By Nick Godt

Investors, who have turned more cautious about the U.S. economy, will turn to next week's kickoff of earnings season full of hope that market expectations have been taken down enough to help stocks return to their winning ways.

"Over the past couple of weeks, we've been going through the digestion phase of the July-to-September gains and now the market is looking for reasons to become optimistic again," said Sam Stovall, market strategist at Standard & Poor's.

On the face of it, things were still bleak for corporate America in the third quarter.

Alcoa Inc. (AA) will play its traditional role as the first blue-chip company to report results on Wednesday. The aluminum giant, seen as a barometer for the economy, is expected to post another staggering loss, reflecting the overall performance of the materials sector.

On average, earnings at S&P 500 firms are expected to be down by 24.8% from the year earlier quarter, marking the ninth consecutive quarter of negative earnings growth, according to Thomson Reuters.

And there have been only a few downward revisions to estimates from analysts or companies. At the start of the quarter, earnings were expected to be down 20.9%. Lowering expectations tends to help stocks when the actual results come out.

"But the trend [of revisions] is similar to what we saw in the second quarter," said John Butters, financials analyst at Thomson. "And in that quarter, we saw 73% of companies topping expectations, the largest percentage since the first quarter of 2004."

And companies on average topped expectations by a huge 13.4%, helping the market continue its rally through the summer and into September.

"With the Dow falling in the past two weeks, the market has been discounting some possible disappointments in earnings, so that when they come out, we may see the rally resume," said Ken Tower, market strategist at Quantitative Analysis Service.

Jobs and profits

Stocks stumbled over the past week, marking the second consecutive week of decline, with a series of disappointing reports raising questions about the hoped-for economic recovery.

Yet on Friday, after heavy losses in the previous session, news that the economy shed a worse-than-expected 263,000 jobs in September failed to rock the market too hard.

The Dow Jones Industrial Average (DJI) lost 21.61 points, or 0.2%, to finish at 9,487.67. The S&P 500 index (SPX) fell 4.64 points, or 0.5%, to end at 1,025.21, while the Nasdaq Composite (RIXF) dipped 9.37 points, or 0.5%, to 2,048.11.

For the week, both the Dow and the S&P fell 1.8% and the Nasdaq lost 2%.

Friday's mild reaction "is fairly positive," said S&P's Stovall. "The jobs report was plenty of reason for people to say 'here comes the correction'. But not getting that big sell-off shows, I think, that the street is expecting good earnings."

Sector breakdown

Earnings from materials companies are expected to have fallen the most in the S&P 500's 10 sectors, with earnings there expected to have slumped by 68% on average. The sector includes Alcoa and Monsanto Co. (MON), which both report results on Wednesday.

The next worse sector is energy, where earnings are expected to drop 64% from the year earlier quarter, when oil prices where still hovering above $100 a barrel. Next up is industrials, where earnings are expected to fall by 45%.

Both energy and materials have lagged the rest of the market for a while, notes Owen Fitzpatrick, head of U.S. equities at Deutsche Bank.

"People are now looking beyond the numbers, which have been pretty weakened in both energy and materials," he said. "The stocks have been lagging and so it's likely they will play catch-up, even if we don't get great numbers."

The financials sector, freed from the write-downs that crippled results last year, is expected to be the best performer this quarter, with earnings on average expected to be up by 59% from the year earlier, according to Thomson Reuters.

"But the big move has already been played out in that sector, and there are still concerns out there," Fitzpatrick said.

The next best sector is consumer discretionary -- which includes retailers, homebuilders, and automakers -- where earnings are expected to be up by 17% year on year.

In that sector, Yum Brands Inc. (YUM) will report on Tuesday, and on Wednesday, retailers Costco Wholesale Corp. (COST) and Family Dollar Stores Inc. (FDO) will post results. Hotel operator Marriott International (MAR) reports Thursday, along with PepsiCo Inc. (PEP), whose stock is in the consumer staples sector.

In the case of many retailers, and of the likes of Ford Motor Co. (F) and homebuilders, "we're talking about smaller losses, which translates to year on year growth," S&P's Butters noted.

Healthcare is next up, with earnings in that sector expected to be only down slightly year on year.

Meanwhile, the information technology sector, where earnings are expected to be off 15% year on year, could provide some upbeat surprises, according to Fitzpatrick.

Business at Research in Motion (RIMM), whose stock got hammered last week when it lowered its guidance, "is not that bad" while industry leaders such as Intel Corp. (INTC) and Hewlett-Packard Co. (HPQ) have made some positive comment, he said.

"I expect this earnings season to be like previous quarters, with companies beating expectations," Fitzpatrick said. "But now we do want to see more visibility and some improvements in [revenue], not just the bottom line."