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Tax breaks, cost-cutting and the worst job market since the Hoover administration were a recipe for corporate success in the third quarter. But the success could be short-lived.

While Americans aren't happy about continued job losses this year, U.S. companies have been reaping benefits. For the third quarter, the

S&P 500

components are expected to record earnings growth of around 15%, although the final number could be closer to 19%, according to Thomson First Call Director Chuck Hill. "It's going to be a good quarter earningswise with a lot of good news coming out," he said.

Few analysts dispute that profit growth will be strong in the current quarter, and energy, financial and technology stocks should contribute heavily to overall growth.

Lucent

(LU)

alone should add about 3 percentage points. The firm took a sizeable tax charge in the third quarter of last year and now faces a much easier comparison.

And while stocks have risen sharply over the past couple of months, earnings estimates have also risen, keeping the S&P's price-to-earnings ratio at 18 times this year's operating earnings and 16.5 times next year's profits. Based on normalized earnings, which compensate for earnings being at a peak or trough, the forward P/E stands at 17.5, according to Thomson First Call.

Although that's reasonable, Hill questions whether the earnings expectations, particularly in the tech sector, are attainable. And based on this year's GAAP earnings, the P/E is actually closer to 23.

For the S&P 500's P/E to move more in line with its historical average of 15, component companies would have to post aggregate operating earnings of $67 a share this year, instead of the projected $55.

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The question, as always, is how much longer the good times will last. That's where some analysts get nervous. Absent any negative surprises, the third quarter will see the biggest sequential rise in earnings so far in this recovery, "and at least at the moment, it looks bigger than any likely over the next few quarters," Hill said.

For the fourth quarter, analysts are calling for 22% growth, but the rate of increase will decline in 2004, with First Call predicting profit growth of 12.6% and 11.7% in the first and second quarters, respectively.

If the recent decline in the dollar continues, earnings will no doubt get a boost from favorable currency translations and increased demand overseas. But the dramatic cost-cutting -- much of which has come from the shedding of jobs -- is not likely to help out as much next year. In the third quarter, technology stocks are expected to grow earnings by 22%, but sales are slated to rise just 6%. That's a trend that can't continue for very long because at some point there won't be any extra expenses to cut without actually hurting business.

Analysts also note that capacity utilization rates are sitting stubbornly at 75%, with technology rates below 65%. This means companies aren't using their resources as much as they could be, and until they do, spending and hiring aren't likely to pick up. Meanwhile, some say earnings growth has been helped this year by government stimulus, which isn't likely to goose profits in 2004.

Richard Bernstein, chief quantitative strategist at Merrill Lynch, said his work suggests that the profits cycle may be peaking.

"If the profits cycle slows, it is hard for us to see how the market's rally continues unabated because most investors do not expect the profits cycle to slow," he said.

Bernstein readily admits that he has missed the rally this year, but he remains cautious on the market, noting that stocks are simply too speculative.

Hill also worries about the earnings outlook. "The question is what happens next year," he said. "My worry is that with all this good news, the market gets bid up and we get a market that's ahead of itself, even for higher expectations."

Prudential Securities Chief Investment Strategist Ed Yardeni is less concerned. Indeed, he recently raised his forecasts for next year's earnings. The weaker dollar will not only boost demand abroad but will raise prices in the U.S., he said, because imports will become more expensive. That should give firms more pricing power. He is not concerned about poor capacity utilization rates, saying profits can rebound even if this rate remains low because productivity is still strong.

And over the near term, things certainly look good. The ratio of negative to positive preannouncements for the third quarter stands at 1.6 compared to 2.2 at the same point last year. Aside from a 22% jump in technology earnings, investors can expect to see a 39% jump in energy profits and a 20% gain in financial earnings in the current quarter.

Still, a few ominous signs are already starting to show up. Hill notes that consumer cyclical stocks have not seen the positive revision activity that other sectors have had. "What's got to get us out of this is an increase in consumer spending and I'm worried that trends in the consumer dependent sector are not as strong as in other sectors," he said. "We're getting more and more convinced this is going to be a long, drawn out, gradual recovery."