Apple's Earnings Miss Will Unnerve Investors

A lousy economy may finally hit big companies' bottom line.

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Apple is subject to the laws of gravity after all.

In a rare disappointing earnings report Tuesday, the tech giant fell short of analyst expectations, casting gloom over the entire stock market. Apple reported sales of $35 billion and a profit of $8.8 billion for the quarter that ended in June.

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But analysts had been expecting better, and slowing growth in sales of the iPhone, Apple's cash cow, reflect broader worries that corporate profits may finally be succumbing to chronic debt problems in Europe, a stagnating U.S. economy and emerging markets that can't shake the malaise infecting advanced economies.

The main problem in Apple's numbers was slowing momentum in revenue and profit growth. Sales and profits for the quarter were both higher than they were a year ago, but the rate of growth from the prior quarter slowed. That affects overall profitability. Apple's profit margin for the quarter was 25.2 percent, down slightly from 25.6 percent for the same period in 2012.

Most companies would kill to have Apple's margins, yet the failure of such a bellwether firm to meet expectations suggests that economic struggles are hitting the bottom line harder than skeptical investors have anticipated. Corporate profits held up remarkably well during the recession and the early stages of the recovery, but even the mightiest companies now seem vulnerable to gloomy economic trends.

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Economists at Bank of America Merrill Lynch, for example, recently pointed out that there have been fewer positive earnings surprises so far this quarter than in prior ones, a sign that Wall Street has been too optimistic about big companies' ability to protect their profits in an austere economic climate. The whole routine in which analysts forecast earnings, and companies strive to beat them, is kind of a Wall Street parlor game that tends to make companies look a bit more successful than they are. But that makes it all the more ominous when companies miss a target—especially one like Apple, with a stellar record of beating expectations.

Some analysts have already been warning that profit estimates for the second half of 2012 are too high, and need to come down. More than half of the firms that have reported earnings so far have missed the revenue targets set by Wall Street analysts, and with the easiest cost-cutting completed months or years ago, it's harder to protect profitability than it was during the recession. "The broad trend in earnings is very weak," Dick Green of Briefing Research wrote to clients recently. "Upcoming reports will be worse."

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Other companies also seem to be feeling the pressure as strapped consumers cut back, in all corners of the world. McDonald's, which has been another standout performer, also missed analysts' target for the quarter, largely because of weak results from Europe. UPS and Netflix—both highly sensitive to consumer spending—reported weak numbers that sent their shares lower.

The slowdown at Apple could come from factors unrelated to a weak economy, such as customers holding off on buying an iPhone until the next model comes out, reportedly in the fall. But for now, investors are likely to interpret the numbers as a warning that many other companies are likely to miss their targets, too.

The overall stock market, which was up about 6.5 percent for the year prior to Apple's latest announcement, could struggle for the rest of 2012. UPS, for instance, said it expects the economy to grow by just one percent this year, an anemic pace considerably lower than many economists had been predicting just a few weeks ago.

But economists have been cutting their growth forecasts, and they may interpret Apple's weaker numbers as more evidence of a stalling economy. If Apple drifts back down to earth, other companies could land with a much heavier thud.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.