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By Jason Stipp and Robert Johnson, CFA | 09-26-2012 12:00 PM

Will the Economy Break Earnings' Win Streak?

Wall Street expects 3Q will be the first down quarter of earnings in the recovery, but the U.S. economy should pick up some global slack, says Morningstar's Bob Johnson.

Jason Stipp: I'm Jason Stipp for Morningstar.

Despite a generally sluggish economy, we've had a string of pretty good earnings seasons throughout the recovery, but analysts have more pessimistic assumptions for upcoming third-quarter earnings. What's behind that? I'm checking in today with Bob Johnson, our director of economic analysis, to get some insights.

Bob, thanks for joining me.

Bob Johnson: Great to be here.

Stipp: So, Morningstar analysts don't actually calculate earnings expectations quarter-by-quarter specifically, but you looked at several sources.

Johnson: Yes.

Stipp: … And it looks like that folks expect a more disappointing third-quarter earnings season. What are some of the numbers saying?

Johnson: The general view is now that S&P earnings will be down about 3% in the third quarter. That's compared to the same quarter a year ago and that stays with my framework of always wanting to look at things year-over-year to strip out the seasonality. So, we've got about a 3% decline expected by analysts right now. That represents the first decline of this recovery, which began in 2009. So, it's kind of a big deal. It's a psychological point where it looks like maybe we'll have down earnings.

Stipp: You found also that some of the Wall Street expectations are for generally flat revenues, but as you said, earnings to be down. How is that a change from what we've seen in the past?

Johnson: I think that in the past we've seen margin expansion coming from increased productivity, and falling commodity prices in some cases helped to aid the numbers as well. And so we had earnings going quite a bit faster than revenues. Now, we've got the reverse, where we've got some foreign exchange issues in particular hitting the numbers, and so I think that we'll actually have relatively flat revenues and down earnings.

Stipp: We do know that management teams can sometime sandbag the numbers, and they've got lots of room for cover with emerging markets seemingly slowing down, and the situation in Europe, although stabilized, is still out there. How much do you think management teams are trying to under-promise and hopefully over-deliver when the results come out?

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