Profits: Expect a Third-Quarter Slowdown

S&P sees profits downshifting in the third quarter but anticipates a reversal in Q4 and solid earnings growth in 2008

Corporate America's profit engine will shift into a lower gear in the third quarter—and the weak housing sector is partly to blame. Third-quarter 2007 operating earnings for the Standard & Poor's 500-stock index are expected to post the lowest increase in more than five years, according to figures released Sept. 26 by S&P. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).)

Expected third-quarter earnings of $208.3 billion would represent a 2.4% gain over the $207.2 billion reported for the third quarter of 2006. The 2.4% gain would be the lowest rise in S&P 500 operating earnings since the first quarter of 2002, when the index posted a 1.1% quarterly year-over-year gain.

As-reported earnings are expected to increase 1.1% to $191.7 billion, vs. $193.2 billion. The 1.1% increase would represent the lowest as-reported earnings gain for the S&P 500 since the fourth quarter of 2002 when massive write-offs (due to a new accounting regulation) caused a 45% drop in quarterly year-over-year earnings.

Financial Services Falling

"Uncertainty over liquidity and the impact of the housing slump has spread into corporate earnings, causing a drastic increase in market volatility that hasn't been seen since 2002," says Howard Silverblatt, S&P senior index analyst. "In addition, because Standard & Poor's expects a down third quarter from financials—which is the largest sector component of the S&P 500—the impact on the overall index will not be difficult to see. You can't have a good earnings period without financials."

Profits in the financial-services sector are projected to fall 2.9% for the third quarter. This is significant because in the second quarter, financial-services stocks provided 28% of the overall profits posted by S&P 500 companies. As a sector, on a market-cap-weighted basis, financial-services stocks make up 19.9% of the "500."

Information Technology: Double-Digit Gain

Standard & Poor's notes a wide variance in sector projections. While telecommunications is expected to post a 25% gain, consumer discretionary, which includes the homebuilders and related issues, is projected to post its third quarterly decrease in a row, with a 10.8% year-over-year quarterly decline.

Bucking the downtrend is information technology. The sector, which has been mixed this year, is expected to post a double-digit earnings gain of 10.4%, after a 5.1% rise in the second quarter of 2007.

S&P expects that the softness in profit growth will be reversed in the fourth quarter. "While there was a significant slowdown in third-quarter earnings growth, we believe that the fourth quarter will see a return to double-digit growth for S&P 500 earnings," says Sam Stovall, S&P's chief investment strategist. "The momentum generated should help it to reach the high single digits for the year. Overall, Standard & Poor's Equity Research sees the S&P 500 experiencing solid earnings growth in 2008 that will lead to a 12% gain for the year."

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