6 things to watch during profit reporting season

NEW YORK -- Political dysfunction in Washington and fears of financial calamity that economists predict if the U.S. defaults on its debt have overshadowed the all-important third-quarter earnings season.

But while the drama in Washington is attention-grabbing, it's earnings that really determine the direction of stock prices, says Jeff Kleintop, chief market strategist at LPL Financial.

"While Washington drives market volatility, the market trend is determined by earnings growth," Kleintop noted in a report, The Six Trends to Watch This Earnings Season.

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Heading into this week's busy earnings schedule, in which 69 companies in the Standard & Poor's 500-stock index are slated to report, analysts expect earnings to grow 3.8% vs. the same quarter a year ago, according to Thomson Reuters I/B/E/S.

Earlier Tuesday, drug maker Johnson & Johnson topped analyst estimates for earnings per share and revenue. In contrast, Citigroup's earnings came in shy of estimates as revenue from bond trading came in lighter than expected.

Six trends Kleintop says investors should keep an eye on:

1. Analyst profit projections. In recent quarters, corporate earnings have come in around 4% above analysts' estimates. If that trend persists, overall earnings for the S&P 500 would finish up 7% to 8%, which would mark the strongest growth rate in over a year, Kleintop says.

2. Impact of government shutdown. While Kleintop doesn't expect a lot of companies to cite a negative impact from the government shutdown, he says it "adds to the combined drag on business from spending cuts, higher taxes . . . the rollout of the Affordable Care Act and overhanging uncertainty of more fiscal battles to come."

The key, he says, will be if higher stock prices and stronger global growth will offset some of the negatives.

3. Improving outlook. More businesses are likely to cite improvement in the global economy, which should "boost confidence in futur! e earnings growth." The Institute for Supply Management's Purchasing Managers Index (PMI), for example, is in expansion mode and has a good record of forecasting future profit growth, says Kleintop.

4. Stronger overseas demand. China, Europe and Japan also have rising PMIs. And that bodes well for profits for American firms, as roughly 40% of S&P 500 profits come from global sources. "Demand is firming around the world," says Kleintop, citing sales of machinery and vehicles.

5. Dividend increases. Dividend payouts by S&P 500 companies are up 15% in the past year and are 26% above their level back in 2008, Kleintop says. He expects companies to continue boosting payouts for investors in search of income.

6. Rising interest rates. Interest expense isn't a big cost for U.S. companies, but higher borrowing costs can impact rate-sensitive industries, such as housing. In early September, the yield on the 10-year U.S. Treasury note almost hit 3%, its highest level since July 2011. The 10-year was yielding 2.7% in early trading Tuesday.

"We will be watching," Kleintop says, "for the impact on bank lending and refinancing activity along with demand for homebuilders."