March 27, 1997
Wall Street Journal
By DAVID BARBOZA
NEW YORK -- Now that the Federal Reserve has raised
its short-term interest rate target, Wall Street is
turning its focus again to corporate earnings.
As the end of the first quarter approaches, though,
small clouds are gathering around an earnings outlook
that was already less than robust compared with the last
two years of double-digit growth.
The dollar, which has risen 8 percent this year against
the German mark and 7 percent against the Japanese yen,
has already begun to eat into the profits of American
There are other concerns, such as pricing competition
and wage pressures at home, slower economic growth in
the United States and abroad, and fears that many large
companies can no longer use restructuring to increase
"Earnings in 1997 will probably be weaker than people
expect," said Richard Bernstein, director of
quantitative research at Merrill Lynch. "Keep in mind,
we're big bulls at Merrill. But we're seeing a slowing
in the growth rate of earnings."
Industry analysts at Merrill Lynch -- those who follow
individual companies -- are projecting that earnings of
the companies in the Standard & Poor's 500-stock index
will grow by about 17 percent this year. But Bernstein
believes those estimates are "overly optimistic."
Even if the downgrades are not large, some fear that
falling expectations would further disrupt a stock
market that has been staggering in a trading range since
the Dow Jones industrial average first reached the
7,000-point level in mid-February.
"There's a general malaise hanging over the market,"
said Charles Pradilla, a market strategist at Cowen &
Co. "Right now stocks are overvalued relative to bonds,
and the strong dollar is not benefiting anyone."
Of course, there are those, like Abby Joseph Cohen at
Goldman, Sachs & Co., who disagree with the weakening
earnings scenario. Yet even Ms. Cohen concedes that
slower growth in Europe could reduce her 10 percent
earnings growth forecast to 7 percent.
And while Byron R. Wien, the U.S. investment strategist
at Morgan Stanley, has not revised his forecast yet, he
has begun to rethink his modest earnings growth
expectation of about 7 percent because of worries about
the strong dollar.
"It's a significant problem," said Wien, who has already
forecast that the stock market will fall sharply later
this year. "We're going to see some impact on
first-quarter earnings. The companies that will be hit
are the multinationals."
Earlier this year, IBM said the stronger dollar was
curbing its profits, and just last week Eastman Kodak
said that revenue in the first two months of this year
was flat compared with last year, due in part to the
strong dollar. Shares of both stocks plummeted on the
A strong dollar hurts profits two ways. It makes
American exports more expensive abroad, which can reduce
sales. And when those foreign sales are translated back
into a stronger dollar at the end of a quarter, they are
Analysts of the technology sector, which has the largest
foreign exposure, have also begun to worry about
currency translations and weakening demand in Europe,
two factors that have helped exacerbate an already
ferocious drop in technology stocks this year.
In addition to the dollar, price competition -- as
suggested by McDonald's recent decision to lower the
price of selected items -- could also reduce earnings.
And if pricing competition does not eat up profits,
strategist like Charles Clough at Merrill Lynch suggest
that other factors will. Although real sales growth
gained about 2 percent a year in the 1990s, he said that
earnings had grown by about 16 percent a year, largely
because of "restructuring" or downsizing. "But our
belief is that that string is running out," he said.
But Ms. Cohen of Goldman, Sachs contends that the gloomy
predictions are overstated, partly because a new
formulation is at work in corporate America.
More than the strong dollar, she worries about a
European economy that is in a "funk," burdened by
unemployment and weak domestic activity. But those
problems are offset, she said, by the fact that American
companies are spread across the globe, including in
countries where they benefit from a favorable currency
But even more important than the fact that many large
companies hedge against bad times, Ms. Cohen said, is
the fact that U.S. products sold abroad often have a
"value added" component.
"If you're selling steel, chemicals or newsprint, then
you're customers have options," she said. "But much of
what we produce is value-added," such as Intel's pentium
processor, which has few competitors in Europe and
"If we were going to see a significant dollar effect, we
should have seen it in the fourth quarter," she said. "I
think the surprise was that the dog didn't bark."
There are two ways of tracking earnings on Wall Street,
and both of them are slipping. "Bottom up" projections
are based on analysts' estimates for individual
companies while "top down" forecasts are made by
strategists and economists using economic and industry
figures to estimate overall earnings growth.
Traditionally, the "bottom up" and "top down"
projections vary widely early in the year, with industry
analysts more optimistic than market strategists. This
year is no different. Industry analysts are projecting,
on average, a 13.6 percent growth in earnings of the
companies in the S&P 500, down from 13.8 percent a few
weeks ago. Top-down equity strategists are projecting
6.6 percent, down from 6.8 percent about two weeks ago,
according to First Call, which tracks earnings
But as the year progresses, the two forecasts get
closer, usually with the bottom-up analysts reducing
their forecasts, said Charles Hill, director of research
at First Call.
"The critical question is not whether the industry
analysts lower their numbers, but will they lower them
more than normal," Hill said. "But so far, no one is
pushing the panic button."
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