More pain ahead as GDP shows profits at 2-year low

NEW YORK (Reuters) - Government data on profits may indicate more pain ahead for earnings at big U.S. companies.

Weak earnings at all taxable U.S. companies last year, when profits slipped year-over-year in all four quarters of 2007, according to data included in the governments' reading on economic growth, were later followed by dismal corporate profits for companies in the S&P 500 stock index.

The precedent is troubling because Thursday's U.S. gross domestic product report for the second quarter of 2008 showed profits at all taxable U.S. companies fell to their lowest level since 2005.

The government data includes small and private companies, some of which will have felt the pinch from the housing slump much earlier than their bigger, publicly listed counterparts in the benchmark S&P500 stock index, as smaller firms often have less overseas exposure to counterbalance weakness at home.

"Domestic profits tend to lead the business cycle," said MKM Partners' chief economist Michael Darda.

There would need to be an upturn in corporate profits to indicate a business cycle turnaround but there is no sign of that yet.

Darda added that with the G7 economies of the world's most industrialized countries slowing, threatening U.S. exports, and with stressed credit markets and a weak U.S. jobs picture threatening consumer spending, the economy is likely to struggle in the second half.

"I think we're going to have more earnings issues," said Richard Hoey, chief economist at Bank of New York Mellon and Dreyfus. Hoey noted that apart from financial sector firms, which have suffered from huge write-offs and losses, other companies are also feeling the strain.

"If you think about the sources of demand, the U.S. economy is unlikely to repeat the 3.3 percent real GDP growth we saw in the second quarter in the next few quarters and overseas economies have slowed sharply so the source of demand is not favorable there either," Hoey said. Due to the credit crisis, the cost of financing is also uncomfortably high for non-financial companies, whose earnings have so far held up relatively well, he added.

The weak outlook for S&P500 index company earnings in the second half of the year is starting to be reflected in analysts' forecasts for the third-quarter, if not for the fourth quarter.

Wall Street's expectations for the third quarter are falling fast, according to Thomson Reuters proprietary data, and, if analysts' revisions continue at the current pace, will soon predict S&P500 companies notching a fifth straight quarter of falling profits.

At the beginning of July analysts were expecting a 12.6 percent gain in S&P500 index companies' earnings, but that view has now eroded to expected profit growth of just 1.3 percent. Fourth quarter earnings are currently seen growing 62.7 percent.

Bank of New York Mellon and Dreyfus' Hoey noted that another reason S&P 500 companies had trailed the negative earnings growth seen in the government data was that S&P 500 company earnings were reported as earnings-per-share.

"Among S&P 500 companies there is often more managerial flexibility in terms of managing cost and expenditures for the first several quarters in a profit slowdown. Companies can take financial engineering steps," Hoey said.

"It tends to flow through more directly in the GDP data as the government is not trying to influence the quarterly numbers."