St to look for subprime surprises in results

NEW YORK: Just as earnings season hits full swing next week and investors get their first full taste of how the housing meltdown affected corporate profits, Wall Street will take a moment to recall how the Dow plunged nearly 23% on a “Black Monday” 20 years ago.

The earnings season gets going full blast with results expected from more than 80 companies in the Standard & Poor’s 500 Index, as well as hundreds of mid-sized and smaller companies. Expectations are low with Reuters estimates saying S&P 500 profits are expected to grow just 3.2%.

Late summer credit market seizures as the housing sector spiralled out of control will come into focus when Citigroup Inc and Bank of America Corp report results, providing more clues on how the mayhem hit the financial sector.

The mix also includes several pharmaceutical companies such as Eli Lilly and Co, Pfizer Inc, Wyeth and Johnson & Johnson. Bob Millen, co-manager of The Jensen Portfolio, a Portland, Oregon-based mutual fund, said that rather than actual earnings for the recently completed third quarter, companies’ forecasts of future profits will be more crucial.

“I think what is probably going to move the market more is now many companies lower their earnings expectations going forward,” he said. “If there are a significant number of them, I don’t think the market will treat that very kindly.” Millen said that in latest crop of earnings reports, companies deriving earnings from overseas sources will have an edge.

Any company that is largely depending on their revenues coming exclusively from the US is subject to potential earnings warnings going forward, he said. The Dow Jones industrial average finished the week up 0.2%, the S&P 500 rose 0.3% and the Nasdaq Composite Index gained 0.9%.

In addition to next blitz of numbers from earnings reports and economic indicators, Wall Street will face on Friday the 20th anniversary of the 1987 stock market crash. Friday’s date commemorates “Black Monday,” as October 19, 1987, came to be known, when the blue-chip Dow Jones industrial average fell 508 points, or 22.6%, in what is still the Dow’s biggest %age drop.

Millen said he was working in the banking business at the time. He remembers the person who ran the trust department calling and asking what he should do. “I said ‘take a break, don’t get too excited, keep watching it, and eventually it will go back up.”

Millen thinks a recurrence is unlikely. The economic backdrop was very different in 1987, with higher interest rates and a recession looming then, he said. “Markets are more sophisticated today, and risk is more dispersed,” he said.

Among the coming week’s economic data, September housing starts, due on Wednesday, will be closely watched as that industry remains mired in what many describe as a recession.

In a Reuters poll of economists, the median forecast is for housing starts to slip to an annual pace of about 1.29 million units, down from 1.33 million in August. Ed Vallar, director of investments and research at GM Advisory Group in Port Washington, New York, said the housing slump is definitely not over. He is especially concerned about the resetting of adjustable rate mortgages, which will mean bigger monthly payments for borrowers.

“We’ve got a huge amount of resets coming up in the first half of 2008,” Vallar said. He sees declines in the value of homes making it difficult for borrowers to refinance. Some may even owe more than their house is worth.

“It’s not a question of liquidity, it’s a question of credibility,” he said. Vallar, nevertheless, expects the stock market to add to its gains between now and the end of the year despite a slowing economy. He favours defensive plays like food and beverage stocks and utilities.

He also likes technology stocks, with the larger companies benefiting from stronger economic growth overseas. In addition to the housing starts, Wednesday will also feature the release of the September US Consumer Price Index and the Federal Reserve’s ‘Beige Book’ on business activity in the 12 Federal Reserve Bank districts. Economists polled by Reuters expect both the overall CPI and the core CPI, which excludes volatile food and energy prices, to rise 0.2%.

The Fed’s Beige Book will be studied for clues on whether the Fed will cut interest rates again or hold steady when it meets at the end of October. Figures on industrial production and capacity utilisation are due on Tuesday.

The consensus view is for a rise of 0.1% in industrial production. Capacity utilisation is seen holding steady at 82.2%.Thursday’s data includes a report on leading indicators of the US economy.

The Philadelphia Federal Reserve Bank’s index of business conditions in the U.S. mid-Atlantic region in October is also due on Thursday. The Philly Fed index is expected to decline to 7.3 from 10.9 in September. Index readings above zero show growth in manufacturing in the region.(Wall St Week ahead runs weekly.