By John Byczkowski
The Cincinnati Enquirer
Corporate profits are on the upswing. As the third-quarter earnings season moves into full swing, much of the news has been good.
Coca-Cola is up. Bank of America is up. eBay was up a whopping 70 percent. Intel, Yahoo and Fannie Mae all saw profits more than double.
Locally, Cincinnati-based E.W. Scripps reported a 24 percent increase in third-quarter sales and its stock on Friday reached a 52-week high at $93.48 on the New York Stock Exchange.
More companies will report their third-quarter results in the coming weeks, and their news is expected to be largely positive. Thomson First Call, which compiles earnings estimates and reports, projects third-quarter profits to be up 21 percent - the best numbers so far during this economic recovery - and the fourth quarter will be even better.
But whether this will continue in 2004 is debatable, and economists and stock market watchers say investors may be setting themselves up for a fall. Strong earnings now are boosting expectations for next year - to unreasonable levels, some say.
Chuck Hill, director of research for Thomson First Call, said he's already seeing next year's profit estimates rising based on third-quarter reports. So far, many estimates are reasonable, but if they keep rising, "I think we're setting ourselves up for a correction in the market," he said.
Profits are up because the economy is growing faster, but much of that growth is coming from the July cut in federal income taxes. "We think the tax cuts will give us a boost for the next four to six quarters," said David Wyss, chief economist for Standard & Poor's in New York. "After that, what do we do for an encore?"
Profits are important because they lubricate the economy. When profits rise, companies invest, expand and hire, and that's good for workers and investors alike. But when profits are weak, companies stagnate, close plants and cut back, resulting in higher unemployment and lower stock prices.
Companies are seeing profits rise because of stronger economic growth - estimated at 6 percent in the third quarter - on top of their own efforts at cost cutting. Wages are growing very slowly, so any increase in sales translates to higher profits, said economist Jan Hatzius of investment banker Goldman Sachs. A weaker dollar and faster depreciation is also helping profits, he said.
But the economy isn't expected to stay that hot, with growth dropping to around 4 percent this quarter and 3.7 percent for all of 2004, according to Goldman Sachs.
That's not a bad rate of growth, but it's not the rate many are hoping for. "It's that kind of lukewarm economy which frustrates people, because they feel it should be growing faster," Wyss said. "On the other hand you can't really whine much about it either."
Lukewarm economic growth translates to lukewarm profits. First Call estimates that profits, after growing 21 percent in the third quarter and 22 percent in the fourth, will grow just 12.9 percent in the first quarter of 2004. They'll slow further, to 12.1 percent, in the second quarter of 2004.
And that slowdown in profits will affect stock prices. "We're not optimistic about the market," Wyss said. "What we're getting now (in the market) is a short-term rebound, which is warranted. But once that rebound's over, then we think we're going to go back to single-digit increases, not the 18 percent a year we got used to in the '90s."
Hill said he believes the key is capacity utilization. Factories have been running at about 75 percent capacity for the last year, compared to 82 percent or more in 1998 and 1999, during the heat of the last expansion. Until factories get busier - reflecting stronger consumer spending and a stronger economy - companies won't invest deeply in expansion and hiring.
But Hill said when he looks at profit estimates for 2004, it appears Wall Street is expecting businesses to begin spending on expansion. Profits for industrial companies are expected to rise 15 to 20 percent. At technology companies, the gain is expected to be 30 percent or more.
"There's a lot of ambition there," he said. "The key to that is if consumers continue spending to use up some of this excess capacity that we still have."
Wyss agrees. With an economy growing at a lukewarm pace, manufacturers' profits will grow slowly as well. "It's going to make it hard to justify a lot of major investment, especially given the amount of excess capacity out there, both in the United States and abroad," he said.
Slow growth is something the nation will have to get used to. "This is the nature of the new economy," Wyss said. "Recessions tend to be milder, but so do recoveries. We saw that in '90-'91 as well, where you had a very mild recession, followed by a very slow jobless recovery, pretty much like this one."
That recession, however, was followed by the longest economic expansion in the nation's history. "It may not be a coincidence," he said. "Slow and steady wins the race."
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