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Can corporate profits keep pleasing investors?

Earnings growth slowed sharply in the second half of 2012, but it's still going — and better than expected, fueled in part by companies' cost cuts. It's unclear how long that can last.

March 03, 2013|By Tom Petruno
  • Year-over-year earnings growth slowed sharply in the second half of 2012. Above, an electronic board displays trading activity on the NYSE.
Year-over-year earnings growth slowed sharply in the second half of 2012.… (Jin Lee / Bloomberg )

Stocks' rally since 2008 has been underpinned by a resurgence of corporate earnings.

But now what?

Year-over-year earnings growth slowed sharply in the second half of 2012 from the torrid pace of 2010 and 2011, when the global economy was in the first phase of its rebound from the 2008 crash.

Most of the companies in the Standard & Poor's 500 index have reported their fourth-quarter 2012 results. Overall, operating earnings for the S&P 500 firms are on pace to rise 6% from the final quarter of 2011, according to data tracker Thomson Reuters I/B/E/S.

Although well below the double-digit percentage growth in 2010 and 2011, the 6% gain in earnings still is double what Wall Street had been expecting at the start of this year. It is also improved from the measly 0.1% year-over-year rise in the third quarter of 2012.

The surprise was that earnings weren't much weaker in the fourth quarter, given the global struggles: The economies of the Eurozone, Japan and Britain all contracted last quarter, and the U.S.' grew at an annualized rate of just 0.1%.

Despite the lack of brisk growth in the developed world, one advantage the giant companies in the S&P 500 have is that many operate worldwide, including in typically faster-growing developing nations.

But something else has helped propel corporate earnings since the 2008 financial crash: an austere approach to spending, including on new hires. That is one explanation for the slow pace of U.S. job creation in this economic recovery.

"A big question is how long companies can maintain their profit margins by cutting costs," said Gregory Harrison, earnings research analyst at Thomson Reuters in New York.

Don't expect that corporate mind-set to fade anytime soon, said Steven Ricchiuto, chief economist at Mizuho Securities in New York. Just the opposite: He expects slow global economic growth to push business hiring plans back this year.

Yet if they take that path, companies also will make slow growth self-fulfilling by limiting workers' overall income gains, he said. "A weak labor market will foster another year of well-below-trend gross domestic product growth," he said.

Wall Street analysts, however, remain their usual optimistic selves about earnings growth this year.

They now expect S&P 500 operating earnings (i.e., results before "one-time" gains or losses) to rise just 1.4% in the current quarter compared with a year ago. But they project 6.5% growth in the second quarter and 10.2% in the third quarter, led by continued strength in the housing, auto and financial sectors.

Market bulls note that even if earnings growth is modest in 2013, holding at current high levels for a while could be enough to appease investors who can be patient enough to wait for the global economy to accelerate again.

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