With the flood of earnings reports received in the last two weeks, it may be hard to believe that we are only half way through the third quarter reporting period.   Alas, that is where we stand -- or maybe we should say "where we kneel."

A market that had been running strong is down on bended knee at the moment having gotten the wind knocked out of it by a litany of companies reporting the effects of weak demand.

That message has resonated in top-line results that suggest central bank policies have done more to lift asset prices than they have done to lift the real economy.

To illustrate this point, we are showcasing the third quarter results reported so far by members of the Dow Jones Industrial Average -- results that have effectively recast their domain as the Dour Jones Industrial Average.

The Chosen Ones 

The companies in the Dow Jones Industrial Average are selected by the Dow Jones Averages Index Committee based on the idea that they are representative of the economic activity that takes place in the United States. 

That distinction is why the companies are pulled from a variety of sectors that include financials, industrials, consumer staples, consumer discretionary, health care, information technology, telecom services, energy, and basic materials.  That is also why industry leaders in these respective spaces are tapped for inclusion.

Dow 30 companies are large in size, typically have international exposure, and are widely held by retail and institutional investors alike.  These 30 stocks are not "the market," yet they are often thought of in that way.  The S&P 500 has a much bigger roster of companies that fits the bill of being "the market." 

Still, the operational performance of the Dow 30 components is followed closely as a gauge of global business conditions and investor behavior.

How Now Dow?

So far, 23 of the 30 Dow components have reported their results for the September quarter.  The prevailing message in those results is that demand is weak right now. 

Source: S&P Capital IQ; Company Reports

Table Summary

• Excluding debt valuation adjustments for JPMorgan Chase and Bank of America, revenue growth for the 23 companies out with their results has averaged just 1.1%.
• Only 5 of the 23 companies that have reported -- Boeing, Johnson & Johnson, JPMorgan Chase, United Technologies, and UnitedHealth -- have reported revenue growth in excess of 5.0%.   
• The average growth in diluted earnings per share for the 23 companies that have reported is 8.0%. 
• A 180% gain in Travelers' EPS has skewed the diluted EPS growth average; nonetheless, it is evident that cost-cutting, and not sales growth, has been the dominant driver of earnings per share growth in the third quarter.
  • 9 of the 12 companies reporting an actual increase in revenue reported higher EPS growth, which shows the effect of other factors such as cost-cutting and share buybacks in boosting EPS.
  • 3M, AT&T, IBM, Merck, and Procter & Gamble all reported a decline in revenue but an increase in diluted EPS. 
• Boeing, Johnson & Johnson, and United Technologies reported revenue growth that exceeded EPS growth.  Gross margin for each of these companies was lower than the year-ago period.
• Boeing, which has limited exposure to Europe (14% of sales), and UnitedHealth, which has no exposure, have reported the strongest revenue growth (JPM excluded).
• Only 3 of the 7 components that have yet to report their results -- Cisco, Wal-Mart, and Walt Disney -- are expected to report a yr/yr increase in revenue.
• Pfizer, pressured by the loss of patent protection for Lipitor, is expected to show the largest decline in revenue among the 30 Dow components.

What It All Means

Since Dow component Alcoa reported its results after the close on October 9, the broader market and the Dow have struggled to move higher.  The S&P 500 is down 2.1% since then while the Dow has dropped 2.7%.

Those aren't major declines by any means, although the market has shown a tendency in the past to rally in the early part of the reporting period as companies have rolled in with earnings results ahead of lowered expectations and, importantly, reassuring guidance.

We're still seeing more companies beat earnings estimates on the bottom line than miss, but the top line in most instances has been lacking.  Guidance has been lousy.   

The latest data from Thomson Reuters indicates 63% of the 272 S&P 500 companies reporting so far have topped earnings expectations, but that only 37% of companies reporting revenue have beaten estimates that were already extremely low (-0.1% in aggregate at the start of the reporting period).  Meanwhile, the negative to positive pre-announcement ratio for the fourth quarter is a whopping 9.3, which is the highest on record dating back to 1996.

The fourth quarter earnings growth estimate for the S&P 500 has been cut to 8.2% from 9.9% on October 1 and from 13.9% on July 1. 

If the dour nature of the earnings reports so far continues, analysts may yet have more cutting to do.

Either way, what we have heard from most of the Dow components this reporting period has made it clear that Europe and the fiscal cliff uncertainty are major headwinds and that the economic boost the Fed is banking on with QE3 is threatening to be a bust.

Demand is weak and it is evident in the top-line results from leading blue-chip components.  Companies will be hard-pressed to keep growing earnings with little to no revenue growth if they can't find a way to boost profit margins that are already near record highs.

The earnings slowdown and the message of weak aggregate demand in spite of central bank stimulus are risk factors that should not go unappreciated.  

--Patrick J. O'Hare, Briefing.com

Notes:

(a) Excludes DVA and FVO adjustment; including DVA and FDO, total revenue, net of interest expense, down 28.0% yr/yr
(b) Excludes effect of $273 mln pre-tax gain from sale of majority interest in CAT's third party logistics business
(c) Excludes effect of preferred stock redemption
(d) Includes recently completed acquisition of Synthes, Inc., which contributed 5.8% to worldwide operational sales growth
(e) Excludes DVA; including DVA, revenue up 6.0%
(f) Results reflect loss of market exclusivity in U.S. for SINGULAIR in August 2012 (SINGULAIR sales down 55% yr/yr in 3Q12)
(g) Excluding deferred revenue, revenue down 7.9% yr/yr
(h) Loss of patent protection for Lipitor at the end of November 2011 is weighing heavily on top line
(i) Lower catastrophe losses and higher underlying underwriting results helped fuel large yr/yr increase