Now, All Eyes Will Be on the Earnings Reports

If the U.S. economy is as hot as Friday’s June employment report suggests, owners of many stocks--especially technology issues--are wondering why nobody informed their companies.

After two weeks of forecasts of lower-than-expected second-quarter earnings from a barrage of tech firms, the bullish June employment report was something of a non sequitur. For whom, exactly, is the economy going so well?

Tech firms haven’t been alone in signaling earnings problems in the quarter just ended. U.S. auto makers all reported weaker-than-expected June sales. Cereal companies have launched a price war, and generic drug makers, mining and chemical firms are also suffering from weak pricing.

Ben Zacks, head of earnings tracking service Zacks Investment Research in Chicago, warns that second-quarter profits in general “will be penalized by the continuing strength of the U.S. dollar [devaluing foreign-derived earnings] and by margin pressure from a very competitive pricing environment.”

That presents a frightening specter: If many companies are having trouble maintaining prices but wages are increasing at an accelerating pace (as Friday’s employment data suggested), a profit squeeze could be ensuing.

That could mean that Friday’s 114.88-point plunge in the Dow Jones industrials, to 5,588.14, was just a scene-setter for much heavier selling, some analysts warn. Growing corporate profits have been a critical underpinning of the bull market. If earnings disappoint--and the Federal Reserve Board begins raising interest rates to slow the economy--stocks could suffer a double whammy.

David Shulman, investment strategist at brokerage Salomon Bros. in New York, believes that earnings for the blue-chip companies in the Standard & Poor’s 500-stock index are hitting a plateau after three years of strong growth.

Historically, Shulman says, the trend of U.S. corporate earnings has been relatively short periods of rapid growth followed by several years of stagnation.

The stagnation phase this time, he says, will stem from slower sales growth as world markets become more competitive, the stronger dollar, and from many companies’ inability to wring more profit out of cost-cutting.

For many tech firms, however, dashed hopes for good second-quarter earnings may be a function of something more basic: an old-fashioned inventory problem.

Computer sales soared in 1995 but have cooled this year, in turn slowing sales of peripheral equipment and software. Many tech firms, however, failed to account for the slowdown in their projections. Some even ramped up production, expecting last year’s launch of the Windows 95 personal computer operating system to fuel another sales boom.

But Windows 95 has shipped below projections. In the meantime, inventories of disk drives, peripheral equipment and software have built up, as semiconductors did last winter. In the second quarter, many tech companies chose to sell off excess inventories and reduce orders for components.

“Nobody wanted to hold inventory as prices dropped,” said David Brown, technology analyst at the California Technology Stock Letter in Half Moon Bay, Calif. As a result, he said, “we have an inventory correction at best and at worst the beginning of a [another] slowdown” in the computer business.

But some Wall Street pros advise against extrapolating the recent profit warnings of tech firms like FileNet Corp., Sybase Inc. and Digital Equipment Corp. into a broad commentary on earnings, tech or otherwise.

For one thing, analysts note that companies often pre-announce disappointments but rarely pre-announce when results will meet estimates. So the bummers naturally stand out early in the quarter.

Also, despite rising market interest rates in the second quarter, “housing, consumer spending on durable goods and business fixed investment have not buckled,” notes John R. Williams, economist at Bankers Trust Co. in New York. Nor has the overall U.S. inflation rate, certain industries’ pricing troubles notwithstanding.

Abby J. Cohen, investment strategist at Goldman, Sachs & Co. in New York, believes that the economy’s resilience will mean better earnings for many companies. “We think [earnings growth] accelerated in the second quarter,” she says confidently.

Earnings tracker Zacks says that despite the negatives of the strong dollar and pricing pressures, “these potential shortfalls should be more than offset by the benefit of stronger-than-expected [economic] growth in the quarter.” He sees better-than-expected earnings in such industries as financial services, oil and oil services, retail, and electric and gas utilities.

Meanwhile, tech stocks could just be ahead of the curve: Many may already be washed out and fully reflecting the industry’s current inventory correction. That could mean they are closer to a bottom than are many other stocks if the Fed begins to tighten credit and sparks fresh inventory corrections in other industries.