Earnings Outlook Critical..margins front and center

If 2011 is to be a record year for stocks, this earnings season had better get off to a strong start.

Analysts currently expect companies in the Standard and Poor's 500-stock index to turn in full-year earnings of about $96 a share, according to Thomson Reuters, which would easily surpass the $88 peak reached in 2006.


To get there, though, companies will have to overcome two challenges: continued weakness in the financial sector and profit-margin pressure across many industries.

Although earnings season kicks off Monday with aluminum giant Alcoa's fourth-quarter results, the more telling read could come with J.P. Morgan Chase's report Friday. The bank is seen as one of the strongest, so any weakness would be troubling for the industry and broader market.

And financial institutions face headwinds. For one, rock-bottom interest rates make it tougher to earn interest income. There also is pressure on fee income, in part because of financial-overhaul caps on overdraft and debit-card charges. That's not to mention the risk of further home-price declines, which could crimp balance sheets. And as recent foreclosure lawsuits show, litigation risk stemming from the financial crisis also remains high.

The financial sector, as a result, has been lagging the broader market. That will have to change.

"The market could do just fine in '09 and '10 without financials being part of the leadership," says Credit Suisse strategist Douglas Cliggott. "It will be much tougher this year" if they don't participate, he said.

The other key metric to watch this earnings season is profit margin. To at least maintain margins, revenue growth for the S&P 500 will have to be strong enough to outpace rising commodity costs and potentially higher labor expenses. Consumer-oriented companies in particular are feeling the squeeze, as they have had trouble passing along price increases.

It is notable that one of the strongest consumer brands, Nike, recently warned of such pressures.

At least there is a potential silver lining if earnings disappoint in 2011 because of higher labor costs. The V-shaped rebound in corporate earnings was an early driver of the nation's economic recovery. An upward tilt to job growth is now needed to sustain it.

—Email: tape@wsj.com