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U.S. government shutdown, debt impasse stalk earnings season

By Caroline Valetkevitch

NEW YORK (Reuters) - "Government shutdown" and "debt ceiling" will top the list of phrases that investors will track in the coming weeks as they listen to corporate chief executives and try to gauge the impact of Washington gridlock on U.S. company earnings.

Companies began reporting their quarterly results this week amid mounting worries about the partial federal government shutdown that began October 1 and the possibility that the United States could default on its debt. Investors see both as threats to already modest levels of consumer spending and economic growth.

Profit and revenue growth are slowing, too, raising concerns about equity valuations. Stocks are less than 3 percent off their record highs even after drifting lower since the fiscal stalemate between Republicans and President Barack Obama's Democrats began earlier this month.

The benchmark Standard & Poor's 500 Index surged more than 1.5 percent on Thursday after Republicans in the House of Representatives unveiled a plan that would avert a debt default. The Treasury Department says it would be unable to pay all of its bills if Congress does not raise the $16.7 trillion debt ceiling by October 17.

"It's hard to quantify at this point, but there will definitely be a negative impact" on the economy and earnings, said Natalie Trunow, chief investment officer of equities at Calvert Investment Management, which has about $13 billion in assets.

"Some capex might be delayed and some hiring might be delayed until the political situation resolves itself."

Some damage has already been done, and companies operating in the defense and health care sectors have borne the brunt because of their higher exposure to government contracts. A Goldman Sachs note listed companies that derive at least 20 percent of sales from the government, many of them in the defense and health care sectors.

Lockheed Martin Corp, among the biggest weapons systems vendors to the U.S. Department of Defense, has said it would furlough about 2,400 employees who work at government facilities idled by the shutdown. Its stock has dropped as much as 4.3 percent since the shutdown began before paring some losses on Thursday.

United Technologies Corp last week said it would furlough as many as 4,000 employees if the shutdown dragged into a second week. On Monday, however, the Defense Department recalled most civilian employees. United Tech shares have also fallen more than 4 percent during the shutdown before paring losses on Thursday.

Managed-care providers Humana Inc and Health Net Inc have said they face delayed payments on contracts to provide healthcare services to military families.

Even companies not directly affected through contracts are concerned about the budget impasse, including Starbucks Corp. The company's CEO, Howard Schultz, this week urged business leaders to push for an end to the stalemate.

A top concern of investors is that companies will announce reductions in profit estimates for the fourth quarter, and that cautious forecasts by companies will further dampen the rally in stocks this year.

The S&P 500 had lost 1.5 percent since the shutdown began, although Thursday's surge on signs of a possible compromise effectively erased all of that loss. The index remains up 18.1 percent since the start of the year.

"Earnings uncertainty is a reason to be cautious in the near term," said Leo Grohowski, chief investment officer at BNY Mellon Wealth Management in New York. "We're going to be watching very closely the companies that come out with guidance."

So far, there has been a minimal impact on earnings expectations. Fourth-quarter S&P 500 profits are seen rising 10.8 percent from a year earlier, compared with an October 1 forecast for 10.9 percent growth, Thomson Reuters data showed.

By comparison, companies are expected to post third-quarter earnings gain of just 4.2 percent.

Still, many investors consider those fourth-quarter estimates, and for estimates for 2014, to be overly optimistic given U.S. economic growth hasn't picked up. The Federal Reserve in September cut its forecast for 2013 economic growth to a 2.0 percent to 2.3 percent range, and lowered its forecast for 2014.

Profit growth has averaged 4.1 percent over the past four quarters, while revenue growth has averaged just 1.3 percent.

Earnings for 2014 are expected to rise 11.4 percent, above the 5.8 percent expected for 2013, Thomson Reuters data showed.

Investors have closely watched changes in those numbers as valuations have risen. The current forward 12-month price-to-earnings ratio at 13.9, still considered a bit low historically, is above the 13.1 at the beginning of 2013.

"Until we start seeing a pickup in GDP growth, we don't think revenue targets will be met, even if those targets are reduced," said Michael Mullaney, chief investment officer at Fiduciary Trust Co in Boston.

A shutdown that lasts for two weeks could subtract a half of a percentage point from fourth-quarter gross domestic product growth, according to a note from Bank of America Merrill Lynch analysts, who estimate that lost government sales would equate to 0.2 percent of total annual sales.

While that is not a huge amount, the uncertainty generated by the shutdown could also sap consumer confidence.

"If it starts to detract from overall consumer confidence, then you could see it impacting overall consumption," said Dan Suzuki, equity strategist at Bank of America Merrill Lynch in New York.

"It's a risk for the more consumer-driven areas of the market, an area that we're already somewhat cautious on."

(Additional reporting by Ryan Vlastelica; Editing by Dan Burns and Grant McCool)

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