Most US strategists predict corporate profits slowing yet still showing year over year gains of approximately 7%. But according to the latest from The Economist magazine the devil is in the details.
Optimists cite the relatively modest ratio of share prices to forecast profits as a reason for buying equities. That assumes the strength of profits will last. But, according to Chris Watling of Longview Economics, a consultancy, profits now comprise the highest share of American output since the 1960s. If profits revert to the mean, a pillar of the stock market will be removed.
Gerard Minack, a Morgan Stanley strategist, says American earnings per share are now 75% above the long-term trend, the biggest divergence recorded in the past 90 years. Most explanations for the recent strength of corporate profits have centred on the effects of globalisation; in particular, the impact of Asian workers on labour costs. But there is another possibility; the influence of the financial sector. According to Mr Watling, the sector now contributes around 27% of the profits made by companies in the S&P 500 index, up from 19% in 1996. He reckons financial companies are responsible for a third of all of the growth in American quoted-company profits over the past decade.
My comments: Inverted yield curve, contraction in credit and overall collateral declines will continue to negatively impact the Wall Street EPS machine. Houston we have a problem.