G.D.P. Growth Fails to Carry Profits With It
By SYLVIA NASAR -- April 1, 1999
[I] n the early 1990's, it was the
jobless recovery. Now it has become
the profitless boom.
While the economy raced out of 1998's
fourth quarter running at a 6 percent
annual rate, after-tax corporate profits
fell 1 percent from the previous
quarter, the Commerce Department
reported yesterday. For the year as a
whole, profits slipped 2.2 percent --
the first year in which profits have
fallen in the 1990's -- despite economic
growth of nearly 4 percent.
That contradiction between zooming sales
and sagging profits inevitably raises
questions about the future of stock
prices and may even point to weaknesses
in the eight-year-old economic expansion
itself. At the very least, it helps
explain why recent gains in share prices
have been concentrated in a relatively
small number of high-profile stocks.
And it makes many analysts wonder how
strongly corporations will keep on
investing and hiring. "Stagnating
profits are a sign of a very mature
expansion," said Robert Di Clemente, an
economist at Salomon Smith Barney.
Most American corporations, of course,
are still making a bundle. And profit
margins -- while no longer as wide as
they were a year or two ago and not
quite what they were in the golden era
of the 1960's -- are still a lot fatter
than they were during most of the long,
strong 1980's expansion.
But clearly the profit picture has
changed dramatically from that in 1996
and 1997, when overall earnings were
expanding 10 percent or more each year.
Moreover, given that profits usually do
best not just when the economy is strong
but when it is actually accelerating,
few economists think the outlook for
future earnings growth is glittering.
The culprit behind the profit squeeze is
not primarily rising costs. If anything,
corporations have reaped hefty savings
from last year's low interest rates and
rock-bottom energy and commodity prices.
And last year's decent wage increases
were mostly offset by significant
increases in productivity.
The real trouble, from the companies'
point of view, is that most of them are
finding that most of the time they
cannot raise prices without losing so
many customers that the attempted price
increases are self-defeating. "Pricing
power is almost nonexistent," John R.
Williams, chief economist at Bankers
Trust, said.
Indeed, many companies are having
trouble just holding the line. The
average prices charged by nonfinancial
corporations -- 80 percent of the
economy -- actually fell last year.
The reason is that competition is as
ferocious as it has ever been in the
careers of today's corporate chieftains.
A long capital spending boom has left
American manufacturers with lots of
spare capacity. And that could even get
worse. The Commerce Department reported
yesterday that factory orders were down
2.5 percent in February, the biggest
monthly drop in nearly four years.
Overseas, where huge swaths of the world
are mired in recession or at best
growing far more slowly than the United
States, there are even more plants and
equipment standing idle. Those that are
still operating have been slashing
prices simply to generate cash and keep
their factories running. Over all, said
Stan Shipley, a senior economist at
Merrill Lynch, "prices are falling
faster than costs are rising."
What makes life uncomfortable for
company managers and nerve-racking for
investors is, as Adam Smith was the
first to point out, a boon for
consumers. Gail Fosler, chief economist
at the Conference Board, a business
research outfit in New York, said,
"Competition is as fierce as we always
hoped it would be and in that kind of
environment, productivity gains tend to
get passed on as savings."
The forces that pressed down on profits
last year had disparate effects across
industries. For some businesses,
including telecommunications, health
care, much of high technology and
anything related to housing, 1998 was a
banner year. For others, like cars,
entertainment, travel and financial
services, it was a mixed bag. And for
energy producers, makers of basic
industrial materials like steel,
chemicals and paper and energy utilities
bracing for the cold new world of
deregulation, it was a year best
forgotten.
Most economists -- unlike many equity
strategists -- do not see a big rebound
in 1999.
Some things will change for the better,
to be sure. For starters, the big hits
to profits in 1998 -- the General Motors
strike and the meltdown in emerging
markets that took bites out of auto and
bank profits -- were special events. And
the hundreds of corporate revampings
announced in recent months should begin
to pay off in terms of cost savings in
coming ones.
But other forces that have held earnings
down will not dissipate. Despite
flickers of recovery in Japan, there is
little sign of renewed growth in Asia.
Europe, where things were looking a bit
firmer just a couple of months ago, now
seems to be softening again.
Costs, while not as critical up to now,
are apt to creep higher, too. Oil prices
have already rebounded sharply. That may
stop the bleeding in the oil patch, but
it will eventually exact a toll on
airlines, utilities and other big energy
users. (According to one estimate,
$18-a-barrel oil would shave nearly
three percentage points off economy-wide
profits; oil is now selling for $17 a
barrel, up from an average of $14 last
year.)
Moreover, the labor market, which looks
to stay tight, will inevitably put
continued pressure on wages.
What will happen to interest costs is a
trickier question. If the rest of the
world remains stagnant, foreigners will
keep sending their money to the United
States, inflation will remain low and
rates could stay down. On the other
hand, weak profits combined with
determination to keep investing in new
capital -- either to cut costs or on the
basis of optimism about future profit
opportunities -- have already led to a
ballooning of corporate borrowing, which
only adds to pressures lifting long-term
interest rates.
All in all, "except in industries where
supply is truly limited like airlines,
raising prices is no longer a feasible
strategy for raising profits," said
David Blitzer, chief economist at
Standard & Poor's. "You have to earn
them the old-fashioned way."
Copyright 1999 The New York Times Company
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