Daily Gains Letter (www.DailyGainsLetter.com), an e-letter published by Lombardi Publishing Corporation, a 27-year-old consumer publisher that has served over one million customers in 141 countries, cautions that stronger-than-expected preliminary third-quarter gross domestic product (GDP) numbers ignore worrisome signs that point to tough times ahead for corporate profits.
On Thursday, December 5, the U.S. Bureau of Economic Analysis announced that preliminary third-quarter real GDP increased at a rate of 3.6%, up from its initial growth rate estimate of 2.8% and higher than economist predictions of 3.1%. This is also a significant increase over the second-quarter GDP growth rate of 2.5%. (Source: “National Income and Product Accounts, Gross Domestic Product, 3rd quarter 2013 [second estimate]; Corporate Profits, 3rd quarter 2013 [preliminary estimate],” Bureau of Economic Analysis web site, December 5, 2013; www.bea.gov/newsreleases/national/gdp/2013/gdp3q13_2nd.htm.)
“The BEA said the increase in third-quarter real GDP came on the heels of positive contributions from personal consumption expenditures, exports, state and local government spending, and private inventory investment,” says financial analyst Sasha Cekerevac. “In fact, the better-than-expected results are attributed to strong increases in inventory levels, which are estimated to have added 1.6% to the overall GDP growth.”
Unfortunately, Cekerevac notes, a buildup in inventory can negatively impact a company’s bottom line if consumers don’t buy. While excess inventory is problematic, he points to more worrisome signs that indicate tougher times ahead for corporate profits. While the S&P 500 has almost doubled since 2009, much of the growth in corporate profits can be attributed to cost-cutting, not revenue growth.
“Businesses cannot build sustainable models built on cost-cutting. Over the past year, companies are actually beginning to hire new workers, albeit at a relatively slow pace. The net result is higher costs. Interest rates are beginning to move upward, too; again, this is a higher cost,” he adds. “Many analysts continue to believe corporate profits will grow 10%–15% next year, but if revenues are not increasing and costs are beginning to rise, this simply doesn’t add up.”
Despite the strong GDP numbers, the growth in corporate profits for S&P 500 companies is beginning to decelerate. Domestically, corporate profits generated by non-financial companies in the third quarter increased to $13.0 billion, a much lower level than the $37.8 billion of corporate profits generated in the second quarter.
“What we are witnessing is a deceleration in corporate profits, and many investors and analysts are far too optimistic in their belief that the S&P 500 companies can continue driving growth to the bottom line,” Cekerevac observes.
As the S&P 500 has recently continued moving higher, another worrisome indicator is a negative divergence between the index and the moving average convergence/divergence (MACD) indicator. Essentially, the momentum appears to be decreasing, even as the S&P 500 moves higher.
“This doesn’t necessarily mean that the S&P 500 has made a top, but it is yet another worrisome sign for investors at these lofty levels,” Cekerevac concludes.
Founded in 1986, Lombardi Publishing Corporation, which has served over one million customers in 141 countries, is one of the largest consumer information publishers in the world. For more information on Lombardi Publishing Corporation and Daily Gains Letter, visit www.lombardipublishing.com.
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