Rally needs more profits

Coming off a week on the Toronto stock market that saw the TSX briefly go above 11,000 for the first time in 10 months, it may seem like investors can finally relax.

Coming off a week on the Toronto stock market that saw the TSX briefly go above 11,000 for the first time in 10 months, it may seem like investors can finally relax.

But investment advisers are cautioning that the recent rally — which has been largely based on a stream of positive second-quarter earnings results — doesn’t have the fundamentals to sustain itself.

So far, three-quarters of American companies’ quarterly earnings have topped expectations, as have more than half of Canadian companies.

But Gareth Watson, director and Canadian equity adviser for Scotia McLeod, said he would append “an asterisk” to these better-than-expected results if he could.

“While earnings expectations have been beaten, revenue expectations have not been beaten as much, which to me indicates that the earnings that are being reported are better than expected because of cost cutting and not because of revenue growth,” Watson said.

Although it was heartening for investors to see many major companies reporting an improvement, Watson cautioned that the rally experienced in recent weeks isn’t sustainable unless companies see some real growth.

“The only way I think you’ll see this market sustain itself is if in the next few quarters these corporations really start to see accelerated revenue growth, because you can’t keep cutting costs,” he said.

The key to revenue growth is increased consumer spending, but so far the numbers aren’t encouraging.

Major U.S. retailers released their July sales data last week, with most companies reporting lower sales as shoppers remained tight-fisted, raising concerns about the back-to-school and holiday shopping seasons.

Official U.S. retail sales data are due out on Thursday.

“You’ve got to get that spending going again, and the indicators that we’ve seen aren’t necessarily supportive that the U.S. consumer is right back on track to spending again,” Watson said.

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