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The Honolulu Advertiser
Posted on: Sunday, June 8, 2003

Companies likely to see more profit troubles

By Rachel Beck
Associated Press

NEW YORK — The stock market is soaring. The economy is looking up. And corporate profits? Ah, don't be so sure.

Analysts say second-half corporate profits may be hard to come by even with the weakening dollar and lower oil prices.

Associated Press

Here's the problem: The massive cost-cutting that's gone on across corporate America has been great for improving profits, but companies can't squeeze out too many more efficiencies.

That means they have to find other means to lift the bottom line, no easy task when they can't raise their prices and are still struggling to find new business.

All this means stock investors should beware. There's a chance that earnings growth will decelerate in the second half of the year — and that could rein in some of Wall Street's gains.

Expectations for year-over-year earnings growth in the Standard & Poor's 500 stock index are now about 12 percent for 2003, according to earnings-tracker Thomson First Call. The big question is what will fuel those gains.

Since the start of the economic downturn three years ago, companies have been closing underperforming factories, slashing jobs and cutting back capital spending.

Their efforts have had positive results: a surge in productivity that has buoyed profits. In fact, the output per hour of work for all of 2002 grew by 4.8 percent, the strongest showing since 1950, according to the Labor Department.

But many companies already operating at extremely lean levels.

"The benefits from productivity are now largely behind us," said Anthony Chan of Banc One Investment Advisors. "The next driver of earnings is going to have to be growth in the economy and an increase in demand."

The problem is that the economy, which is showing signs of slight improvement, remains sluggish. And while new tax breaks and efforts by the Federal Reserve may provide some economic stimulus, there's no guaranteeing immediate results.

Companies still struggle to find new customers. And raising prices to current customers will just drive them to seek out cheaper options elsewhere.

That's seen in the May survey of about 100 manufacturers by Federal Reserve Bank of Philadelphia, which showed that three-quarters of respondents expect the prices that they get for their goods to decrease or stay the same in the coming six months.

The lack of pricing power hurts profit margins because companies can't fuel sales growth.

"Eroding margins make it increasingly difficult to derive real earnings growth aside from the cost cutting that has already taken place," Brian Belski, market strategist at US Bancorp Piper Jaffray, wrote in a report last week.

The best news for earnings may be the weak dollar, which has tumbled this year against major world currencies. When the dollar declines, it makes U.S. exports more attractive abroad and gives U.S. products a competitive advantage here against foreign imports.

Also beneficial is the drop in oil prices, now around $30 a barrel after hitting $37 in March.

Still, Francois Trahan, chief investment strategist at Bear, Stearns & Co., questions how much more support the dollar or oil will give to earnings in the year ahead.

"These two variables should help earnings in the second half of 2003, but their contribution should be classified as a level adjustment and not the beginning of an everlasting trend," Trahan said.

And he points to an indicator that could signal trouble for earnings. The producer price index's core crude figures track prices of raw materials such as sand, aluminum and cotton. Historically, Trahan said, trends in those figures have led S&P 500 operating earnings by a few months.

According to the Labor Department, the 12-month growth rate in the PPI's core crude peaked at 15 percent in March and slipped to 11.3 percent in April. That suggests "trouble for S&P 500 earnings beginning in June or thereabouts," Trahan said.