Earnings season always seems to steal the show in the first month of the quarter.  This week, 135 S&P 500 companies are reporting results, and we will see lots of big percentage increases in profits compared to last year, as last year’s first quarter was flat-out pitiful.

What’s more important is seeing revenue growth, as it gives evidence firms are moving from retrenchment and cost-cutting into a real expansion.  Markets have advanced in recent weeks on optimism that a double-dip in the economy can be avoided.  Renewed revenue growth is needed to validate that story.

Once earnings season comes to a close, a number of headwinds will come back into focus including: removal of monetary and fiscal stimulus; interest rate uncertainty; still weak housing market; national debt burdens; strained state and local government budgets; Chinese economic and policy questions; expiration of the Bush tax cuts; the growth-restraining effects of the rapid rise in commodity prices. 

I believe, however, these negative catalysts are likely to only dampen growth rather than lead to a double-dip.  I’ve said it before and I’ll say it again, this recovery will be bumpy and market pullbacks should not come as a surprise.  I say this because it seems to me that the market will take a breather once focus shifts from earnings season back to economic data and policy direction. 

You may notice I didn’t include inflation as one of the headwinds; but don’t be fooled, inflation is a serious threat that deserves our attention.  The enormous output gap and the fact that a banking crisis is inherently deflationary make inflation less of a near-term concern.  Inflation will return, though, but the degree and timing is difficult to predict. Nonetheless, inflation is a significant long-term threat to the market and economy.

Inflation expectations in the bond market remain muted, but there is no doubt the Fed’s loose monetary policy will work its way into price levels.  It’s also worth noting that inflation has historically been the political tool of choice to reduce national debt burdens.

Pinpointing the catalyst that will reverse market sentiment is not easy.  Consistently predicting the timing of such reversals in sentiment is impossible.  That is why it’s important to understand that there is also risk in abandoning your long-term investment plan and being out of the market.

Of the risks I’ve discussed, which do you think poses the biggest threat to the market?  Click here and place your vote and I’ll reveal the results next week.

Peter Lazaroff, Investment Analyst

www.acrinv.com