[A-List] New economy bull

["Keaney Michael" <Michael.Keaney@xxxxxx>]

Good grief! Can it get any more convoluted than this? Had to include
this if only because it's symptomatic of the smoke and mirrors which
this particular thread was inaugurated to track...


Chief executives vs the statisticians
John Lipsky and James Glassman explain the disparity between profits at
S&P 500 companies and optimistic GDP forecasts
Financial Times: April 8 2002

Who is right about the US economy? Is it the chief executives and
financial officers who are facing a round of downbeat first-quarter
earnings reports? Or is it the Department of Commerce statisticians,
whose calculations of gross domestic product portray an economy that
already began producing an impressive profits rebound late last year?

Consider the facts: according to the stunning GDP figures released last
week, after-tax profits from current production of all US corporations
surged in the fourth quarter, leaving profits 5.7 per cent higher than a
year earlier. But this stands in sharp contrast to the 24.5 per cent
year-on-year fourth-quarter drop registered in 2001 in the after-tax
operating earnings of the S&P 500 corporations.

Who is right? In one sense, both are. Profits have dropped sharply since
mid-2000 at the big, high-profile companies that are represented in the
S&P 500 index. However, the composition of the S&P 500 over the past few
years has become more heavily weighted towards the telecommunications,
media, technology, energy and financial sectors. These were precisely
the sectors that soared in 1998-1999 but slipped during 2000-2001.

The profit performance of the S&P 500 over the past few years therefore
has not reflected accurately the entire US economy. In fact, operating
earnings of S&P 500 companies represent only two-thirds of US corporate
profits. In contrast, the government's quarterly profit estimates
reflect the results from more than 8,000 US corporations.

The gap between reported (S&P 500) and economic (GDP) profits reflects
methodological issues as well as the specific sectoral slant of the S&P
500.

Investors' corporate profit perceptions typically focus on corporate
reports prepared using generally accepted accounting principles (GAAP).
These exclude the impact of cumulative accounting changes, discontinued
operations, and one-off charges. However, GAAP- based profits fail to
account for other distortions.

The most important of these differences relates to the treatment of
depreciation charges. Such charges are deducted from profits under both
GDP and S&P definitions. According to the government's statisticians,
however, corporations following GAAP guidelines reported depreciation
charges on investments that exceeded "true" economic depreciation. In
other words, corporations at present are allowed to write down
investments more quickly than their economic usefulness expires.

This gap became a significant factor amid the rapid build-up of business
investment spending during 1995-2000 and probably accounted for up to a
third of last year's S&P/GDP "profit gap".

Other important differences exist between the two accounts but,
surprisingly, they would normally tend to reduce, not boost, the
reported profit gap.

Most notably, the GDP accounts deduct the cost of stock options from
earnings at the time that they are exercised, while S&P operating
profits do not deduct employee stock options from earnings at all, in
line with GAAP guidelines. Last year, however, it is likely that the
cost of options exercised waned, so the effect would have boosted 2001
GDP profit growth. Other methodological differences do not create
meaningful divergence in the outcomes.

Last quarter's profits surge may also have been obscured in part by Wall
Street's focus on year-on-year profits comparisons. This practice
reflects the practical unreliability of seasonally adjusting any single
company's quarterly earnings. The GDP-based profit figures are
seasonally adjusted, which is a much more reliable exercise when applied
to aggregate figures.

While this adjustment did boost GDP profits in last year's final
quarter, seasonal factors for last year's fourth quarter nonetheless
have to be viewed with caution.

Cutting through the technicalities, there is little mystery why broadly
measured profit growth is rising. Companies in all sectors have been
squeezing out new productivity gains in spite of an economic stall that
left national output roughly flat last year.

Furthermore, businesses have been curbing costs, including slowing wage
gains. With sales volumes growing since late last year and unit labour
cost falling, corporations' after-tax cashflow has rebounded to a record
level and is relatively high even as a percentage of national output.

If this more upbeat profits analysis is correct, it will go a long way
to explaining another mystery: why the US stock market has continued to
support a historically impressive ratio of stock prices to reported
operating earnings. In fact, the GDP accounts indicate that the
after-tax profits share of national output has already been restored to
the level reached in the mid-1990s, largely reversing the slide that
began in mid-2000.

The chances are that chief executives are going to have a more upbeat
story to tell in the next few quarters.

The writers are senior economists at JP Morgan in New York

Full article at:
http://news.ft.com/ft/gx.cgi/ftc?pagename=View&c=Article&cid=FT3WKTQ4RZC&live=true

Michael Keaney
Mercuria Business School
Martinlaaksontie 36
01620 Vantaa
Finland

michael.keaney@xxxxxx