Over the last couple of years, Fisher Investments has witnessed US companies stage a stunning recovery from recession depths, with profits at S&P 500 firms growing for five consecutive quarters through Q4 2010.* This week, 110 firms are set to reportQ1 2011 earnings. Investors are likely paying attention—after all, the expectation of strong corporate profits can be a powerful driver of stock market returns.
A public service announcement from Fisher Investments: Investors shouldn’t expect to see the same extraordinary earnings growth of the last several quarters. Consensus expectations are for 12% year-over-year profit growth in Q1 2011 and an 8% rise in revenue. Given profits were up 31% overall for 2010, should less vaunted profit growth be cause for disappointment? Not at all. First, note: After a very sharp rebound, by many measures, after-tax profits are at all-time highs.
What’s more, it’s just normal for the torrid profit growth rate to fall off at this stage. First and foremost, gone are the easy comparisons to earnings levels severely depressed by recession. We also caution it’s less likely earnings beat expectations by the wide margins we’ve seen since the most recent cyclical low. This isn’t a sign of anything broadly amiss. Rather, expectations seem to be gaining ground on reality, likely limiting the wide margins of upside surprise. (This is, in fact, a key feature of the Fisher Investments market outlook for 2011—read more here.)
This isn’t to say we have a dimmer outlook on US companies and their stocks—far from it. There’s no reason profits must peter out. Plenty of fuel is left in this economy to drive overall corporate profitability. Companies continue to have massive amounts of cash on their balance sheets. While having tons of cash isn’t a prerequisite for decent earnings, in this case, the built-up reserves likely get deployed in ways adding to demand down the road. Additionally, firms are still capitalizing on increased productivity gained in the recession. (Read a Fisher Investments MarketMinder cover story on that topic here: “More With Less.”)
And the US is still well positioned for continued economic growth. (S&P’s recent announcement on their negative US outlook was predicated largely on their concerns over the political process, not economic metrics, which remain overall expansionary. For more, see Fisher Investments MarketMinder’s recent cover story: “The Scarlet Letter.”) The same is true globally.
The era of consecutive 30%+ quarterly profit growth is likely behind us—for this cycle at least. And profit growth, like stock returns, likely becomes more differentiated among sectors and narrower categories this year. But this is just a sign of a transition out of recovery and into expansion.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.