Corporate Earnings Are No Sign of Recovery

Author: admin

11 Aug

Despite grim predictions, most major U.S. companies have reported positive earnings for the second quarter of 2009. Given how wrong past predictions have been, the fact that earnings have blown away expectations shouldn’t be so surprising. Still, the numbers are genuinely impressive: More than 73% of the companies that have reported so far have beaten earnings estimates—and stocks have rightly rallied.

Yes, profits are down sharply from a year ago, but this is in the context of an overall global economy that is shrinking. If a company made $30 million on $100 million in revenue a year ago, and made “only” $20 million this quarter, it’s accurate to have a headline that says its profits fell 33%. But making $20 million, or a 20% margin, in an economy that contracted is nonetheless startling, or should be.

The same Wall Street culture that failed to anticipate the tipping point in the financial system is just as prone to a herd mentality of negativity. Having overlooked the gaping fissures in the system last year, most analysts went to the other extreme in their analysis of what would happen this year. A similar process occurred in 2002 and 2003, as views whipsawed from unrealistic optimism to irrational pessimism.

This time, the slew of better earnings has also led to the conviction that the worst of the economic travails are behind us. As the stock market has soared, many have declared the recession either over or ending. These voices range from public officials at the Federal Reserve to notable pessimists such as New York University economist Nouriel Roubini. This rosy view assumes a connection between how listed companies are fairing and how the national economy will fair. That assumption is wrong.

The delinkage of the fate of corporate profits from that of the overall economy is not new. Beginning earlier in this decade, profits began to accelerate far in excess of either global or U.S. economic growth. Next >>