Why the Third Quarter Could Get Ugly

Earnings are the lifeblood of the stock market. When you look back at the history of the market's slow but steady rise over the decades, you can tie that success to the higher net income that the biggest companies in the U.S. have produced over time.

When the earnings machine starts to slow, though, that's when it's time to start worrying. Unfortunately, after the slowdown was held at bay for an extra quarter, it appears the time of reckoning is finally upon us.

When earnings fall
The third-quarter earnings season isn't slated to start for another couple of weeks, but already expectations are pretty bleak. FactSet Research expects profits for the S&P 500 as a whole to drop 2.7% -- the first fall in three years.

Drilling down more closely, a look at the Dow Jones Industrials (INDEX: ^DJI  ) shows that fully half of the Dow's 30 companies are seen posting lower earnings for the current quarter than they did in the corresponding quarter a year ago. Although Travelers is seen posting much better earnings -- assuming it can get through the last week of September without a major disaster -- analysts expect nearly a dozen companies to post double-digit percentage earnings declines.

Among the culprits are ExxonMobil and Chevron, whose earnings tend to track oil prices fairly closely. With oil locked in the $90 to $100 range, it's uncertain when Big Oil might return to the record-breaking days of early 2008, when oil spiked near $150. Intel (Nasdaq: INTC  ) expects to lose almost a quarter of its earnings per share in its continuing challenge to become relevant beyond the PC market, while Boeing's (NYSE: BA  ) earnings may drop a similar amount despite huge successes in booking big aircraft orders over the past year. And amid story stocks, Alcoa (NYSE: AA  ) hasn't solved the big macroeconomic issues of the aluminum market, and Bank of America (NYSE: BAC  ) is still trying to figure out how to manage its slimmed-down banking business more efficiently while retaining some of its competitive edge.

After the fall
Admittedly, a lot is going on right now to pressure earnings. Here in the U.S., the threat of the fiscal cliff has introduced an unusually high amount of uncertainty about what the immediate future will bring next year. Slowdowns in Europe and China are adding to the discomfort, and even though investors are loath to fight against central-bank interventions, they aren't convinced that those interventions will work.

Still, those stimulus issues won't decide themselves in the coming earnings season. Rather, you'll see their impact take shape gradually over the next several quarters.

Along those lines, long-term investors shouldn't despair. Current projections see the third quarter's earnings malaise as a one-shot phenomenon, with earnings expected to rise at nearly a 10% clip in the fourth quarter and by more than 11% in 2013.

Get ready to buy?
If those optimistic predictions come to pass, then any sell-off resulting from bad earnings this quarter could provide a nice buying opportunity for more bullish news next year and beyond. With many investors having remained on the sidelines throughout the stock market's bull run since early 2009, any sort of all-clear signal on the economic front could trigger a return of reluctant investors to stocks.

On the other hand, those future projections rely in large part on expectations about the success of attempts to stimulate economic growth around the world. If those efforts falter, then disappointment could persist. And since the stock market doesn't like disappointment, not to mention outright nasty surprises, investors could suffer if the Fed ends up losing its all-in bet for economic recovery.

When the recovery does come, it'll be because individual companies take the lead. Both Intel and Bank of America have great prospects for the future, but they also have obstacles they'll need to overcome in order to succeed. Our analysts have put together detailed reports on both stocks that will help you judge when they'll emerge from the pack. Click here to read our Intel report, or click here for our report on Bank of America.

Fool contributor Dan Caplinger can deal with some ugliness. You can follow him on Twitter @DanCaplinger. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Exxon Mobil, Intel, and Bank of America. Motley Fool newsletter services have recommended buying shares of Intel and Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy keeps it pretty.

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