Bleak profit outlook clobbers stocks

Advertiser News Services

NEW YORK — Just one look, that's all it took.

Two clerks with Thomas Weisel Partners take a breather at the end of yesterday's frantic selling spree on the New York Stock Exchange. Associated Press

The impetus behind much of that selling seems to be a bleak outlook for profits in the current quarter and beyond.

Corporate America is in the midst of reporting second-quarter financial results and, so far, earnings have generally met expectations. The problem is that many companies met expectations by cutting costs rather than increasing sales. Revenue growth has been anemic and few executives are willing to say they expect improvement any time soon.

"What's been missing is revenue growth," said Phil Dow, director of equity strategy for RBC Dain Rauscher. "We were going right along and we're still hitting the earnings numbers, but the guidance going forward is really subdued."

Need proof? Look no further than Sun Microsystems—formerly one of the country's best-performing stocks. The second-quarter profit that Sun reported yesterday met Wall Street's expectations, but it painted a gloomy outlook for the future. Sun closed down $1.64 at a new 52-week low of $4.16.

Of the 177 S&P 500 companies that have given third-quarter earnings projections, 93 have said profits will be lower than forecast, according to Thomson First Call. That's more than twice the 40 that have said they will surpass estimates.

"I think you could easily see another 10 percent on the downside" for benchmark indexes, said Jeffrey Sledge, managing director and portfolio manager for Brencourt Advisors, a $900 million New York hedge fund. "There seems to be no reason to build any positive momentum."

Investors also got bleak economic news this week that bolsters the notion of poor corporate profits.

Last week, the University of Michigan Consumer Sentiment Index showed consumer confidence falling to 86.5 this month from 92.4 in June—the lowest level since November. This week it was the Philadelphia Fed Index, a key early read of manufacturing performance, that fell to 6.6 — well short of expectations and down sharply from a 22.2 reading in June. Yesterday, the consumer price index showed inflation at a negligible 0.1 percent in June—a sign of meager economic growth.

All those figures are particularly unsettling given that the Federal Reserve started slashing interest rates 18 months ago and the market has yet to react, said James Paulsen, chief investment officer at Wells Capital Management in Minneapolis. Unemployment remains about 6 percent, capital spending has ground to a halt, no one is borrowing, companies aren't building inventories.

"I think it's sort of a Fed impotency panic. People are wondering is the Fed having any impact and if they're not, what are they going to do about it," Paulsen said. "The economy seems to be fading again. ... That's scary."

A lack of trust is compounding the problem. Investors have seen Enron, WorldCom and a string of others get caught using aggressive—and sometimes outright illegal—accounting, leaving them skeptical about every company's financial reports.

"Even revenues are becoming suspect," said Michael Kennedy, who manages the AXP Stock Fund for American Express Financial Advisors in Minneapolis. Kennedy suspects that the collective earnings of the S&P 500 and other stock indexes will be adjusted and readjusted for a long time. "We're not going to know what earnings were for the indices for last year or this year probably for three or four years."

Kennedy, as a result, hasn't been paying as much attention to earnings reports. Kennedy has been watching for companies that are producing real operating income growth, but mostly he's been doing nothing. "My activity in the fund has slowed up quite a bit in the last month or so," he said. "It's not a time to go running out there and do a lot of things. I've actually gone in and picked up some of the drug stocks that have gotten hit pretty hard. I've bought a couple cyclical stocks, chemical stocks."

As of Wednesday, investors had pulled $11 billion out of equity mutual funds in a week and some soothsayers expect record outflows of $60 billion for the month. The old record was $29 billion.

That tells Dow that retail investors are giving up—and probably making a big mistake. "The American psyche now expects bad things to happen and that's not the history of our country, that's not the history of the economy. That's not the history of the market," he said. "It will recover, and it will recover without those people."