Profits at American companies are poised to be one of the few bright spots in the US, helping to steady the faltering recovery.
Earnings will climb an average 10 per cent a year through 2013, more than three times quicker than the economy, after what has already been the fastest rebound since the late 1940s, JPMorgan Chase & Co projects. In mounting signs of confidence, Macy’s has raised its annual profit forecast, Intel and Target Corp increased dividends and DuPont plans to invest more than $500 million to boost production.
Surging overseas sales, improving US demand and the Federal Reserve’s pledge to keep interest rates close to zero for an extended period bode well for earnings, said Robert Mellman, an economist at JPMorgan who has tracked corporate profits since 1985 and published a special report May 20 on the subject. Widening margins will give businesses the means and incentive to invest and hire, paving the way for accelerating growth in the world’s largest economy, he predicted.
“Corporate profits have plenty of room to run,” as “returns on investing and expanding are high,” Mellman said in a June 10 interview from New York. “This makes companies want to grow the business. As profitability remains strong, they’ll increase hiring.”
The recent spate of weak economic data, capped by news that payrolls grew in May at the slowest pace in eight months, has sparked concern about the expansion’s sustainability. Even so, JPMorgan projects growth will pick up in the second half as higher energy costs and supply-chain disruptions subside. The economy will return to a 3 per cent growth rate in the third and fourth quarters, with profit gains accelerating to 10 per cent, Mellman said.
10% RISE
The earnings trend likely will mean a boost for the stock market, predicts John Carey, a Boston-based money manager at Pioneer Investments, which oversees about $250 billion. It’s “reasonable” to expect the Standard & Poor’s 500 Index will be up 10 per cent this year from the end of 2010, he said, compared with about 1 per cent as of June 10.
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Investors in financial companies such as banks may see some “nice gains,” and technology stocks including semiconductors are a good bet, Carey said. Mergers, acquisitions and share-repurchase activity also may pick up, while dividend increases will become more widespread and frequent as companies armed with stronger balance sheets put their cash to work.
“There’s certainly a lot of gunpowder,” Carey said.
BEATING PROJECTIONS
Cincinnati-based Macy’s, which slashed its quarterly dividend to 5 cents a share from 13.25 cents in early 2009, said May 11 it will double the payout to 10 cents. The same day, the second-biggest US department-store chain boosted its 2011 profit forecast to as much as $2.45, above analysts’ projections of $2.35 a share according to the average of 14 estimates compiled by Bloomberg.
Intel, the world’s largest chipmaker, also raised its dividend May 11 by 16 per cent to 21 cents, while Target, the second-largest US discount retailer, announced June 8 a 20 per cent boost in its dividend to 30 cents.
“Conditions for better corporate profits will be there for the next couple of years, barring some catastrophe,” Carey said. “If this is going to be a normal business cycle, we have a lot of growth still to come.”
Earnings, adjusted for depreciation and inventory costs, surged at an average annual rate of 29.9 per cent in the eight quarters through the end of 2010, the strongest such growth in more than half a century, according to the JPMorgan report, which Mellman wrote with Chief Economist Bruce Kasman.
‘ENORMOUS’ GAINS
The “enormous” gains came despite little help from the economy, Mellman said. Adjusted for inflation, growth averaged 1.5 per cent a year during the period. Businesses also lacked the power to raise prices during the final months of the recession, which ended June 2009, and in the early stages of the recovery.
Given this backdrop, the profits rebound is sustainable for at least three years, albeit at less lofty growth rates, Mellman said. The latest figures show earnings rising at a 5.3 per cent annual pace in January-March from the prior quarter, while gross domestic product expanded 1.8 per cent.
Companies are starting to get relief from energy costs, as crude oil has fallen 13 per cent from this year’s peak of $113.93 on April 29. Businesses also have more clarity on the parts-supply shortages caused by the March earthquake in Japan, and a rebound in motor-vehicle production is “a bullish sign” for the labour market, said Joseph Carson, director of global economic research at AllianceBernstein in New York.
“We have a lot of positives lined up,” Carson said. “Unless we see a big change in underlying conditions such as balance-sheet strength, record liquidity, pent-up demand and easy monetary policy, I doubt the economy is at risk.”
MORE OPTIMISTIC
Some executives already are looking past the soft patch. A survey of 99 companies completed June 6 showed businesses are more optimistic about capital spending for this year than they’ve been since records began in 2003, according to a report from ISI Group in New York. Hiring plans were the highest in five years.
The results are consistent with analysts’ forecasts for a 14.5 per cent gain from a year ago in the second-quarter earnings of S&P 500 companies, ISI said.
“The corporate sector is in much better shape today than it was in past cycles,” Carson said. Given that “liquidity is the lifeblood of all cycles,” the US has “the foundation for a strong recovery.”
DOMESTIC SURGE
Companies in the S&P index had $2.58 trillion in cash and short-term investments at the end of the last quarter, according to Bloomberg data. Operating profits increased a cumulative 44 per cent since the recovery began, six times faster than the 7 per cent rise in nominal GDP, Carson said, with the surge led by domestic industries, which posted a 52 per cent jump in earnings.
Even more compelling is the long-term boost American companies are getting from their overseas earnings, which grew an average 12 per cent during the past decade, or about double the rise in the US, Carson said.
“Strong profits create the incentive to generate more profits,” he said. “That comes through investment.”
DuPont said May 11 it plans to increase production of titanium-dioxide pigment by about one-third to satisfy rising global demand. It will add about 350,000 tonnes of annual capacity across five sites in the US, Mexico and Taiwan, said the Wilmington, Delaware-based company, the world’s largest maker of the paint ingredient.
TRICKLE DOWN
Even as companies see their bottom lines improving, the gains are taking time to trickle down to employees. Seven quarters after the recession ended, labour costs are running 2.3 per cent below the second quarter of 2009, according to Jonathan Basile, senior economist at Credit Suisse in New York. In the nine other post-war recoveries, labour costs rose by an average 2.7 per cent in the same period.
“Employment growth will gradually get better, but the increase in wages for each worker will remain weak,” Mellman said. Unemployment exceeding 9 per cent and a pool of almost 14 million Americans without a job give workers little leeway to ask for higher pay. That means the Fed will stick to its “low- for-long” policy on interest rates for some time, he said.
“With increasing profits and a lower jobless rate, at some point wages start to go up as workers get more bargaining power,” Mellman said. “But we’re probably a few years away from that.”