US braces for sharp profits slowdown

US braces for sharp profits slowdown
By Francesco Guerrera in New York and Eoin Callan in Washington
Published: April 9 2007 20:13 | Last updated: April 9 2007 20:13
Copyright The Financial Times Limited 2007


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.