The Outlook for 1998 United States Corporate Earnings

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The June survey of 3,400 security analysts affiliated with over 300 institutional equity research firms, conducted by the Institutional Brokers Estimate System (IB/E/S-U.S. edition), is forecasting an 10.4% increase in U.S. corporate earnings in 1998. The forecast is based on the United States IB/E/S Universe of 5,822 publicly traded firms as of June 18, 1998. The expected growth rate for 1999 is 20.4%. The expected 1998 growth rates for the Major Market Indexes are generally lower. Based on the current composition and shares outstanding, the S&P 500 earned $44.79 on an operating basis in 1997. Operating earnings are expected to increase 7.2% in 1998 to $48.02 and grow 16.9% in 1999 to $56.15. For the S&P Industrials, an increase in earnings of 5.9% is expected for 1998 (EPS of $49.97 is expected) and growth of 19.0% is anticipated for 1999 ($59.46). For the Dow Jones Industrial Average (DJIA), earnings are forecast to rise 6.3% in 1998 ($444.13) and 15.17% in 1999 ($511.13). S&P Midcap 400 earnings are forecast to rise 16.3% in 1998 ($17.44) and 21.5% in 1999 ($21.19). S&P Smallcap 600 earnings are forecast to rise 12.2% in 1998 ($9.32) and 28.5% in 1999 ($11.98).

Since our last writing in March, the global equity markets have generally traded sideways as the Asian currency volatility remained lower than in the fourth quarter of 1997. The consensus is that nearly all of the Asian economies will see earnings slow significantly in 1998 or even move into a recession. Investor sentiment regarding US corporate profits has changed markedly since the beginning of the year. However, instead of overreacting and punishing any company remotely connected with Asia, investors are dumping shares of companies that have pre-announced poor results and bid up shares of other companies on the premise that no news is good news.

While negative earnings preannouncements are up substantially from the first quarter, no major corporations have knocked on the confessional door, a definite positive. Exports to Asia continue to dwindle while imports from the region are surging into the United States, now seen as the consumer of last resort. Although profit forecasts have fallen sharply for the major indexes, consumers have benefited handsomely from the favorable exchange rates and continued their buying spree. Clothing retailers have seen a sizeable increase in their sales as a result.

However, we continue to believe that the crisis is not over by any stretch. Rising imports will serve as a drag on US corporate profits in the second half of this year. There also remains the prospect of another round of currency devaluations from the global emerging markets. Another shoe that could be dropped is a slowing of growth in Europe, which would further compound the profit's recession that is developing in the United States.

Inflation, which continues to be absent, contributed to the predictability and accuracy of analysts' earnings forecasts in the past year. Although no corporations have as yet cited the tight labor market and rising wages as a reason for the profit declines, we expect that businesses will show slower profit growth in the next year. The chances of a recession occurring in the United States in 1998 continue to be very low due to strong consumer demand. Based on the aforementioned scenarios, we are altering our forecast for 1998 S&P 500 earnings growth to a range of 1.0% to 3.0%, still well below the equity analysts' estimate of 7.2%. Clearly, there is much more room for corporate profit forecasts to decline in the second half of 1998. The impact on the equity markets should not be major as investors will soon turn their focus towards 1999 expectations.

ESTIMATE REVISION TRENDS

Due to greater than anticipated weakness in small company earnings, 1998 earnings expectations as measured by the broad aggregates have fallen at a faster pace in the past three months. The 1998 mean estimate for the UB/E/S Universe is down -3. …