income earnings slated to take effect over time from the Patient Protection and Affordable Care Act recently ruled constitutional by the Supreme Court.

Regardless of the political or redistributive value of these taxes, there is no doubt that higher taxes on investments will reduce the value of investments. The uncertainty over future investment taxes will weigh on stock prices in the immediate months ahead.

What It All Means

Normally, earnings season brings the prospect of a market rally. This is sometimes due to earnings coming in stronger than expected (as happens almost every quarter after estimates drop). Sometimes it is called a “relief rally” because the markets are pleased that the news was not worse than expected, and better times are hoped for in coming quarters.

This quarter the chances of any significant earnings-based rally are lower.

In recent weeks, the stock market focus has moved very quickly. One day, the markets are focused on Spanish bond yields. The next day the markets rally on some announcement out of Europe, only to turn completely away from that topic to something new the very next day.

There will be a focus on corporate earnings over the next four to five weeks. Yet, behind it the continuing concerns over the credit crisis in Europe and global economic growth will persist.

Earnings will be decent and probably won’t cause a broad-based sell-off. But the prospect of a market rally in response to the reports is much lower this earnings season than in typical quarters.

Dick Green

Founder and Chairman, Briefing.com