Corporate America closed its books on the second quarter last Friday. But as Wall Street eagerly awaits the quarter's earnings tally, its attention has turned to the rest of the year. With the latest chapter in the bag, there is one question on every investor's mind: Will earnings recover in 2001?
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Over the past four weeks, a broad swath of companies have confessed that second-quarter numbers will fall short of forecasts, and Wall Street has been fairly forgiving. In the past few days, the market has shrugged off warnings from the cyclical companies, such as
, and technology businesses, such as
Applied Micro Circuits
, leading some to believe the worst is over.
Currently, investors are debating whether or not earnings will accelerate later this year. Optimists point to aggressive monetary and fiscal policy, strength in consumer confidence, and signs of an earnings bottom from businesses. Meanwhile, pessimists note that plenty of companies have not seen improvement, capital spending is weak, and productivity has slowed.
While the jury is still out on an earnings turnaround, the opposing arguments in the debate have taken shape. Let's explore the five reasons why earnings will recover this year, then list five reasons why there is little chance for a turnaround. Time will tell, but bulls and bears are already making their bets ...
The Optimists' Take
1. Can You Say 'The Fed?'
Federal Reserve lowered short-term interest rates six times this year in order to give the lagging economy a shot in the arm. "The money supply has seen unprecedented growth," said Tony Crescenzi, chief bond market strategist at
. "The lag effect of interest-rate cuts will be a source of stimulus." In June, the M3 broad money supply measure (it includes, among other things, currency in circulation, money in savings accounts, and deposits over $100,000) registered its highest year-over-year gain in 20 years.
2. Consumers Are Confident
Studies show consumers, who have held up the economy like Atlas as corporations have sputtered, remain upbeat. Last week, the
consumer sentiment index touched its highest level since January, while the
consumer confidence index reached a peak for the year. "That's good news, since consumers are keeping the economy afloat," said Bruce Steinberg, economist at
, in a research note on Friday.
3. Rebates Are on the Way
As part of the government's $1.35 trillion, 10-year tax cut, it will begin to mail 98 million rebate checks, which economists estimate will total between $38 billion and $40 billion, to American taxpayers at the end of July. "While there has been some debate as to the actual short-term stimulating effects of the rebates, some estimate it may increase
GDP by 0.5% to 1.5% this year," said Joseph Kalinowski, equity strategist at
Thomson Financial/First Call
in a research note on Monday.
4. Inventories Have Begun To Work Off
Excess inventory, a condition that has plagued the technology industry for more than a year, has begun to ligthen up. The first-quarter
gross domestic product showed the biggest drop in inventories in 10 years. Business inventories declined for two months in a row, in February and March, for the first time since the end of the last recession in 1991.
5. Companies See the Bottom
Bulls are gaining confidence as big-name companies point to greener pastures. When software giant
stated earnings in mid-June, it said the worst might be behind it. "Oracle,
are speaking to demand," said Art Hogan, market analyst at
The Pessimists' Take
1. Companies Don't See The Bottom
Blue-chip companies are raising red flags about their 2001 earnings outlooks. Less than two weeks ago, drug giant
, for instance, warned about its second-quarter and full-year earnings amid a slowdown in Vioxx sales. "I'm not sure the market was ever convinced that Oracle is a turning point," said Matt Johnson, head of Nasdaq trading at
2. Businesses Aren't Spending
durable goods orders report, released last week, showed a hefty pickup in demand for certain items. But core-capital goods orders, a key gauge of capital spending, rose only modestly. "Capital spending remains on a downward trend, as corporate America continues to slash costs in an effort to preserve profit margins," said Christopher Wiegand, economist at
Salomon Smith Barney
, in a research note last week.
3. The Other Shoe Is Dropping In Europe
kicked off the current preannouncement season by warning that its fiscal fourth-quarter earnings would be lower than expected, due to an economic slowdown abroad. And several other companies, including 3M,
, cited problems overseas in their confessions. "Europe is not providing an avenue of growth for the U.S.," said Josh Feinman, chief economist at
Deutsche Asset Management Americas
. "It is constraining export opportunities."
4. The Market Is Nervous
Since the beginning of June, the
S&P 500 is off 1.9%. The
Dow Jones Industrial Average is behind 1.9%, while the
Nasdaq Composite is lower by 4.2%. "If the equity market weakens significantly over the next few months, it could offset the positive effects of other forces," said Crescenzi, who is nonetheless optimistic about an earnings recovery this year. "It could reduce business confidence."
5. Productivity Is Slowing, Layoffs Are Rising
First-quarter productivity figures, which reflect how efficient workers are in the U.S., showed the biggest decline since the first quarter of 1993. Meanwhile, unit labor costs, which represent the cost of an employee's output, registered the biggest gain since the fourth quarter of 1990. "Cost pressures are significant for most U.S. companies," said Thomas Van Leuven, stock market strategist at
. More layoffs, as productivity slows, are worrisome particularly for the technology industry. Just last week,
all announced job cuts.