Wednesday, October 10, 2007

Profit Growth Slowing Sharply

A wave of earnings warnings in recent days, from particularly banks but also energy companies and International Paper, means that official profit growth estimates for the S&P 500 companies is likely to turn negative. Just last week, I reported them to be 3%. Actual earnings growth might actually still end up at 3% as companies on average always beat the official estimates that is presented just before the reports, on average by 3%. Still, 3% would be unusually low and it implies that stocks are very expensive indeed, considering that prices are 16% higher than a year ago. Loose monetary conditions and hopes of more Fed rate cuts could perhaps push stocks even higher in the coming weeks despite the fact that stocks are highly overvalued, but clearly the downside risks are much greater than the upside potential.

Moreover, it seems safe to say that the entire increase and more will come from foreign operations, as the sharp decline in the dollar not only raises margins of exporters but also raises the dollar value of foreign profits. If say half of all profits are foreign and the dollar falls 10%, then even if the dollar value of domestic profits are flat and even if the euro or pound value of foreign operations profits are flat too, then the dollar value of total profits rises 5%. And with the S&P 500 companies being far more globalized than other American companies, then this implies that we likely saw falling profits even in nominal terms for the U.S. economy as a whole. That is very bearish for business investments, of course.


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