Relax. Earnings Will Be Better Than You Think

Is the party over? The Federal Reserve, which has raised interest rates seven times over the past year, should finally reach its goal of slowing the economy in 1995. With BUSINESS WEEK forecasters expecting the economy's growth rate to cool to 2.5% this year from the surprisingly strong 4% in 1994, overall corporate profits are likely to be squeezed. More restrained consumer and business spending will hold down revenue gains, while slightly higher labor bills will begin to put pressure on costs.

But it's by no means certain that the new economic environment will have the chilling across-the-board impact that Corporate America fears. True, many companies won't be able to downshift smoothly. But keep in mind that 2.5% growth is nothing to sneer at. What's more, a host of industries will continue to prosper regardless of the tighter monetary policy (table).

Computer software and telecommunications should weather the new climate with hardly a hair out of place, say analysts. Even though the pace of capital spending will slow, corporations are still expected to make huge purchases of high-tech equipment as they seek to improve productivity.

Surprisingly, cyclical industries, the traditional victims of slower growth, are also expected to do well. Many economists believe rebounding economies in Europe and Asia will continue to fuel demand for everything from paper products to chemicals--offsetting the anticipated downturn at home. Morris Cohen, an economic consultant in Hackensack, N.J., is particularly optimistic about machine tools because of the European recovery. "A big gain in exports should help to offset a drag in domestic orders" especially from auto makers, he says.

FEWER SOFAS. And with aggregate demand healthy, some experts believe that many U.S. companies will be able to raise their prices and preserve the profit margins they have so painfully acquired in recent years. "There won't be a slowing in profit margins," says James R. Solloway, director of research at Argus Research Corp., "only a slowing in their growth rate."

Of course, not every sector will thrive in the year ahead. Businesses that produce big-ticket consumer goods are the most vulnerable. Already, retail sales of autos and furniture fell in January. Homebuilding, too, is slowing. As a result, analysts at Standard & Poor's Corp. are down on industries that feed materials to these sectors: Cuts in auto and truck output reduce the demand for the lead that fills car batteries. Weaker housing sales mean fewer consumers are buying sofas, carpeting, and La-Z-Boys. That pinches demand for textiles, 37% of which are used in home furnishings.

The Fed's tightening will also hit services. Truckers and wholesalers that distribute consumer goods will struggle to stay on their feet this year. So will financial services, especially if short-term interest rates go higher. That means 1995 will not bring all good news for corporate planners, but the soft landing won't clip everyone's wings, either.

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