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Can American corporate earnings be sustained?

The US corporate sector has been a tower of strength over the past few years, but fears are mounting that the tide may be about to turn.

Can American corporate earnings be sustained?

US corporate profits have continued to rise over the past three years, but investors and economists are increasingly divided over whether this trend can continue.

Domestic profits from the US non-financial sector have risen from 8.7% in the second quarter of 2009 to 15.1% at the end of last year (as a percentage share of current production value added), representing a 40-year high.

But some argue that rising energy costs, the eurozone crisis, and a potential 'hard landing' in China are not only constraining corporate spending but creating an uncertain outlook.

Bespoke Investment Group highlights a fall in the number of companies that beat earnings expectations during the first-quarter earnings season. After a bright start that saw 73% beating analysts’ estimates in the early part of the season, this stood at 60%, below the long-term quarterly average of 62%.

US corporate profits have peaked

Jeremy Batstone-Carr, Charles Stanley’s chief economist and strategist, believes that US corporate profits have peaked, and he expects them to revert to the mean from current levels. Although this process could take time, he says the low interest rate environment for the foreseeable future will dampen inflation expectations.

‘This awful process of margin compression will be a fairly long-winded affair. Top lines are by and large okay, but bottom lines are under pressure,’ he said.

He pointed to constrained consumer spending and ongoing austerity packages in Europe. While visibility is likely to be lessened against this backdrop, he said surprises are more likely to be on the downside.

‘Without that clarity, one would have to question whether companies will be able to deliver an improvement over the second and third quarters of the year, particularly as the equivalent period last year was quite strong,’ he said. ‘I would be quite surprised if the corporate sector was able to deliver a sufficiently robust period in the second and third quarters to drive markets higher.’

Although he has been advising investment managers at the firm to increase US equity exposure over the past couple of months, he says this has been a currency call rather than a market call.

Profits from production to fall

Capital Economics believes the downward trend in labour’s share of value, which has helped to boost profit share, is unlikely to continue, causing profit share to fall. If this does occur, the consultancy thinks earnings will not keep pace with output, causing profits from production to shrink next year, while the economy grows by 2.5%.

Against this backdrop, the stock market is unlikely to rise, as further monetary stimulus from the Fed is less likely.
However, this is not a view that is shared by economic consultancy MRB Partners, which estimates that US earnings growth will pick up later this year on the back of improving prospects for the global economy. Although margins may be under pressure, MRB argues that downside risks come from weaker growth more than escalating costs.

Likewise, Citywire A-rated James Thomson, manager of the Rathbone Global Opportunities fund, expects continued growth in US corporate profitability. He points to companies giving prudent guidance, having been burnt by markets post 2008 when they were too bullish.

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