While financial markets swooned yesterday over seemingly ominous new economic data, Wall Street's investment strategists said they saw little in the numbers to change their conviction that the fundamental economic picture remains bright and that corporate profits should continue to boom.
The strategists discounted government reports that showed economic growth slowing and compensation costs rising. The gross domestic product figure is often revised, they said, and the higher employment costs last quarter should be measured against data showing productivity increasing at a faster pace.
"I don't think the government numbers reported this morning throw a [wrench] into the works," said Jeff Applegate, chief investment strategist at Lehman Brothers Inc. Applegate cited unusually strong corporate profits, noting that positive surprises--earnings that exceed expectations--are now outrunning negative surprises by 6 to 1, far above the 2-to-1 rate during the second half of the 1990s, when the current economic boom was gathering strength.
Earnings of the nation's largest businesses were expected to be about 15 percent above year-ago figures in the April-June quarter, according to First Call Corp., which tracks the profits of the large companies included in the Standard & Poor's 500-stock index.
That is better than the 10.5 percent increase in earnings posted in the first quarter of this year, but not as good as what First Call is predicting for the current July-September quarter, when big-company earnings are expected to rise 21 percent over last year, according to Chuck Hill, First Call's director of research.
"We're in a period here where the growth rate [of earnings] is accelerating," Hill said. Factors contributing to strong earnings growth include the continuation of the consumer-led economic boom here in the United States and a turnaround in overseas markets that can now absorb more U.S. exports. This quarter's numbers also look particularly good when compared with slumping profits of a year ago.
Analysts saw little in yesterday's government numbers to change that picture, at least for now. They attributed the sharp drop in the stock market yesterday to jitters over a possible rise in inflation and an increased possibility that Federal Reserve policymakers might raise interest rates again as soon as next month--not to concerns about the general health of corporate profits.
Analysts conceded that some of the figures the government released yesterday did look troubling. For example, the employment cost index registered its sharpest quarterly rise since 1991, suggesting that the cost of the wages and benefits that companies provide their employees has risen significantly, which could depress profits.
But analysts said those rising wage and benefit costs have been offset by rising productivity, which allows companies to shave costs and produce more goods and services with the same amount of labor.
"Productivity improvements are still good and accelerating," said Rao Chalasani, chief investment strategist for Everen Securities Inc. in Chicago. "Corporations can still pay more [wages] and yet maintain profit margins and still expand."
Federal Reserve Board Chairman Alan Greenspan alluded to this phenomenon in congressional testimony Wednesday, when he noted that corporate executives and the hundreds of analysts who follow S&P 500 companies report no end in sight to the productivity growth that is allowing companies to offset rising labor costs.
Greenspan said the dynamic cannot continue forever, but he acknowledged that at least for now, "the recent acceleration in productivity has provided an offset to our taut labor markets by holding unit costs in check and by adding to the competitive pressures that have contained prices."
Corporate profits are expected to retreat a bit by the end of this year, but they are still forecast to remain strong, according to First Call, which is projecting that fourth-quarter earnings will be about 18 percent above comparable 1998 numbers.
Hill noted that that is still well above the long-term average earnings growth rate of about 7 percent for S&P 500 companies.
Technology companies, including large software makers, computer manufacturers and cyberspace firms such as America Online Inc., have been leading the profit growth curve this year, Hill said. That is in part because of strong fundamentals, but also because the sector stumbled last year when manufacturers had to work their way through a computer glut, and comparisons to those weak quarters have produced first- and second-quarter profit growth of 40 percent or more.
That is expected to tail off to 30 percent in the third quarter and 15 percent in the fourth quarter, not so much because of any projected weakness in the industry, but because last year's third and fourth quarters were comparatively stronger, Hill said.