(MONEY Magazine) – Look for a Shift in Earnings Growth
The business page headlines would make you think stocks are on a tear. Earnings rose 13.8% on average for companies in Standard & Poor's 500-stock index in the first quarter. That's nearly double the gain analysts were predicting in January, and it's the eighth quarter in a row that earnings exceeded expectations. But the market is down in 2005. What gives?
First, there are worries about inflation and interest rates (see "Why This Market Will Get Unstuck," page 69). Second, energy companies, fueled by high oil prices, posted the biggest increases in profits. That's actually bad news for most companies, since, along with us, they're the ones buying gas. That has some analysts predicting corporate profit growth will slow, a negative for stocks.
But if the first quarter is any indication, the economy isn't getting the credit it deserves. Gross domestic product grew by 3.5%, and bellwethers such as Intel and Home Depot posted great results. "This recovery is statistically among the strongest we have ever had," says James Paulsen, chief investment strategist at Wells Capital Management.
Going forward, other sectors besides energy appear ready to start picking up. Profits at health-care companies are expected to rise 31% in the fourth quarter, according to Standard & Poor's. Automakers and retailers should do better as well. But investors aren't convinced yet. "Right now we are swinging toward the anticipation of weakness," says Richard Hoey, chief economist at Dreyfus. If profits do rise in those down-in-the-dumps sectors, however, it could help the market in general by confirming the economy's strength. --STEPHEN GANDEL
THE LAST SHALL BE FIRST
Earnings laggards should start to perform better.
2005 EARNINGS GROWTH
SOURCE: Standard & Poor's.
HOW THE MARKET FARED
Though May was mostly a bright spot, major stock indexes are still down over the past three months.
NOTES AND SOURCES: Benchmark data as of May 19. Index returns from Lipper, New York; 877-955-4773. Index levels from Bloomberg. Bond index data from Lehman Brothers. Stock data as of May 24 from Thomson/Baseline. Monthly S&P 500 ratios as of May 11 from Standard and Poor's. Ratios are based on previous four quarters of earnings.  Annualized.  Price change only. N.A.: Not applicable or not available.