GLOBAL MARKETS WEEKAHEAD-Final earnings test before year end

By Natsuko Waki

LONDON, Oct 2 (Reuters) - With three months to the end of 2009, third-quarter corporate earnings -- due in the next couple of weeks -- will hold the key to whether risky assets can sustain their rapid recovery since March.

On Wednesday, Alcoa, the largest U.S. aluminium maker, will kick off the Q3 reporting season which is expected to show an earnings contraction rate of almost 25 percent for the S&P 500 index.

World stocks, measured by MSCI, have risen more than 62 percent since their March trough, and just posted the third biggest ever quarterly gains in the three months to end-September.

However, they are on track to post a second consecutive week of losses as investors grow nervous that the improvement in the macro economy might be easing. A closely-watched U.S. jobs report showed a sharper than expected fall in September, fanning concerns that the weak labour market could undermine recovery.

"How companies beat estimates in the last quarter was down to cutting costs. We need to see companies boost top line revenue. We also need to see evidence the better macro picture is feeding through better revenues," said Michael O'Sullivan, head of global asset allocation at Credit Suisse's private bank.

"The rally was too great. A lot of people in broader universe have missed out in the rally and want to get in. In that context correction is not a bad thing to take some of the excess out of the market."

O'Sullivan also said correlations between equity sectors are coming down, giving more importance to stock pickings.

"High beta, macro gains are done now. We are transitioning from a beta to alpha environment," he said.

Uncertainty for the Q3 corporate performance is indeed high with high dispersion of analysts estimates of rolling 12-month forward earnings for S&P 500 firms.

According to Thomson Reuters data, the coefficient of variation -- which gauges the difference in analysts estimate from consensus -- stands at 9.6 percent, compared with a long-term average since 1985 of 6.5 percent.

The higher the number is, the greater the disagreement is among analysts. In December 2008, at the height of financial market turmoil, the coefficient rose as high as 15.5 percent.

The dispersion is the highest in the financial sector, followed by material and energy sectors.

Going forward however, the estimated earnings growth rate for S&P 500 firms is set to improve drastically in the Q4 to 193.1 percent from an expected contraction rate of 24.7 percent in the Q3, according to Thomson Reuters data.

For the first quarter of 2010, the growth rate is expected to ease to 34 percent. This could underpin equity and other risky assets in the long term.

"If we do see another sell-off in risk assets, it will be yet another buy-on-dip opportunity," said Stephen Jen, managing director of macroeconomics and currencies at Blue Gold Capital Management.

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"We remain positive in thinking that improved corporate profits and low interest rates will enhance both the ability and the willingness of companies to raise their business investment again."

Also on the agenda next week are interest rate decisions by Australia, Britain and the euro zone.

While all of the central banks are expected to leave monetary policy on hold this time, November is favoured for the first interest rate hike in Australia.

UP THE RISK CURVE

Now that investors have some difficulty outperforming their peers by investing in plain-vanilla equities, some are going up on the risk curve.

SEB says it is now investing 2.5 percent of its "modern growth" portfolio in private equity, where valuation is still low, compared with traditional assets where valuation has improved so much that future returns might be lower than now.

"The financial world is in a process of increased risk acceptance, in light of better predictability concerning economic trends and the fact that central banks are likely to keep their interest rates very low for another while," the bank said in a note to clients.

"We foresee a gradually improving climate for private equity companies. Meanwhile there is still a good discount on the valuation of private equity assets, not least via the attractive secondary market, which influences price levels."

According to Thomson Reuters data, the S&P 500 12-month forward price to earnings ratio stands at 14.9, up from a recent trough of 9.5 in November.

SEB, at the same time, is shifting its hedge fund allocation away from long/short in favour of a market neutral strategy to give a portfolio a degree of protection.

(Reporting by Natsuko Waki; Editing by Victoria Main)