Sun Jan 17, 10:34 AM

By Claire Sibonney

TORONTO (Reuters) - Canada's biggest companies look likely to meet or slightly beat forecasts for double-digit earnings gains this reporting season, which should be enough to nudge the stock market higher.

But analysts said the upside is limited given the market's 31 percent rally last year, and that investors could punish any companies falling short of forecasts.

Companies in the Toronto Stock Exchange's blue-chip S&P/TSX 60 index are expected to report earnings that are about 18 percent higher than the year-earlier quarter, according to Thomson Reuters data.

"That just reflects how absolutely brutal Q4 of 2008 was and the year-over-year comps are easy because of that," said Paul Taylor, chief investment officer at BMO Harris Investment Management.

Fourth-quarter earnings are expected to rise after a brutal year in which most company's results were hammered quarter after quarter by the financial crisis and resulting recession.

Yet the Toronto market began rallying in March in anticipation of a recovery by the economy and improved corporate earnings, pushed along by heavy stimulus from governments and central banks.

Veteran market watchers said investors will need to see more than a quarter of solid profitability to sustain further market gains.

"There is more room for upside than there is for downside but I don't think it's going to be any kind of a barn burner," said Fred Ketchen, director of equity trading at ScotiaMcLeod.

"We need some extra time to build some of the earnings momentum and it isn't going to happen in a month or two."

Aluminum giant Alcoa Inc kicked off the U.S. fourth-quarter earnings season with weaker than expected results last Monday, which sank its stock and set a wary tone.

Among heavyweight Canadian companies reporting results over the next few weeks are Potash Corp , Canadian National Railway Co and Imperial Oil Ltd.

MORE SALES GROWTH THAN COST-CUTTING?

Investors will pay particularly close attention to whether companies are actually generating higher revenues rather than relying on tough cost-cutting to bolster their bottom lines.

Looking further out into 2010, analysts see earnings growth, but they warn the transition, and market reaction, could prove jagged if macroeconomic indicators fall short.

"We're looking at probably high single-digit returns for the year, which is good but nothing like what we saw last year. And of course that's the norm: you don't expect to see the same rate of progression as you get further into the recovery," said Bob Gorman, chief portfolio strategist at TD Waterhouse.

"We're probably going to see, at some point this year, some meaningful correction."

Gorman forecasts Toronto's S&P/TSX composite index , which closed at 11,685.37 on Friday, will end the year at 12,625, a 7.5 percent increase from a year earlier.

Some analysts warn bigger economic developments could easily overshadow corporate results in the weeks ahead, given that the global recovery still appears fragile.

"There's concern about the U.S. commercial real estate market, how the Fed reduces its balance sheet, does inflation turn up?" said George Vasic, chief economist at UBS Securities Canada.

"All these things are going to matter far more to valuation levels and earnings for the market than will the extent to which this earnings season meets or doesn't meet expectations."

David Rosenberg, chief economist at Gluskin Sheff and Associates, warns investors are making a mistake by treating the credit collapse as a distant memory. He said earnings and growth expectations priced into the market look high.

"Practically all of the growth in the fourth quarter comes down to the arithmetic contributions from inventories," he said.

"Once we start to see the emperor disrobed on these recovery hopes, then my sense is that we are going to see a giveback on this bear market rally. And that might not be evident until we're headed to the end of the first quarter, beginning of the second quarter."

The former Merrill Lynch economist, who gained fame for calling the U.S. downturn, said investors should favor traditional safe-haven stocks, like utilities and telecoms, which pay steady dividends.

"Right now, if I was going to be in the stock market, I'd want to be clipping coupons," he said.