G.D.P. Growth Fails to Carry
Profits With It
By SYLVIA NASAR
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."
nytimes.com |
