Traders work on the floor of the New York Stock Exchange. With the Dow and the S&P 500 in record territory and an S&P 500 price-to-earnings ratio of 15.6, the highest in nine years, a substantial break to the upside on earnings would be a welcome development for investors.

Reuters

New York

With all the hoopla over the Dow topping 17,000 out of the way, the market’s next focus will be whether the fast-approaching earnings season can justify US stocks climbing further into record territory. Many factors point to a second-quarter earnings season poised to surprise substantially to the upside. There is an outside chance that profits for S&P 500 companies could return to double-digit growth for the first time in nearly three years.

On the heels of Thursday’s strong US employment report, some economists have begun talking up prospects for a 4.0% annual growth rate in gross domestic product for the April-through-June period, a dramatic snap back from the first quarter’s contraction of 2.9%.

“It’s a strong report that capped off a strong quarter. Everything in the report points to 4% growth in the second quarter,” said Stuart Hoffman, chief economist at PNC Financial Services in Pittsburgh, referring to June’s jobs data.

Analysts polled by Reuters are calling for earnings growth for the second quarter of 6.2%, and a return to double digits in the third and fourth quarters: 10.9% and 11.9%, respectively. The last time that S&P 500 earnings achieved double-digit percentage growth was the third quarter of 2011, when the growth rate was 18%.

But some signs suggest the 10% handle could be breached a quarter earlier by the time all of the second-quarter numbers are in.

“There is a chance that earnings could see double digits this quarter, but only a very slim chance. The strong jobs report can translate to better earnings after a period of time but it can’t be immediate,” said Tim Ghriskey, chief investment officer at Solaris Group in Bedford Hills, New York.

In the coming week, aluminum producer Alcoa will get the earnings season started on Tuesday with second-quarter results after the closing bell. Family Dollar Stores, Inc will report quarterly results on Thursday before the market opens. On Friday, earnings will be released by Fastenal Co, a parts and tools supplier to the construction and manufacturing industries, and Wells Fargo & Co, the largest US mortgage lender.

First among the encouraging signs of profit growth: Earnings pre-announcements from companies have the most positive skew in six quarters.

Of 133 pre-announcements from S&P 500 components so far, 97 have been negative, 24 positive and 12 in line with existing forecasts, according to Thomson Reuters data. That puts the negative-to-positive ratio at 4-to-1 for the second quarter, the lowest since the fourth quarter of 2012. Moreover, that compares with 5.9-to-1 in the first quarter and 5.5-to-1 a year earlier in the second quarter of 2013.

Second, actual earnings growth tends to exceed forecast growth by a sizable margin, because companies and the analysts who track them tend to underestimate profits. Since the fourth quarter of 2009 when profits returned to growth after the recession, actual S&P 500 earnings growth at the end of each quarterly cycle exceeded the growth forecast at the start of each reporting period by an average of 5.7 percentage points. Even factoring out the outsized profit growth rates in the first six quarters following the recession, earnings have come in an average of nearly 3 percentage points higher than the forecast at the start of each reporting season.

For the first quarter, for example, the profit growth rate on April 1 was pegged at 2.1%. When the numbers from all 500 companies in the index were tallied, though, growth was actually 5.6%, 3.5 percentage points higher.

With the Dow and the S&P 500 in record territory and an S&P 500 price-to-earnings ratio of 15.6, the highest in nine years, a substantial break to the upside on earnings would be a welcome development for investors.

On Thursday, the Dow closed above the 17,000 milestone for the first time, and the S&P 500 came within 1% of piercing through 2,000. The Dow is up 3% for the year, while the S&P 500 and Nasdaq are both up 7.4%.

“We’ve had such a big move to this point that good data just isn’t enough to drive this market much further. It’s really coming down to company earnings. That’s the only thing left that can lead this market higher,” said Rick Meckler, president of LibertyView Capital Management, an investment advisory firm in Jersey City, New Jersey.