Comeback of the Year? Try Corporate Profits

May 7, 2010
Comeback of the Year? Try Corporate Profits
By PAUL J. LIM

THE market remains worried about plenty of things — including a sharp decline late last week, and the spreading debt crisis in Europe. But, recently, it has appeared that investors are ready to strike one item off their list of concerns: corporate profits.

“To say that earnings so far have been off the charts would not be too much of an exaggeration,” said Robert C. Doll, global chief investment officer for equities at BlackRock, the investment management firm.

Of the companies in the Standard & Poor’s 500-stock index that have announced first-quarter results, 77 percent have beaten Wall Street earnings forecasts. And profits for the quarter are on track to grow 56 percent compared with the 2009 period.

These earnings reports, however, started to arrive just as the market has shifted from confidence to much uncertainty.

From Feb. 8 to April 26, the S.& P. 500 gained 15 percent, largely in anticipation of an improved earnings and economic outlook. But the downgrading of Greece’s debt and fears that the crisis may be spreading throughout the region and the world have taken center stage, sending the market tumbling more than 8 percent. Concerns about Europe notwithstanding, many analysts have already begun ratcheting up their forecasts for stocks for the rest of this year.

Still, it’s important to remember that earnings season isn’t over, so it’s premature to proclaim complete victory on the profit front.

Stuart A. Schweitzer, global market strategist at J.P. Morgan Private Bank, noted, “Where the jury is still out is on the sustainability of this upswing, because companies had been achieving improvements in profits largely by slashing costs.”

He added, “Without increased revenues, it would be hard to imagine companies moving from cost-reduction to spending mode and hiring mode.”

So far, sales for the S.& P. 500 have also been stronger than analysts anticipated. Of the 437 that have reported earnings, 66 percent had revenue growth exceeding analysts’ expectations, according to Thomson Reuters.

But the news isn’t all positive. For one thing, revenue surprises pale in comparison with profit surprises. Companies are beating Wall Street profit forecasts by 15 percent but beating revenue projections by just 0.8 percent.

And not all companies are reporting revenue growth. The casino operator MGM Mirage said revenue fell 4 percent in the first quarter versus the 2009 period. And Sara Lee, the food giant, said quarterly sales fell 2.5 percent.

David A. Rosenberg, chief economist and strategist at Gluskin Sheff & Associates, the investment manager in Toronto, said that if figures from just one sector — financial services — were excluded, revenue of S.& P. 500 companies would be just about meeting expectations.

To be sure, analysts’ forecast for first-quarter sales growth is 11 percent — nothing to sneeze at.

“The interesting thing is how much of the good earnings news is coming from the banking and financial sector,” said David C. Wright, managing director of Sierra Investment Management.

He pointed out that this sector, which was hit hardest in the financial crisis, has been a big beneficiary of government stimulus. That ranges from mortgage relief efforts and the government purchase of “toxic” mortgage-backed securities to the recent Fed policy of near-zero short-term interest rates.

Because these efforts can’t continue forever, he said, “I can’t conclude that we’re seeing anything resembling a self-sustaining recovery.”

IF the improved outlook for the financial sector is indeed spreading to the broader economy, he said, an uptick could be expected in commercial and industrial loan activity.

But according to the Federal Reserve Bank of St. Louis, commercial and industrial bank loans nationwide have fallen every month between October 2008 and March 2010, the latest period for which data is available.

For now, at least, Mr. Schweitzer of J.P. Morgan says he is optimistic. “You know that saying that half a loaf is better than none? At this point,” he said, “I’m willing to take a quarter of a loaf.”

But such patience won’t last indefinitely. For evidence of a full recovery, investors will need to keep checking corporate reports through the end of this earnings season — and, quite likely, well into the second quarter.

Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.

http://www.nytimes.com/2010/05/09/business/09fund.html?ref=business