NEW YORK (AP) Just as a surge in corporate profits fueled a strong year on Wall Street, a slowdown in earnings growth could spoil some of the fun in 2004.
It's not that anyone is forecasting a free-fall in profits in the new year. In fact, companies are expected to show healthy gains in the coming quarters, especially in those in the technology, materials and transportation sectors.
But the pace of growth probably won't be as strong as we've seen in the recent past, largely a result of companies adding on expenses to keep up with the growing economy.
The big unknown is how investors will react will they latch on to all the good news about the economy's recovery or worry that earnings have passed their peak?
''Most people don't think Armageddon is right around the corner, but they do expect earnings growth to slow, and for investors to take note of that,'' said Sam Stovall, chief investment strategist at Standard & Poor's.
Corporate earnings climbed over the last year to levels not seen since the height of the market boom in early 2000. Fueling much of the gains: The weak dollar and continued productivity improvements.
Profits in the third quarter for stocks in the Standard & Poor's 500 index jumped about 21 percent from the same period a year ago, and similar gains are expected when companies report their fourth quarter starting in January. For the year, earnings growth is expected to come in around 17 percent, according to earnings-tracker Thomson First Call.
All that good news helped propel a winning year on Wall Street, with the broad market climbing nearly 25 percent.
But what happened in the past doesn't really matter. The future is what investors are supposed to focus on, and forecasts for the coming year aren't as upbeat, with analysts expecting earnings growth to slow to about 13 percent during the first two quarters and finish the year with about a 12 percent year-over-year gain.
The reason is twofold. Companies, still scarred by the economy's downturn and worried about the strength of its recovery, have kept their costs under control and have been slow in ramping up expenses. For evidence of that, just look at the continued weakness in the labor market and lack of inventory building.
As a result, executives have been able to add that cash to the bottom line in recent quarters. But as business continues to pick up, they'll put that money back to work.
Earnings over the last year also had the advantage of being compared with the lackluster results in 2002. So heading into the new year, the market ''could be disappointed as the pace of earnings growth decelerates relative to 2003 due to tougher earnings comparisons throughout 2004,'' said Richard Nash, chief market strategist at Victory Capital Management.
Still, not everyone on Wall Street is convinced that slower earnings growth will hurt the market.
For one, investors may choose to focus on the continued strength of the economy, which finally managed to break out of its sluggish state late in 2003. In addition, the Federal Reserve has indicated that interest rates will stay low for a while, which is good for stocks because it lowers corporate borrowing costs.
There is also the possibility that things will turn out better than what's expected.
Consider what happened in the third quarter of 2003. At the start of the quarter, analysts expected about a 12.7 percent gain in earnings, while the results ended up rising more than 21 percent.
And even if profit growth slows, it doesn't mean that everyone will head for the doors.
S&P's Stovall points out that earnings and the market don't always work in lockstep. He looked back over the last 40 years to find that the market actually accelerated six out of 10 times after earnings peaked and growth began to slide.
Take the case of June 1988 through September 1989, when earnings for the S&P 500 went from a 50.3 percent expansion rate to a 4.3 percent year-over-year increase. During that time, the S&P 500 advanced 28 percent.
Or from March 1995, when earnings rose 43.3 percent from the year before, to June 1996, when they rose by just 1.4 percent. The market shot 34 percent higher during that period.
The only thing to do now is wait and see what's to come. It's really about what investors can stomach.
Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org
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