U.S. Profit Forecasts May Be Too Rosy

Wall Steet Journal

A 4% economic-growth rate for 2011 now looks like a pipe dream. In that case, assumptions about corporate earnings may be high.

The rosy view most economists had at the start of the year has given way to a more sober reality. U.S. gross domestic product increased at just a 1.8% seasonally adjusted annual rate in the first quarter, and is likely to post a similarly disappointing 2% pace in the second, according to Barclays Capital. That is a far cry from the average 3.5% first-half pace economists polled by The Wall Street Journal expected as recently as February. And it means the economy will have to accelerate sharply in the months ahead to achieve 3%, let alone 4%, growth this year. While some pickup can be expected, especially as Japan-related supply disruptions fade, a doubling or tripling of the current rate seems quite unlikely. Indeed, the Blue Chip survey of economic forecasters out this week will show full-year GDP estimates falling as a result of the unexpected first-half weakness.

The stock market, though, has been slow to wake up to the change. Yes, the S&P 500 is down about 4% from its recent April 29 peak, but it is still up by some 20% from a year ago. The pillars supporting this strength are looking wobbly. The Federal Reserve’s latest bond-buying program is winding down at the end of this month. Growth in emerging markets like China and India, while enviably strong compared with Western countries, is cooling.

Most important is the trajectory of corporate earnings, whose strength has formed the bedrock of today’s market. Even as economic growth projections have been falling, analysts have continued to raise their full-year earnings estimates. In fact, they now expect earnings of nearly $100 per share for the S&P 500 this year, up about $4 since January to a record high.

The lower economic-growth projections mean those estimates are now looking lofty. « I think we’ll see a lot of earnings and revenue figures getting cut » in the weeks ahead, says Wells Fargo Chief Economist John Silvia. Such downgrades tend to trip up individual shares. They would also suggest stocks in general aren’t as cheap as they may currently appear.

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