Merrill's Steinberg Turns Bullish on Earnings, but Bernstein Remains Bearish -- NYTimes
March 17, 1999
MARKET PLACE
1999 Is Already the Year of the Flip-Flop Forecast
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By JONATHAN FUERBRINGER
The unexpectedly strong performance of the economy
so far this year has pushed the earnings forecasts
of many strategists higher. For example, Bruce
Steinberg, the chief economist at Merrill Lynch, turned
his earnings growth prediction on its head, flipping to
an increase of 3.5 percent from a decline of 5 percent.
But his colleague, Richard Bernstein, the director of
quantitative research at Merrill Lynch, has a different
view. Unlike Steinberg, he says the direction of
earnings is down, not up. As he put it in a recent
report, "We do not have one indicator that suggests
that the profit cycle will accelerate."
Disagreements within one shop are not unusual,
especially because big firms have many analysts who use
different approaches to try to fathom what is going on
in financial markets. But this difference in direction,
especially after the two were in accord before
Steinberg's switch, does show how confusing the
earnings outlook might be for investors -- and how
quickly it can change.
"The investment environment is very complex right now,"
Steinberg said, giving his view on what the difference
in the forecasts means. "We each have our own
discipline," he added. "Strategists and economists
often disagree with each other, so this is not
unusual."
Bernstein acknowledged that "it certainly is a
difference in direction." He explained that his
forecast is the outgrowth of his main theme for 1999 --
that the profit cycle has decoupled from the economic
growth cycle. That is, profits can now lag behind the
pace of the economy, which is the opposite of the
situation in the mid-1990's, when profits were growing
at a double-digit pace.
While the economy grew briskly at a 3.9 percent rate
last year, operating profits for the 500 companies in
the Standard & Poor's stock index rose five-tenths of 1
percent, according to I.B.E.S. International, which
tracks company earnings. The performance was better --
but well off a double-digit pace -- according to the
First Call Corporation, the other major company that
collects earnings forecasts. It put earnings growth at
3.7 percent.
Bernstein also notes that Merrill's current 1999
earnings estimate for the S.& P. 500 companies has
fallen below Wall Street's consensus, an unusual
occurrence.
What makes this debate important is that the move to
10,000 by the Dow Jones industrial average, the new
highs for the S.& P. 500 and the rebound in the Nasdaq
composite index, despite a lot of earnings warnings
from technology companies, all seem to be riding, in
part, on the expectation of a revival in corporate
profits later this year.
Both I.B.E.S. and First Call are expecting big jumps in
earnings in the third and fourth quarters. Using the
so-called bottom-up approach, which is based on a
separate earnings forecast for each of the companies in
the S.& P. 500, they both foresee earnings growing at
more than 20 percent in the last two quarters of the
year, following a jump to around 13 percent in the
second quarter.
Although such predictions are traditionally too
optimistic and are usually revised downward, these
estimates are still awfully strong after a decline in
earnings was posted as recently as the third quarter of
1998. In the current quarter, the two companies see
growth of 5 percent to 7 percent. (Fourth-quarter 1998
performance, with the data all but complete, is
difficult to assess because of the firms' differing
calculation methods. First Call is up 6 percent, while
I.B.E.S. is unchanged.)
But Bernstein says that earnings are not going to
rebound because companies have lost their ability to
raise prices and, in turn, pass on increasing costs,
especially rising wages. He said that because rising
labor costs could not be passed on in higher prices,
profits were being squeezed. This squeeze, he said,
will eventually force layoffs that will crimp consumer
spending, the backbone of the economy's recent
surprising performance.
"We differ from the consensus," he said, "in that we
believe that the weakness in corporate profits will
lead to increasing unemployment, slowing investment
spending and a slowing in the overall economy during
the year."
Steinberg acknowledged that there had been some
disconnect between the performance of the economy and
profits. But he says that there were a lot of one-time
factors that contributed to the divergence in
performance last year. And those factors, including the
strikes at General Motors during the summer, will not
be present this year, he said.
"This year has begun so strongly that earnings growth
will pick up again," he said.
But while Steinberg may represent the consensus and
Bernstein the contrarian view -- and investors may just
have to choose whose view to follow -- they do agree on
several areas. One is that consumer stocks are the
place to be. Bernstein, although he sees slower growth,
says that the loss of profit growth for companies turns
out to be a gain for consumers. They are benefiting
from both higher wages and savings from the inability
of companies to pass on price increases.
And Steinberg, while far more bullish about earnings
than he was three months ago, still thinks the stock
market faces a rocky outlook.
"With the economy so strong, interest rates are not
likely to fall," he said. "There even may be another
growth scare, and interest rates may back up again. And
that is not good for equities."
Copyright 1999 The New York Times Company
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