Behind the stock market's anxious ups and downs of late lies the fear that a weakening U.S. and global economy could dash hopes for an uptick in corporate earnings.
For the first quarter, earnings season is nearly done. More than 90% of big companies have reported results and they were lackluster.
Most beat analyst estimates, but only because expectations were rock bottom.
Profit gains for S&P 500 companies were just 2.1% overall compared with a year earlier, well below the previous quarter's 8.5% rise, FactSet said.
Now investors are seeing soft reports on industrial production, housing starts, consumer sentiment and European economic growth, and they are growing anxious.
Investors had expected results to improve in the second quarter. Analysts are forecasting a 6% profit gain.
Yet of companies offering guidance, 72% have warned that second-quarter results could fall short of Wall Street expectations, which isn't great but is better than the 80% level of the past three quarters.
Now, investors are worrying they may have been too hopeful.
"People have been expecting better earnings forecasts, but I'm a little more concerned that earnings estimates are going to be ticking down," said Robert Pavlik, chief market strategist at Banyan Partners, which oversees $4.5 billion.
In the portfolios he manages, he has boosted cash holdings and shifted toward more defensive investments. He said he sold out of biotechnology several weeks ago and now prefers bigger, safer companies.
Hopes that future earnings would benefit from improved U.S. and world economic growth helped major stock indexes inch up to new records this spring. But the latest economic data have showed weakness in Europe and China.
Now, the U.S. indicators look uncertain as well. Especially troubling to market veterans was the sharp decline in yields of U.S. Treasury bonds. If the economy were strengthening, they reasoned, market interest rates should be rising.
That is especially true because the Federal Reserve is gradually ending the bond-buying program that helped hold down Treasury yields. Instead, yields have fallen: The yield of the 10-year Treasury note was 2.52% Friday, down from 3% at the start of the year. Yields fall as prices rise.
"I think the bond market is a better leading indicator than the stock market," said David Joy, chief market strategist at Ameriprise Financial Inc., which oversees $783 billion.
Mr. Joy still counts himself among the optimists who expect the U.S. economy to rebound from its weather-damped first quarter. Unlike Mr. Pavlik, he hasn't changed his investment recommendation.
But he is growing concerned and is reminding people to keep investments balanced among holdings such as stocks, bonds and cash, "in case I am wrong."
Many already are hunkering down.
Global money managers have boosted cash to an average 5% of portfolios from less than 3% at the start of last year, according to a May survey by Bank of America Merrill Lynch. That is the highest cash level since June 2012.
Just 37% reported higher-than-usual stockholdings, down from 45% in April. The percentage taking less risk than normal doubled to 22% from 11% in April.
The money managers said they still expect world economic growth and corporate earnings to improve, but they worried that the gains could be subpar.
They also worried that short-term crises could disrupt markets. Among their biggest concerns: possible business-debt defaults in China or a geopolitical crisis.
The impact on stocks so far has been modest. After falling 167 points, or 1%, on Thursday, the Dow Jones Industrial Average rebounded 44.50 points to 16491.31 on Friday, leaving it down 0.5% for the year. The S&P 500 is up 1.6% for 2014. So while indexes remain volatile, they are far from panic territory and still above lows hit in April and early May.
Many money managers say that while stock volatility could remain a problem, they think an improving economy will push stocks higher.
Despite the recent negative news, they point out that job creation is improving, new jobless claims are falling, auto sales have been good and small-business optimism continues to improve. Aside from the latest industrial-production figures, manufacturing has been strong, too.
Barclays investment strategist Jim McCormick told clients: "We expect global growth to accelerate and broaden out over the next six to 18 months."
Wells Fargo Advisors sent out a note to clients urging them to hang on: "We continue to expect the U.S. economy to grow at a moderate rate this year and view market weakness as a buying opportunity," the firm said.
But those kinds of reassuring statements go only so far. For stocks to get out of their funk, investors want proof that the economy and corporate earnings actually are strengthening.
Mr. Pavlik of Banyan, who has cut his stock exposure, is hopeful in the longer term. He says economic growth and earnings should improve by autumn, as capital investment and mergers-and-acquisitions activity improve.
He doesn't expect a bear market, meaning a decline of 20% or more in stock prices, but he does worry that indexes might fall as much as 14% from their highs before recovering.
With the S&P 500 up 30% last year and stock prices no longer low, he figures investors will be more inclined than in the past to sell and cash in profits if anxiety rises. So while he waits for good news, he is pulling back.
"I think there is more potential for downside in this market," he said. "I'm worried that this volatility is going to stay with us throughout the summer."
Even optimists like Mr. Joy of Ameriprise are getting nervous.
"For stock prices to move higher, you need good economic growth to get those earnings up, and growth is in question now," Mr. Joy said.
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