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Zero? Less than zero?
An analyst at a prominent bank is forecasting no corporate profit growth next year. Could it happen?
November 4, 2005: 12:54 PM EST
By Alexandra Twin, CNN/Money staff writer
Is zero earnings growth on tap next year?
Is zero earnings growth on tap next year?
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NEW YORK (CNN/Money) - 'Twas the week before Halloween when a big Wall Street firm did send, a note most scary to investors that said ...

Next year, no earnings growth.

What? Zero earnings growth?

Granted, a boatload of bulls and bears alike are concerned about the outlook for stocks, and the economy, in 2006, particularly in the first half. And "slowing earnings growth" has become something of a mantra for many on Wall Street.

But none? Zero? Zip? It would be the first time in four years Wall Street's had to weather that.

In his Oct. 25 note titled "10 reasons to be bearish," J.P. Morgan Chase's global stock analyst Abhijit Chakrabortti highlighted why he thinks that a mix of higher inflation and interest rates, better returns on cash and no earnings growth mean the stock market could be in for a rough ride next year.

Not everyone agrees.

"I don't expect zero earnings growth next year, but I do expect slower growth," said Barry Hyman, equity strategist at Ehrenkrantz King Nussbaum.

Hyman cited a possible slowdown in the economy coupled with higher inflation and interest rates, not to mention tougher comparisons from the previous year. Earnings were bound to slow down after more than three years of surprisingly strong growth.

Profit growth was essentially flat as recently as 2002, when earnings for the S&P 500 grew a scant 0.1 percent from 2001, according to earnings tracker Thomson Financial. (see chart)

But for that to happen in 2006 "you'd need some kind of doomsday scenario," said David Dropsey, a Thomson Financial research analyst. "You'd need an environment where you have rampant inflation, increased unemployment and surging interest rates. I just can't see zero earnings growth next year."

Zero? Less than Zero?

Other market analysts contacted for this story agree that no earnings growth next year doesn't seem likely. Calls to Chakrabortti's office were not returned.

Right now, S&P 500 earnings are expected to grow 12.6 percent in 2006 from 2005, when earnings growth is expected to come in at around 14.5 percent, according to economists surveyed by Thomson Financial.

Of course what comes out in fourth-quarter earnings reports and forecasts could change the outlook for next year considerably.

And to be sure, not everyone out there is as rosy as the consensus. While Thomson Financial's average forecast is nearly 13 percent, many analysts say profit increases could easily come in below 10 percent for 2006.

"We won't see 15 percent growth like we're seeing in the third quarter (of 2005), but I think certainly low- to mid-single digits," said Jon Burnham, portfolio manager at Burnham Securities.

Burnham thinks that's partly because the economy is going to keep posting respectable growth, citing government spending that will kick in from the rebuilding efforts after the 2005 hurricanes.

That's a sentiment that Federal Reserve Chairman Alan Greenspan and other central bankers seem to share. (Full story).

But some market watchers question whether the economy, and the stock market, will hold up as well next year.

"I see the whole business cycle slowing down," said Ken Tower, chief market strategist at CyberTrader, adding he expects a bear market in 2006, something he says tends to happen every four years or so. The current bull market has stretched for nearly three years.

Better quality earnings?

Energy, consumer and tech are among the early sectors primed for strong earnings growth next year, according to Thomson Financial

Energy earnings are expected to grow another 13 percent in 2006 on top of the 50 percent growth forecast for 2005. Consumer Discretionary is expected to grow 20 percent versus 1 percent in 2005. Technology is expected to grow 17 percent next year after growing 16 percent in 2005.

Corporations could be better set to handle a possible economic slowdown next year than would first seem to be the case, said Donn Veckery, co-founder of independent research firm Gradient Analytics.

"Typically, market analysts are too optimistic about earnings, but I think in terms of 2006, there's an excess of pessimism," Veckery said.

He noted that while there are definite exceptions, the quality of earnings overall has been improving in the third quarter of 2005 and that looks to stretch into the fourth quarter, and 2006 as well.  Top of page

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