Profits at American companies are poised to be one of the few bright spots in the U.S., helping to steady the faltering recovery.
Earnings will climb an average 10 percent 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 Inc. (M) has raised its annual profit forecast, Intel Corp. (INTC) and Target Corp. (TGT) increased dividends and DuPont Co. plans to invest more than $500 million to boost production.
Surging overseas sales, improving U.S. 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, is sparking concern about the expansion’s sustainability. Even so, private employers have added 2.14 million workers since job creation resumed in March 2010, nine months after the recession ended. That’s about a quarter of the 8.8 million positions lost during the 18-month slump.
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 percent growth rate in the third and fourth quarters, with profit gains accelerating to 10 percent, Mellman said.
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 percent this year from the end of 2010, he said, compared with about 1 percent as of June 10.
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.
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 U.S. 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 percent to 21 cents, while Target, the second-largest U.S. discount retailer, announced June 8 a 20 percent 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 percent 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.
The “enormous” gains came despite little help from the economy, Mellman said. Adjusted for inflation, growth averaged 1.5 percent 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 percent annual pace in January-March from the prior quarter, while gross domestic product expanded 1.8 percent.
Companies are starting to get relief from energy costs, as crude oil has fallen 13 percent 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 labor market, said Joseph Carson, director of global economic research at AllianceBernstein LP 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.”
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 Inc. in New York. Hiring plans were the highest in five years.
The results are consistent with analysts’ forecasts for a 14.5 percent gain from a year ago in the second-quarter earnings of S&P 500 companies, ISI said.
‘Lifeblood’ of Cycles
“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 U.S. has “the foundation for a strong recovery.”
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 percent since the recovery began, six times faster than the 7 percent rise in nominal GDP, Carson said, with the surge led by domestic industries, which posted a 52 percent jump in earnings.
Even more compelling is the long-term boost American companies are getting from their overseas earnings, which grew an average 12 percent during the past decade, or about double the rise in the U.S., 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 metric tons of annual capacity across five sites in the U.S., Mexico and Taiwan, said the Wilmington, Delaware-based company, the world’s largest maker of the paint ingredient.
Even as companies see their bottom lines improving, the gains are taking time to trickle down to employees. Seven quarters after the recession ended, labor costs are running 2.3 percent below the second quarter of 2009, according to Jonathan Basile, senior economist at Credit Suisse in New York. In the nine other postwar recoveries, labor costs rose by an average 2.7 percent 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 percent 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.”
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