Economy's slowdown no big deal


All the signs of a slowing economy are there: declines in home and auto sales, dampened retail spending, and a rush of warnings from companies that they will miss their earnings projections.

But don't panic. Economists remain convinced that the country's longest economic expansion will keep rolling through the year.

What is different now, they say, is a matter of degree. The economy has been white hot, spawning millions of new jobs, technological advances and companies that are not only more productive, but hugely profitable.

The economy may have cooled, but it has not turned cold, they add.

More than nine years and three months after the boom began, consumer confidence remains near record levels, inflation has been kept in check and jobs are plentiful.

What's more, corporations continue to churn out strong profits.

"The whole profit picture has been surprisingly robust since last summer," said James E. Glassman, senior U.S. economist at Chase Securities Inc. in New York. "We keep hearing worries about wage pressure and wage increases, what we are seeing is that profit margins have been rising."

Economists are so optimistic about the outlook for corporate earnings that they expect stellar second- and third-quarter performances.

First Call Corp., a research company based in Boston that tracks earnings, expects that profits in the second quarter could match the blistering 23.6 percent increase that corporations reported in the first quarter over the same quarter last year.

"That is outstanding," said David L. Donabedian, portfolio manager at Pell Rudman Trust Co., a Boston-based wealth management firm. "We are at one of the great earnings surges of all times. There are thousands of companies out there and there are always going to be some that lay an egg. The vast majority of companies ... are growing their earnings very nicely."

Since April 1, 60 percent of 413 companies warned that profit in the quarter would fall short of analysts' expectations, according to First Call.

While that may appear alarming, economists say it's fairly routine and that they do not get skittish until the figures reaches 70 percent to 80 percent.

Charles L. Hill, director of research at First Call, expects only about 300 companies to make such warning announcements in the next several weeks.

"The [profit] numbers for the year are going to look terrific," he said.

But investors seem edgy nonetheless, and they have little patience for companies that don't meet expectations. Disappoint investors, and punishment is swift and severe. It doesn't matter if the company is a surgical instrument manufacturer, a doughnut maker, or Honeywell International Inc., the world's leading automated-control maker.

Honeywell's shares slid more than $8, or 17 percent, June 19, after it warned that profit would be weaker than expected.

But that was child's play compared with Computer Associates International Inc.'s thrashing. The giant software maker lost more than $21 per share July 5, the day it cautioned that second-quarter profit would be weaker than expected. Its stock tumbled 42 percent to $29.43, and $12.8 billion in market capitalization was erased that day.

"Everybody is on a hair trigger," Hill said. "I think they were receptive about hearing bad news about earnings."

Although profits may be strong, the experts acknowledge that the economy isn't quite what it used to be, especially after the Federal Reserve Board has raised interest rates six times starting in June 1999.

Home sales slipped in May to an annual rate of 875,000, the lowest level in eight months. The decline came on the heels of an 8.6 percent drop in April.

In June, U.S. manufacturing expanded at its slowest pace in 17 months. Sales of light trucks and cars built in North America slipped 5.8 percent at General Motors Corp., and by 9.8 percent at DaimlerChrysler AG's Chrysler unit.

Retailers have suffered with slower sales dampened by rising gas prices and higher borrowing costs.

But these numbers are trending down from incredibly high levels.

"There is quite a bit of evidence that the economy has gone from on fire to good growth," Donabedian said.

What that means is a more temperate profit picture in the fourth quarter, economists say.

Hill expects corporate earnings to slow in the fourth quarter, but still grow about 15 percent over the prior year, which isn't shabby.

However, if the economy sours and profits plunge across the board, then there could be trouble, economists say.

Companies spend less on equipment; they cut back on building plants and offices; divisions close; employees are fired; and problems that were hidden in the good times bubble to the surface.

"As we see a slowing ... it makes corporations work harder to keep their costs in line," Glassman said. "The stock market is highly valued - that is what is keeping the gun to their head. If you disappoint the market, you pay badly with your stock price."

The economy has been growing on average about 4.5 percent for four years, he said. He expects the rate of growth to be between 3.5 percent and 4 percent by spring.

"It is not a dramatic slowdown that we are looking at," he said. "It is a slowdown that tends to have a real significant impact on profits when that happens."

The economy might not be easing enough to satisfy the Fed.

Mark Vitner, an economist at Charlotte-based First Union Corp., expects the Fed to raise interest rates twice before the year is out to keep inflation capped.

"I think we will see more earnings disappointments as the year moves on, particularly in the fourth quarter," he said. "The next president will come into office with a pretty soft economy."

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