McDonald’s has plenty of company. Wall Street, that perennial font of optimism, is taking off its rose-tinted glasses and finding a view that’s not to its liking. After quarter upon quarter in which business seemed to be minting money, signs of an earnings slump are everywhere. Rubbermaid, Caterpillar, 3M, Texas Instruments – they’re all doing well, but hyped-up investors had figured they’d be doing even better. Their disappointments may herald a turning point in the stock market. Says David Shulman, research chief at Salomon Brothers, “I think we’re at the end of the profit cycle.”
That’s Wall Street talk for: watch out. The 1990s have been an endless season of joy for stock investors. Total corporate earnings, after taxes, have leaped by two thirds just since mid-1990. Almost every sector of the economy has gotten its share. Extraordinary earnings performance lies behind this year’s stock-market surge: of the 500 companies in the Standard & Poor’s Index, 62 percent boosted second-quarter profits by more than 10 percent over 1994. Strong profits and low interest rates have propelled almost every market average to record heights. The mutual-fund boom let average families join in the fun. In the past five years, the assets of stock mutual funds have soared 400 percent to nearly $1.2 trillion.
The fun’s over. As third-quarter profit reports start trickling in this week, single-digit gains are likely to be the norm. Twelve months from now, many market watchers forecast, profits won’t be rising much faster than inflation. Says Maureen Allyn, economist for fund manager Scudder, Stevens & Clark, “The second quarter was a peak.” If profit growth slows down, stock prices will be hard pressed to do anything but follow.
It’s not that business has suddenly turned sour. If anything, lower interest rates are reheating the economy after a midyear chill. But that won’t necessarily bring more dollars to corporate bottom lines. There are too many factors working to hold profits down. Manufacturers’ springtime price hikes met with fierce resistance. “Consumers said ’no’,” says economist Richard Berner of Mellon Bank. Multinational companies face a profit hit from the stronger dollar. Banks expect an uptick in bad loans to dampen earnings. And the Federal Reserve has made clear that it won’t let the economy grow more than 3 percent a year. In that environment, a profit spurt can come only from huge improvements in productivity. “It’d be very surprising if companies were able to restructure to such a degree that they were able to make up for that slowdown,” says New York economist Kathryn Eickhoff.
Investment pros see yellow lights flashing. No stock-market crash is imminent. Interest rates could well fall further, giving stocks one more boost. But from here on out, the market may act more like a tired ox than a raging bull. The easy money has been made. You shouldn’t rush to pull money out, says Henry Gailliot of Federated Investors in Pittsburgh, but be careful about putting more in. “If you get into the game late, the odds of getting out in time aren’t very good,” he advises.
Will the profit squeeze kill the election-year economy? Probably not, but it surely won’t help. Weak profits may lead companies to pare spending on plants and machinery, which has been one of industry’s strongest props. The biggest unknown, though, is how a stock stall will play to a generation of investors trained to believe that equities only go up. Each time the market has dipped since 1987, individual bargain hunters have piled in. But no law of nature requires that every dip must lead to a rebound. If business isn’t earning money hand over fist, folks who own a stake in business will find that returns aren’t so easy to come by.
