Global slump eroding U.S. profits

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Slumping global growth and the euro zone debt crisis are deepening their bite into corporate profits.

Investors are bracing for an onslaught of tepid second-quarter corporate earnings reports starting this week, amid expectations of near-zero profit growth and worries that the long upturn in North American earnings is at an end.

The slowing U.S. profit trend threatens to deal another blow to the health of the economy and employment picture south of the border. That, in turn, would hurt a Canadian economy that relies heavily on exports to the U.S. and is already struggling with falling global commodity prices.

Alcoa Inc. kicked off second-quarter reporting season Monday with a profit of 6 cents (U.S.) a share, excluding one-time charges, compared with 32 cents in the year earlier period. Sales declined to $5.96-billion from $6.59-billion.

Although Alcoa's numbers were slightly better than analysts' estimates, forecasters expect that over all, the second quarter of 2012 will post the weakest year-over-year profit performance in almost three years.

That's a reversal from recent reporting periods, when earnings growth provided a bright spot in a challenging economic landscape.

The main culprits are weak demand in Europe, slowing growth in China, and a U.S. economy that appears to be losing speed.

Profits are likely to drop 1 per cent from the same quarter last year, according to analysts polled by research firm S&P Capital IQ, which would be the first negative figure since 2009.

"We have real headwinds out there," said Sam Stovall, chief equity strategist at Capital IQ in New York. "It's a decelerating earnings growth environment."

A big part of the story is the fact that U.S. companies are more vulnerable than ever to external profit volatility, said CIBC World Markets senior economist Peter Buchanan. Fourteen per cent of S&P 500 earnings are derived from Europe, he said.

Several major companies have already cautioned investors that this quarter's earnings are likely to be weaker than expected. According to S&P Capital IQ, out of 103 companies that have offered previews of their earnings, 63 provided so-called "negative" guidance, a sign that they faced challenges during the quarter.

"The two most important things to be watching for [in second-quarter profits] is how many companies miss their estimates and how many beat them. That will reveal the trend going forward," said Scotia Capital strategist Vincent Delisle.

For every S&P 500 member upgrading its estimates for the second quarter, 3.6 have pared theirs, Mr. Buchanan pointed out.

"That's the worst level in 11 years," he said.

"The question is whether all the bad news is priced in the market. We still think there could be potential for disappointment."

John Butters of market research firm FactSet says in a recent report that the financial sector is expecting the highest earnings growth rate – 48.1 per cent – while energy and materials are anticipating the lowest minus 18.4 per cent and minus 12.1 per cent, respectively.

Some companies will receive special scrutiny in the coming weeks. On Friday, JPMorgan Chase & Co. reports earnings, which will also reveal the extent of the losses the bank suffered as a result of massive wrong-way bets by a London trader.

Bellwethers such as McDonald's Corp., Procter & Gamble Co. and Caterpillar Inc. are expected to provide a sense of how consumer and corporate demand worldwide are holding up in the face of bad news from Europe.

Analysts do expect earnings growth to rebound to healthy levels in the last quarter of 2012, but those predictions may start to appear overly optimistic as the year progresses. Without a pickup in economic growth, it will be difficult to generate robust growth in earnings, said Mr. Stovall of Capital IQ.

Of key interest to investors will be what companies have to say about their outlooks for the rest of the year, which could provide some hope even with the expected weakness in the profit numbers. Alcoa, for example, provided a bit of good news by sticking with its forecast for a 7-per-cent increase in global aluminum demand this year.