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Will Corporate Profits Deliver in 2008?

Thu, May 29 2008, 23:18 GMT
by Asha Bangalore

Northern Trust

Will Corporate Profits Deliver in 2008?

Real gross domestic product of the U.S. economy grew at an annual rate of 0.9% in the first quarter of 2008, revised from the advance estimate of a 0.6% gain. In addition to revisions of several components, the main story is about corporate profits. Corporate profits increased 1.3% in the first quarter following substantial declines in the third and fourth quarters of 2007. On a year-to-year basis, corporate profits moved up 1.7%, the fifth consecutive gain that is below 5.0% (see chart 1). On an annual average basis, corporate profits increased 2.7% in 2007, following five consecutive annual gains ranging between 11.5% and 15.5%.

Of greater interest is the source of these profits. Corporate profits have advanced entirely due to earnings from abroad resulting from the weakness of the dollar (see chart 2). On a year-to-year basis, corporate profits from the rest of the world grew 34.9%, the sixth consecutive increase in double digits. At the same time, corporate profits from domestic industries fell 6.2%, marking the fourth decline in the past five quarters. Moreover, within the domestic sector, corporate profits of the financial sector declined 12.2% from a year ago and corporate profits from the non-financial sector fell 2.6%. The bottoms up First Call S&P 500 earnings forecast for 2008 is a 10.5% gain. In light of these details, is it not legitimate to question the validity of the strong corporate earnings forecasts for 2008? Will earnings from abroad continue to support growth of corporate profits? When will profits from domestic operations post gains? Given projections of a weak economy, might it be appropriate to say that profits from domestic industries are most likely to stay on the weak-side in the near term?

Moving on to the details of revisions, they paint a slightly different picture of the economy than estimated a month ago. Inventories subtracted from real GDP for the second quarter in a row (-$14.4 billion vs. +$1.8 billion in the advance estimate). The trade gap (-$480.2 billion vs. -$495.9 billion in the advance estimate) is narrower than the advance estimate not because exports were stronger but due to a drop in imports (-2.6% vs. +2.5% in the advance estimate). Business capital spending is weaker (-0.9% vs. -0.7% in the advance estimate), but outlays on structures rose (+1.1% vs. -6.2% in the advance report) compared with the first estimate. Consumer spending was left unchanged at a 1.0% annualized increase.

Private sector demand -- the sum of consumer spending and fixed investment (structures, equipment and software spending, and residential investment expenditures) declined at an annual rate of 0.6% in the first quarter (see chart 4). Essentially, after revisions, demand still remains significantly weak.

The FOMC is most likely to stay hold for the rest of the year assuming financial markets remain relatively calm. The odds for a lower federal funds rate are greater than the odds for a higher federal funds rate given the risk of weaker economic conditions and/or financial market disruptions.

Jobless Claims – Severely Weak Labor Market Conditions Persist

Initial jobless claims rose 4,000 to 372,000 during the week ended May 24. Continuing claims, which lag initial claims by one week, rose 36,000 to 3.104 million, the largest number since February 2004 (see chart 5). The sharp upward trend of continuing claims in 2008 is supportive of the position the doves in the FOMC are holding. On a year-to-year basis, continuing claims rose 25.6%, the highest since May 2002 (see chart 6). The insured unemployment rate held steady at 2.3%.
Chart

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Published on  Thu, May 29 2008, 23:22 GMT