Investors shrug at longest profit slump since the recession

AP News
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Posted: Jul 14, 2016 1:46 PM

NEW YORK (AP) — Not since the Great Recession have corporate profits been on this long of a slump. The response from investors: So what?

Investors are comfortable enough with the yearlong sag that they pushed stock prices to all-time highs this past week. The records were notched just as companies began to report how much they made from April through June, and expectations are largely glum.

Analysts estimate that earnings per share for companies in the Standard & Poor's 500 index fell 5.5 percent last quarter from a year earlier, according to S&P Global Market Intelligence. If the predictions prove true, it would mark the fourth straight quarter where profits fell, the longest run since the Great Recession ended seven years ago.

Seem odd? Investors own stocks to have a share of the profits that companies make, after all, and stock prices over the long term tend to track their earnings.

Heightening the disconnect are longstanding concerns that stock prices are high relative to earnings. Value investors look at a stock's price and divide it by how much profit the company earns to get a sense of whether it's expensive or cheap. The S&P 500 is above its historical average by that measure, and the only ways for that indicator to fall would be either for stock prices to drop or corporate earnings to rise. Neither is happening now.

Several reasons are behind the stocks-up/earnings-down dichotomy, analysts and fund managers say. And they're largely confident that stocks can hold steady in the face of it. Many market watchers are forecasting a flat to modestly up market over the next six or 12 months. Among the factors they cite:

— You think this is bad, look at the other guy.

The stock market may have many question marks, but other investments have even more.

The bond market is offering very little in interest, for example, and the 10-year Treasury note has a yield of about 1.50 percent, after inching up from a record low set earlier this month. The scant yields make the stock market look better in comparison, particularly when many stocks have dividend yields above 2 percent, says Lori Heinel, chief portfolio strategist at State Street Global Advisors.

"Right now, we're all in a relative game, not an absolute," she says. "Even with the low earnings level, we have an environment where equities on a relative basis look pretty attractive."

— This is no surprise.

Analysts have been warning for months that earnings would be weak in the second quarter.

The worst performances are expected to come from energy producers, which are still contending with a steep slide in the price of oil. Crude began its tumble two years ago.

Other areas of the market, meanwhile, are struggling to find new customers and make more sales in the slow global economy. The glacial pace of improvement for the world's economy has been a frustration for years.

— It's not like stocks have been going gangbusters.

Yes, the S&P 500 set a record this past week. But that's only because it recovered some steep losses from this past winter. The index is up only about 3 percent over the last year.

The disconnect would be more worrying if stocks were zooming higher, like the nearly 30 percent jump logged in 2013, even as earnings fell. Instead, the S&P 500 and the trillions of dollars in funds tracking the index have been lurching forward and back, only to sit close to where they were at the end of 2014.

— This may be the bottom for earnings.

Analysts say profits are returning to growth for S&P 500 companies right now. They're forecasting a 2 percent rise in earnings per share for the July-through-September quarter, largely due to recoveries for companies outside the energy sector.

One example is Alcoa, the metals company whose profit report marks the start of earnings reporting season for many investors. On Monday the company reported that its earnings fell for the fourth quarter in a row. But Alcoa also said the second half of the year looks brighter for some customers, particularly in the aircraft market, which should lead to more demand.

That's why investors will likely pay more attention this earnings season to what CEOs say about upcoming trends than how they performed last quarter. Analysts are mostly optimistic, even forecasting the current quarter will show the first growth in revenue for the S&P 500 in nearly two years.

But if companies themselves prove pessimistic, expect many fingers to point at the same culprit. It will likely take years for the full effect of the United Kingdom's vote to leave the European Union to become apparent, but companies in the interim can easily use it as a reason for disappointing earnings.

"It is likely that over the next eight to 10 (or even more) quarters, companies will be going back again and again to using Brexit as an excuse for underperformance," Scott Wren, senior global equity strategist for the Wells Fargo Investment Institute, wrote in a recent report. "This scapegoat isn't going away any time soon."