Why the US profits boom is illusory
FREE email from MoneyWeek
Discover the latest profit opportunities and understand what’s really going on in the investment world with our punchy daily email. CLICK HERE
This genius investor does dizzying levels of research to uncover...Half Price Shares!
The latest earnings season “has clearly been a home run, knocking analysts’ expectations out of the park”, says Dirk van Dijk on Zacks.com. With around 80% of S&P 500 companies having reported, good surprises on earnings are outnumbering nasty ones by a factor of four to one. Average operating earnings are up almost 20% year-on-year, an unprecedented 18th straight quarter of double-digit growth, according to Standard and Poor’s. And the gains were broad-based, with every sector in the index managing year-over-year gains.
Fund managers are expecting robust earnings to spell good news for equities over the next few months. Of those in the Barron’s autumn survey, 64% describe themselves as bullish. “Stock prices have not kept pace with earnings growth in the past few months,” says Thomas Hull of Lowry Hill; he forecasts that markets will make up this ground quickly, with the Dow Jones reaching 12,450 by year-end and 13,100 by mid-2007.
Meanwhile, the fact that profits remained strong despite a very weak third quarter for US GDP growth suggests that a severe slowdown may be avoided, says van Dijk. “One can easily make an intellectually coherent case for a recession next year. However, there has never been a recession where earnings grow at anything close to a double-digit rate. This is the elephant in the room that must be explained by any recession predictor.”
But there’s a simple explanation, reckons David Rosenberg of Merrill Lynch. Earnings growth is not as good as it looks. Comparing GDP growth with earnings growth is misleading because the two numbers are not calculated in the same way. In addition, earnings growth has been flattered by several factors, such as share buybacks and by comparison with the Hurricane Katrina-depressed third quarter of 2005. If you recalculate earnings on the same basis as GDP, you get a 12% annual growth rate for earnings in the third quarter of 2006 – still decent, but decelerating from 15% in the second quarter, 16% in the first and 20% in the fourth quarter of 2005.
More importantly, the 10.5% earnings growth forecast by analysts for the current quarter would be a decline of 6.5% if measured in the same way as GDP. With productivity growth slowing, labour costs building and domestic demand weakening, “the profits recession has already started. It’s just not evident yet in the year-over-year numbers”.
FREE! For all our latest advice on making profitable investments, claim your 3-week FREE trial of the MoneyWeek website and magazine now.
Money Morning is the FREE daily email from MoneyWeek
– a punchy round-up of the latest investment news and profit opportunities.
DON’T MISS IT!
