Corporate Profits: What Could Take the Wind out of a Strong 3Q

Corporate Profits: What Could Take the Wind out of a Strong 3Q



On the surface, earnings news for the third quarter has been rosy indeed. With all but a handful of companies in the S&P 500 left to report, more than two-thirds have posted a larger-than-expected increase in profits for the period, while only 10% or so have fallen short of estimates.

But there’s a cloud looming on the horizon. A lot of that growth, as companies like General Electric (GE) discussed when they reported, is coming from overseas markets, especially in emerging markets. GE, for instance, noted that growth in sales in Europe, North America, and Japan is in the low single digits; in emerging markets, it’s in the low double digits.

But these days, there’s nowhere to hide from the kind of dangerous scenario taking shape in Europe. If the sovereign debt crisis there can’t be contained and addressed effectively – and even last week’s introduction of new governments in both Greece and Spain didn’t appease many observers – growth in emerging markets will evaporate rapidly, too. After all, the ability of Chinese consumers to buy imported goods is dependent on the ability of the companies that many of them work for to continue exporting to Europe, Japan, and North America. And last week saw a report from China that exports grew at the slowest rate in nearly two years in October: 15.9%, below the 16.1% level economists had been anticipating. That still means China is a fast-growing economy, needless to say, but on balance, one that will feel the impact of any European meltdown in the shape of further declines.
Throughout the third-quarter earnings season, traders and some investors have been heard trumpeting the strong corporate balance sheets and strong earnings performance of the majority of U.S. companies. They’re right to do so – but maybe they should be paying more attention to the behavior of corporate CEOs, who continue to guard the cash on their balance sheets with tremendous vigilance.
In a global economy, there will be no place to take refuge from the European storm; even businesses that have no direct exposure to Europe can expect to feel any fallout. That’s why dramatic headlines will continue to make equity markets volatile and treacherous -- and routinely distract investors’ attention from any good news on earnings.