Weaker Profits Mean Stocks Will Go Into Reverse

Despite of what you’ve been hearing from the mainstream financial media, corporate earnings reports for the first quarter of this year haven’t been nearly as positive as you might believe.

For example, reporters and journalists on broadcast financial shows raved about Goldman Sachs’ first quarter earnings report this past Tuesday. The company announced that its net earnings rose 91 percent during the quarter ended March 31, 2010, compared to the same period a year ago.

Those same reporters failed to mention that Goldman’s operating expenses rose sharply and that the company would have likely reported a net loss during the quarter — if Goldman’s securities traders hadn’t been so successful in earning substantial profits on the company’s securities transactions.

The media also failed to mention that Goldman's net earnings declined 30 percent during the quarter ended March 31, 2010, compared to the prior quarter. This decline resulted, in part, from a drop in investment banking revenues of 28 percent. Revenues from asset management services declined by 16 percent.

In a similar fashion, the mainstream media commented positively on Bank of America’s first quarter earnings, and the fact that the nation’s largest bank handily beat the average earnings estimate provided by Wall Street analysts.

What the stock market pundits didn’t discuss is the fact that Bank of America’s diluted earnings per share declined 36 percent and that the bank’s income from its commercial banking activities fell sharply during the quarter ended March 31, 2010, compared to the same period a year ago.

Looking closer, you’ll see that Bank of America’s income from its credit cards business fell 31 percent while its income from mortgage banking activities declined a whopping 48 percent compared to the same quarter a year ago.

The first quarter earnings from non-banking companies also have been disappointing.

For example, General Electric’s net earnings for the first quarter of this year fell 31 percent while its earnings per diluted share declined 35 percent. Revenues fell to $36.6 billion from $38.4 billion and new orders for the company’s products declined 8 percent compared to the same period a year ago.

Although certain companies that operate in the technology sector of the economy reported increases in their first-quarter earnings, many of those same companies reported very modest growth in their revenues and stated that they now expect revenues to increase at a slower pace than Wall Street analysts currently estimate.

Meanwhile, revenues rose only 7 percent, on average, during the quarter ended March 31, 2010, for the 116 companies in the Standard & Poor’s 500 Index that have reported first-quarter operating results thus far.

The fact is that most companies faced relatively easy year-over-year revenue comparisons during the past quarter due to the worldwide economy experiencing the worst recession since the 1930s. But that doesn’t mean the economy is really getting better.

In fact, a modest, 7 percent increase thus far in corporate revenues suggests that economic conditions aren’t improving to anywhere near the degree that most Wall Street analysts and economists would have you believe.

Such a modest rise is, in reality, a significantly negative development.

Most companies in the United States have already reduced their operating expenses to near the lowest level possible. Given that corporate profits equal revenues less expenses, my research and the developments mentioned above suggest that corporate profits will grow at a very slow pace, at best, during the next few quarters.

That’s important, if it happens I expect, since stock prices are ultimately determined by the profits of their underlying companies.

I therefore expect stock prices in general to pull back sharply within the next couple of months.

If you’re interested in learning how to profit from a substantial decline in stock prices, I encourage you to try a trial subscription to my investment newsletter, The ETF Strategist.

About the Author: David Frazier
David Frazier is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He also writes two very successful investment newsletters. Discover more by Clicking Here Now.