Profits paint worrisome US picture

Cisco's profits have suffered from the slowdown

By BBC News Online's North America Business Reporter, David Schepp

US companies are posting the weakest profits in a decade, which may result in further cutbacks in corporate spending and more malaise for the American economy.

Higher energy prices and labour costs combined with slower growth and productivity have put the pinch on business' bottom line.

With its wallets screwed tight and its newfound frugality, US businesses continue to pull back the reins on expenses, reducing even further investments in computers, new buildings and other items.

For the first three months of the year, corporate profits fell an astounding 43%, compared with a rise of 21% for the same period a year ago, according to research conducted by The Wall Street Journal.

Analysts are not surprised that the adverse factors squeezing business - rising costs and falling sales - have resulted in a paltry profit picture. Rather, they have been anticipating the news.

Falling stocks equal falling profits

While profits have just recently taken a hit, the stock market has been enduring falling stock prices for over a year now.

"As we've seen over the last year, equity prices peaked in the spring of 2000," Ram Bhagavatula, chief economist, Royal Bank of Scotland told the BBC.

"Earnings reports really collapsed in the fourth quarter [2000] and the first quarter of this year. My presumption is the market expects that if the economy is going to do better, corporate profits will follow," he said.

It is what is called a lagging indicator. The effect of falling stock prices and higher interest rates, which the US central bank imposed last spring, take time to work their way through the economy, eventually affecting companies' bottom line.

The implications for the broader economy vary. One of the costs business tries to rein in during an economic slowdown is labour expenses, which result in fewer jobs and possible lay-offs.

But companies also do not buy things when they are trying to reduce costs. That can affect everything from new employee benefits, to new office equipment and supplies.

"If companies don't have the revenue and demand they're not going to spend," Michael Holland, chairman of Holland & Company told BBC News Online.

Industry matters

Of course, some industries have been affected to greater degrees given the current economic climate.

Energy firms have seen profits skyrocket, while auto makers have had to endure not just slumping demand but dwindling prices.

Profits in that sector fell 66% during the first three months of the year, according to The Wall Street Journal.

Other industries hit hardest by the economic slowdown include computer and industrial-equipment makers and advertising firms.

The volatile technology sector saw some of the widest swings between profits and losses, the Journal noted.

Companies such as Lucent Technologies, which makes telecommunications equipment, lost $3.7bn in the latest quarter compared with a profit of $755m last year.

According to the newspaper, other firms hit hard over the last year include Winstar Communications, which has filed for bankruptcy protection and internet company Cisco Systems.

Cisco saw a swing of $3.3bn, from earnings of $641m a year ago to a $2.7bn loss in the first three months of the year.

Confidence building

The US central bank, the Federal Reserve, is acutely aware of the weakness in corporate earnings.

In written comments following each of the five interest-rate cuts it has implemented this year, the Fed has noted that reluctance among companies to invest in new equipment and supplies is a major pull on the economy.

"We need a little more time to build business confidence, which is clearly the problem," said David Blitzer, chief economist for Standard & Poor's in New York.

The Fed is clearly in pullback mode, some analysts note. Mr Holland has long been critical of the Fed for raising interest rates last year, which he said has brought the economy to the brink of recession.

Fed chairman Alan Greenspan has acted aggressively in reducing interest rates in the hopes of spurring an economic rebound. But it may be too little too late.

"The increases were much more significant than the decreases in that respect," Michael Holland told BBC News Online.

"We have to get a rebuilding of confidence that was destroyed in part by previous Fed action."