August 19, 2022

Profit Lag May Dampen Stock Rally

Stocks have seesawed much of this year as investors worried about higher commodity prices, the Japanese tsunami’s impact on global supply lines and Europe’s debt crisis.

Now a string of second-quarter corporate earnings announcements due over the next few weeks could confirm that companies are beginning to have a harder time.

Higher gas prices are soaking up already weak consumer spending, banks are struggling and labor costs may be starting to pick up, squeezing business’s profit margins meaningfully for the first time.

All of that could spell more trouble for the stock market. Stocks rallied sharply last week after the Greek Parliament passed austerity measures. But some analysts question how long the rally will last. If it does not endure, it could complicate the economic picture as these two pistons of the already sputtering economy, profits and the stock market, fire less powerfully.

“For the first time in this economic cycle, there is going to be a fair number of disappointments,” said Doug Cliggott, an analyst at Credit Suisse, referring to the earnings reports. “The economy is going to be without those drivers.”

Europe’s debt crisis may be far from over. Standard Poor’s, the credit rating agency, said on Monday that a plan promoted by France for French and German banks to roll over their large holdings of Greek government debt would in fact amount to a default by Greece, raising questions about how the indebted nation could qualify for a much-needed second bailout.

On the other hand, some analysts are predicting a relatively rosy United States profits season that belies the continued grim domestic economic news. They think companies will do well, since consumers have made some progress in trimming their debt and may be prepared to start spending again. Energy prices have at least stopped going up.

“We are going to get good news out of the corporate sector and markets can move higher,” said Jack Caffrey, equity strategist at J.P. Morgan.

The 5.4 percent jump in the Dow Jones industrial average last week, in one of its strongest weeks in two years, seemed to support that optimism.

Already some investment professionals are predicting that the Standard Poor’s 500-stock index may be back at 1,400 or higher by year-end, if not sooner; it closed at 1,339.67 on Friday. Some are making comparisons with last year, when after a few rocky months markets touched lows in the first week of July — and soared for most of the rest of the year.

“With the exception of the bust of late 2008/early 2009, U.S. stocks are now the cheapest they have been in 20 years,” Steve Sjuggerud, editor of True Wealth, an investment newsletter, wrote in June. He forecasts that the S.P. 500 will be back at 1,450 by year’s end.

But the bears believe that optimism is overdone.

In addition to Europe’s troubles, they point to continued poor United States economic numbers.

Last month the Federal Reserve revised its expectations for economic growth down to a range of 2.7 percent to 2.9 percent, from 3.1 percent to 3.3 percent in April. Many independent economists are more pessimistic. There is a risk that the economy will struggle further from budget and job cuts at the local and state levels, and even at the federal level, depending on the debate about the debt ceiling.

A further drag could be the end of the Fed’s $600 billion asset buying program, which had been buoying stocks since last fall.

Companies had been socking away profits by, among other things, keeping down labor costs and increasing productivity, but their profit margins may now be squeezed as both their unit wage costs and investment spending begin to rise.

Credit Suisse expects the stock market to end the year below its current level, with the S.P. 500 at about 1,275.

“Analysts are expecting blockbuster earnings numbers, but I am not so sure,” said Jeffrey Kleintop, chief market strategist at LPL Financial. “We have a defensive strategy.”

Mr. Kleintop said corporate leaders would most likely reduce their earnings guidance for the second half of this year when they announce their results for the second quarter.

The early earnings reports have been mixed. FedEx reported net income up 33 percent for its fourth quarter, which ended May 31, compared with the same quarter a year earlier — heartening the bulls who see the company as a good bellwether for the rest of the economy.

Frederick W. Smith, FedEx’s chairman, said in a conference call with analysts that the economy had been through a brief soft patch.

Eric Dash contributed reporting.

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