By Sam Stovall On Nov. 26, the National Bureau of Economic Research finally admitted that the U.S. economy had slipped into recession back in March 2001. For Corporate America, though, the contraction -- in the form of a profits recession -- really began back in the fourth quarter of 2000. That's when operating earnings for the S&P 500 fell 5% from the level of a year earlier.
Few investors would have expected that the red ink would continue to flow into the next five quarters (and counting). But flow it has.
IN THE RED. In the beginning of 2001, many thought that the U.S. economy would undergo a modest slowdown during the year's first half. The causes? The hangover from the Federal Reserve's rate-tightening program that lasted from the middle of 1999 until early 2000. On top of that, substantially higher energy prices were expected to drag down consumer spending. Most everyone projected a modest recovery in the second half of 2001, since the Fed started lowering interest rates in January and hefty manufacturing inventory levels had been worked down.
Yet recession, not recovery, became the catchword in 2001's second half after the terrorist attacks on September 11 nearly halted business outlays and severely curtailed consumer spending. As a result, a string of negative quarterly earnings reports for the S&P 500 was extended and deepened.
In total, Standard & Poor's analysts believe that operating earnings for the S&P 500 will fall 27% during 2001, as the Technology sector swings to a loss from a year-earlier profit and the Telecommunications, Materials, and Consumer Discretionary sectors post respective declines of 52%, 48% and 35%. In fact, 64 of the 103 industries in the S&P, or more than 62%, are expected to report a decline in full-year earnings in 2001.
There are a few bright spots, however. Of the 10 sectors in the S&P 500, Health Care, Utilities, Consumer Staples, and Energy are projected to report modest earnings advances of 11%, 9%, 7% and 2%, respectively.
On the whole, though, 2001 will be remembered as a very tough year for corporate earnings.
TURNING AROUND. But 2002 looks different, as both the U.S. economy and corporate earnings are expected to improve. Take a look at the table below, which shows S&P analysts' estimates for operating earnings growth on both a quarterly year-over-year and full-year basis for the 10 sectors in the S&P 500 as of mid-December, 2001. During 2002, the S&P 500 is projected to post an earnings increase of more than 30%, driven by a rebounding economy, renewed consumer spending and still-strong productivity.
Which groups are likely to do the best? The greatest earnings advances are likely to come from the economically sensitive sectors as the economy rebounds. In addition, since these sectors saw their earnings fall so precipitously in 2001, they are starting the New Year from very low bases, which could magnify even small advances. Only the Energy sector is projected to post an earnings decline, due to dramatically lower oil and natural gas prices, as well as a reduction in demand for drilling equipment and services.
The usual caveats apply, of course. There is no guarantee that this recession will end in March, 2002, as S&P predicts. Things that could derail an economic recovery, as well as a rebound in corporate earnings, include a disruption in oil supplies or another terrorist attack. Oil supply disruptions, either because of terrorist attacks on pipelines, refineries, or production or, more seriously, war or revolution in the Middle East, could cause energy prices to spike even higher than they did during the Gulf War.
And another terror attack could deepen consumer gloom. Americans are resilient, and are recovering from the impact of September 11. But if another major attack occurs, confidence could plunge again, delaying the consumer recovery.
Barring these events, S&P expects the earnings picture in 2002 to be a mirror image of 2001. And that's welcome news indeed.
Projected Perecentage Changes in Year-Over-Year Operating EPS in 2002 for the Sectors in the S&P 500
Stovall is senior investment strategist for Standard & Poor's