March 27, 1997

Wall Street Journal


Market Place: Wall Street Shifts Focus to Earnings





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

worth less.


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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