Earnings Bolster Economic Outlook
People who still are downbeat about the U.S. economy are quickly running out of evidence to back that view.
To be bearish is to totally discount what chief executives such as Jim Owens, head of machinery giant Caterpillar Inc., are telling shareholders about 2004.
“It appears the world economy will have one of the strongest, broadest recoveries in years,” Owens said last week as Peoria, Ill.-based Caterpillar reported first-quarter financial results.
Even if you think that corporate talk is cheap, earnings have been anything but.
Caterpillar’s quarterly profit jumped more than threefold from a year earlier, to $412 million.
Qualcomm Inc., the San Diego company that is a leader in wireless phone technology, said its first-quarter profit more than quadrupled, to $488 million.
EBay Inc., the Internet auctioneer, said its results nearly doubled, to $200 million.
Corporate earnings overall have been rebounding since the spring of 2002. But much of the initial turnaround stemmed from brutal cost cutting.
The difference now is that many more companies are posting better earnings in large part because their sales are rising. That pickup in revenue is the tip-off that the economic expansion has entered a new and more vibrant phase.
Cost cutting is a painful and necessary strategy when the economy is weak, but most businesses realize they can’t cut their way to prosperity. It takes rising sales to make executives more confident about the future. As their customers spend more, they figure they can too.
As of Friday, 273 of the blue-chip companies in the Standard & Poor’s 500 stock index had reported their first-quarter results. On average for that group, sales were up 12.5% from a year earlier, according to data tracker Thomson First Call in Boston.
If that number stays on course as the rest of the companies in the index report their numbers, it would be the biggest year-over-year gain since the first quarter of 2001.
The sales data make sense in the context of other economic reports in recent months. On Friday, the government said orders to U.S. factories for durable goods -- big-ticket items such as appliances and industrial machinery -- jumped 3.4% in March from February. That far exceeded most analysts’ estimates.
“A lively manufacturing sector underscores the presence of a full-fledged economic recovery,” said John Lonski, economist at Moody’s Investors Service in New York.
It also should translate into more jobs, he and other economists say.
Yes, you’ve heard that one before. Hiring has been the missing ingredient in this recovery. The government’s March employment report, which showed a net gain of 308,000 nonfarm jobs in the month, offered the first strong sign that hiring was accelerating.
Lonski said the durable-goods report suggests that April could show a net gain of at least 200,000 jobs, as more companies staff up to meet rising demand.
Given first-quarter earnings reports, many executives certainly can’t argue that they lack the wherewithal to hire. Of the S&P; 500 companies that have reported results so far, the average year-over-year profit gain was 26.3%, according to Thomson First Call. That measures operating earnings, or results before one-time gains and losses.
How surprising has first-quarter profit growth been? Seventy-eight percent of S&P; 500 firms reporting so far have beaten Wall Street analysts’ estimates for the period. That is far above the quarterly norm of 58% since 1994, Thomson said.
What’s more, analysts haven’t just underestimated by a modest amount: At the start of the year, their consensus forecast for S&P; 500 firms was for 13.4% first-quarter growth, Thomson data show. Results are running about double that pace.
“We are struggling to find another time when earnings results were stacking up this way,” Thomson analysts said in a report to clients Friday.
Maybe Wall Street got it wrong because so many company executives continued to be excessively cautious in their guidance through the end of last year -- ongoing fallout, perhaps, from the steep plunge in earnings in 2000 and 2001.
But trash-talking the economy finally seems to be out of fashion in the executive suite. That’s apparent in the forecasts many companies are making for the rest of the year as they report first-quarter results.
That optimism was foreshadowed by a report from the business-sponsored Conference Board on April 5. The group’s quarterly survey of more than 100 U.S. chief executives showed that an index of their confidence level in the economy rose to a 20-year high in the first quarter.
As for their hiring plans, “Half of all CEOs anticipate an increase in employment levels in their industry, up significantly from less than 16% a year ago,” the Conference Board said.
Optimism about the economy even has spread to the Federal Reserve. Last week, Fed Chairman Alan Greenspan, testifying before Congress, said the central bank no longer was worried that the nation was at risk of a deflationary spiral, meaning a sustained decline in prices.
Greenspan referred to the economy’s growth rate as “vigorous” and said more companies were finding that they could raise prices, for the first time in quite a while. (That’s another factor behind robust first-quarter earnings.)
The better the economy gets, however, the question becomes, what could bust the boom?
On Wall Street, the primary concern is that the Fed will begin to tighten credit, driving up interest rates. In the bond market, many investors aren’t waiting for the Fed -- they’re bailing out of fixed-income securities now. The yield on the benchmark 10-year Treasury note surged to a six-month high of 4.46% by Friday from 4.34% a week earlier.
The stock market remains torn between excitement over corporate earnings growth and fear of higher interest rates. But last week the bulls prevailed: The S&P; 500 index rose 0.5% for the week; the Nasdaq composite index jumped 2.7%.
Stephen Roach, a Morgan Stanley economist who has been famously pessimistic over the last year, conceded in an interview last week that “the pendulum has swung heavily against those of us who are skeptical” about the economy.
Nonetheless, he said he remained concerned that two key forces driving the U.S. expansion -- the red-hot Chinese economy and the American consumer -- both were poised to weaken.
The Chinese government, Roach noted, has made clear in recent months that it would continue to put the brakes on growth, to avoid overheating. That would have implications for the rest of Asia and for the world.
As for U.S. consumers, Roach said they were “job-short, income-short and overly indebted” -- a recipe for slower spending ahead, he contends.
There are other worries. Energy prices remain high. And if the dollar continues to rebound, it could reverse some of the foreign sales and profit gains that have helped to boost U.S. companies’ recent results.
But Edward Yardeni, an economist at Prudential Equity Group in New York, said pessimists were grossly underestimating how business and consumer confidence could make an economic expansion self-perpetuating once it got traction.
“They forget about the economy’s ‘animal spirits’ as [John Maynard] Keynes referred to them,” Yardeni said. “The economy has its own bias to grow.”
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Tom Petruno can be reached at tom.petruno@latimes.com.
