You Didn’t Read it in the Journal: Profit Outlook Lousy

Is the Wall Street Journal averse to bad news? That may seem a bizarre question to ask about any news organization, since by definition, most news is bad news. But we’ve noted before that the Journal has seemed particularly loath to pick up on certain stories that were covered aggressively in the Financial Times, such as the pervasive cavalier attitude towards risk, the extraordinary use of leverage (and the growth of leverage-on-leverage, for example, via hedge fund of funds), and institutional investor pressure to reduce CEO pay.

We saw another instance today. The FT ran an eye-catching story as the first item in its front page news summary, and in full on the first page of the second section, “US braces for sharp profits slowdown.” We’ve seen nothing of this sort in the Journal, and we waited until a bit late in the day to see if the WSJ might pick up on this item. The closest we got was the daily market report, “Stocks Calm Before Earnings Storm.”

Why would the Journal be loath to report downbeat news (and notice that what it seems to be avoiding isn’t company-specific news, but more general stories its readership might be happier not seeing)? Is this example, they didn’t report on a broad-based negative profits outlook, which could translate into lower stock prices (you would think that would be hard to miss). Admittedly, the FT’s most definitive quote came from a perma-bear, but we have read plenty of posts on the web by professional investors that have been increasingly concerned about the profit outlook, so it has the signs of being a widespread concern.

Is this a manifestation of what we once termed the Tinkerbell Market, where the market is held aloft by belief, and participants conspire to stoke the faith? We hope not.

From the FT:

US companies are bracing themselves for a sharp fall in profit growth this year, amid rising fears that corporate America’s woes will exacerbate the expected economic slowdown.

Wall Street analysts and economists are warning that the end to a record run of profit increases along with already anaemic business investment by US companies could have serious repercussions on the domestic economy.

Any slackening in the pace of earnings growth could also unsettle equity markets as corporate profits have been one of the key drivers behind the prolonged resilience of US stocks.

“The situation is fairly precarious,” said David Rosenberg, chief North American economist at Merrill Lynch. “The typical chief executive sees a slowing economy and acts accordingly.”

Mr Rosenberg, one of the most bearish analysts on Wall Street, last week reduced his forecasts for US economic growth in the first quarter of this year to 1.8 per cent from 2.2 per cent. The US economy grew at 2.5 per cent in the last quarter of 2006, according to the latest official figures.

Companies in the benchmark S&P 500 index have been increasing year-on-year profits at a double digit rate every quarter for more than four years. However, the record streak is about to come to an abrupt end, with Wall Street analysts forecasting an increase of just 5.1 per cent for the first quarter of this year, according to Reuters Estimates.

Companies in basic materials, energy and cyclical consumer goods are expected to bear the brunt of the slowdown, due to falling prices and lower demand for their goods.

Experts say lower profit growth is to be expected given the slowdown in the economy. Some argue that soft earnings growth need not translate into soft stock markets because valuations will be supported by the recent record levels of share buybacks and merger activity. Solid economic growth in the rest of the world should also help the earnings of US companies with overseas operations. “Will weaker growth erode equity markets returns? The short answer is ‘no’,” wrote UBS economist Larry Hatheway in a recent note to clients.

Nevertheless, economists and policymakers remain puzzled by the persistent weakness in business spending, with companies seemingly reluctant to plough their historically high profits back into capital expenditure.

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One comment

  1. unlawflcombatnt

    The fact that companies are not plowing their record profits back into capital goods investment seems pretty easy to understand. They’re anticipating a growth slowdown and a decline in demand for goods produced. Investment to increase production capacity wouldn’t make sense if there wasn’t an anticipated increase in sale of production. With real wages stagnating, and employment increases barely keeping up with labor force growth, there’s no indication consumers will have more money to spend. And with credit tightening and home equity extraction declining, there’s no reason to think consumers will have more borrowed money to spend either. There is simply nothing on the horizon to prop up consumer spending, meaning there’s nothing to prop up production demand. So investors are simply plowing their money into debt purchase and share buybacks, rather than into anything to increase production.

    Economic Populist Forum

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