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Weak Economy, Strong Profits?

 

By Joel Dresang

In the run-up of corporate profitability and the slowdown of the U.S. economy, a disconnect is emerging in the minds of some investors, says Bob Landaas, president of Landaas & Company.

“They scratch their heads and wonder how is it even remotely possible that America is going to return to pre-crash corporate profitability levels by the summer of 2011 when so many people are out of work and the housing market is in a shambles?” Bob says.

And yet, nearly half of the Standard & Poor’s 500 large companies have reported second-quarter results so far, and their combined earnings per share are up 54.1% from the second quarter of 2009. The S&P 500’s earnings will grow another 26.5% by the second quarter of 2011, according to estimates from analysts surveyed by Bloomberg financial services.

Meantime, the Federal Reserve has curbed enthusiasm for a swift rebound from the worst recession since the Great Depression. And U.S. consumers – whose spending drives about 70% of the nation’s output – have turned sour on prospects for improved job markets or higher incomes. The Conference Board’s consumer confidence index dipped in July for the second month in a row.

Economic weakness

“So many people tell me they look around the country and things don’t look very good,” Bob says. “Everybody knows somebody who’s struggling financially. Everybody knows somebody who’s having problems selling a house, have kids who are unemployed, have a spouse who’s unemployed. So everybody can relate to the economic weakness that the country is experiencing.”

The disconnect, Bob says, is that in a global economy, domestic conditions don’t necessarily reflect corporate prospects. Despite the state of the U.S. economy and low expectations for its progress, corporations overall are in fine fettle thanks to internal discipline and overseas markets.

“What everybody wants the government to do, corporate America has already done,” Bob says. “They’ve downsized. They’ve right-sized. They’re living within their means and sitting on mountains of cash. And when you invest in the stock market, it’s all about earnings, and earnings at this point are expected to climb. Ultimately, that’ll lift stock prices.”

Unlike past recoveries, domestic consumer spending is not leading the U.S. economy out of a recession, Bob says. Instead, business from China and India and other developing economies is boosting the fortunes of globally connected U.S. companies.

“It’s the first economic recovery in U.S. history led by emerging markets and not the U.S. consumer or business spending,” Bob says.

Growth overseas

For instance, Caterpillar, the maker of construction and mining equipment, announced second-quarter earnings gains of 91%. It raised its outlook for 2010 profits by up to 26%, based in part on projects in India, China and Brazil.

“Their growth wasn’t driven by selling more earth-moving equipment to people in Ohio. It was driven by selling earth-moving equipment to the folks in Asia,” Bob says. “That’s hard for a lot of people to get their arms around, where so much of the growth is driven by the developing world. Companies that are multinational, companies that perhaps are domiciled in the U.S. but do a whole lot of business overseas are the ones that are really benefiting from this recovery.”

Of course, the health of the U.S. economy can have a powerful effect on financial markets, but because of the global marketplace, the bottom line of many U.S. companies is thriving despite high unemployment and anemic business conditions at home.

With companies in the S&P 500 reporting earnings gains and projecting further profits, analysts estimate that by mid-2011, earnings for the S&P 500 index will be back where they were before the 2007 crash.

“And be clear, we’re not telling you the Dow’s going to 14,000 next summer,” Bob says. “But we are positive that there’s a very close parallel between stock prices and earnings. Earnings go up, stocks go up. Earnings go down, stocks go down.”

Investors considering the role of stocks in their diversified portfolios need to look beyond the immediate view of the domestic economy, Bob says, and see the longer-term global potential.

“There’s a lot of negative news. A lot of people think we’re going to hell in a hand basket,” Bob says. “I think they’re going to be bitterly disappointed.”

Joel Dresang is vice president of communications at Landaas & Company.

Initially posted July 29, 2010

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