Rally without reason

NEW YORK - Wall Street's stunning reversal this past week - going from a nearly 150-point drop in the Dow industrials Tuesday to an astonishing 283-point surge two days later - looks like a rally without reason.

Painful as that drop Tuesday was, it made sense. Earnings warnings from the likes of Home Depot Inc., Sears Holdings Corp., and homebuilder D.R. Horton Inc. sent stocks tumbling and frayed investor confidence.

But little - if anything - had changed when stocks thundered higher, carrying the Dow and Standard & Poor's 500 indexes to new closing records. The outlook for second-quarter earnings reports, which won't start in earnest until the coming week, still was quite uncertain, making that huge rally a little hard to explain.

Some analysts say the advance had nothing to do with investors' expectations for earnings, and call it a case of panic buying, where investors buy simply so they won't be left on the sidelines. That led them to overlook the bad news of the week, and not worry about what the next few weeks might bring.


But that leaves critical questions to be answered: Just what does the market expect from earnings season? And, if the results don't meet those forecasts, will investors decide this past week's rally was based more on foolhardiness than fundamentals?

Projections for the second quarter indicate that profits increased at a slower pace due to rising interest rates globally, and the continued drag from troubled areas such as the housing and automobile sectors. Members of the S&P 500 are expected to show profit rose 4.1 percent from last year's second quarter, according to Thomson Financial.

This would be the slowest growth since the second quarter of 2002, just before companies began a nearly four-year burst of double-digit earnings growth.

But what investors really want to know is whether companies might spring some surprises - and perhaps beat expectations.

"I think investors are anticipating earnings to be moderately good," said James Simos, a principal with Oakland, Calif.-based Infinity Financial Services. "But, right now the question is if analysts on Wall Street have been so conservative that they are getting it wrong."

Indeed, during the first quarter, analysts originally expected earnings would grow by 8.7 percent year-over-year, according to Thomson. But, as the start of first-quarter earnings season grew closer, mounting concerns about corporate profits caused them to adjust that forecast downward to 3.3 percent.

The estimates have been growing increasingly conservative each quarter - and that was the case during the first quarter. After all the results for the S with fewer shares outstanding, earnings per share goes up.

S&P 500 company buybacks in the second quarter are expected to smash the $117.7 billion record set in the first quarter. And, just this past week a number of that index's biggest drivers announced billion-dollar buyback offers - including Yum Brands Inc., Johnson & Johnson, ConocoPhillips, and Home Depot Inc.

Jennifer Ellison, a portfolio manager with Bingham, Osborn & Scarborough, said most investors have already factored in that corporate profits will be on par during the quarter. Only a real unexpected erosion of second-quarter earnings would likely be able to curb investor appetite for equities - and so far, including the warnings issues from a few companies this week, there has been no indications that will happen.

In fact, on Friday General Electric Co. said second-quarter profit rose 9.6 percent to beat Wall Street projections. The conglomerate also increased its stock buyback plan, sending shares to a five-year high.

Wall Street responded by extending the week's gains - sending the S&P 500 past a trading high set more than seven years ago, and the Dow past 13,900 for the first time.

"We're in an environment where gross domestic product is growing and the dollar is falling, which is good for multi-national companies," Ellison said. "Earnings are in good shape, and there's not a big worry they'll put an end to the market's rise."