Q3 Earnings Face A Substantially Higher Hurdle Than The Apparently Massaged-Lower Q2 Consensus

Alright, let’s get ready to rumble. After a few months of “liquidity” being the only fundamental that appear to matter, equities at last start getting some other types of signal as earnings season kicks off with Alcoa (AA) tonight.

But first, the undercard. Although the story first circulated yesterday afternoon, it’s only this morning that the situation in Latvia has started to receive much attention. Essentially, the government is mulling plans to make it easier for homeowners to “DK” their mortgage payments and remove some of the lenders’ power of recourse to evict delinquent mortgagees.

This is being interpreted in some quarters as paving the way for a LVL deval; the SEK is modestly weaker as a result. The great irony, of course, is that the bone-crushing recession which has hampered homeowners’ ability to finance their mortgages has, at the same time, vastly improved Latvia’s current account balance, pictured below. On the face of it, that would appear to forestall the need to devalue in the first place!

Other than a little rally in EUR/SEK and Latvian CDS, however, markets have largely shrugged off the Latvian story. The real main event is earnings season, which kicks off after tonight’s close when Aloca releases Q3 earnings.

Regular readers may recall that Macro Man threw a hissy fit after the Q2 report, in which Alcoa’s accounting department gave their income statement a world-class shiatsu to deliver better than expected operating earnings (while generating worse-than-expected GAAP earnings.) Analysts appear to expect some chance of a return to the massage parlour; according the Bloomberg consensus, GAAP earnings are pegged at -$96 mio while operating earnings are at -$82 mio. (Strangely, GAAP EPS is -0.05 while operating EPS is -0.09. WTF?)

What’s more interesting to Macro Man than the lying clever accounting is the expectations management performed by all comapnies in the run-up to their earnings releases. You can clearly see this for Q2; the chart in the upper right hand corner shows how the consensus forecast for AA fell in the few weeks before earnigns were released in July- and this despite a rallying equity markets and green shoots fever!

This quarter might be a bit more of a challenge; as the chart below demonstrates, the consensus has ticked higher over the past several weeks.

Now, Macro Man doesn’t know if that holds true for the SPX in aggregate; given the uptick in 2010 earnings estimates, however, he suspects that it does. In that case, Q3 earnings face a substantially higher hurdle than the apparently massaged-lower Q2 consensus.

The naturally bearish conclusion is that disappointment is therefore more likely. By the same token, however, if Q3 earnings do exceed consensus by a comfortable margin, it could set the stage for a slingshot higher into year-end. Macro Man plans on staying nimble and playing the data as it comes.

In any event, we’ll know more in 11 hours or so when Alcoa kicks off round one.

Paging Michael Buffer…

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