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Slow growth and inflation eating into US corporate gains

Analysts cut forecasts for first quarter as profit margins shrink, due to higher costs

WASHINGTON – CORPORATE profit margins are set for an uncomfortable squeeze this year, as companies pay more for materials but yet have little leeway to raise prices.

Inflation is tricky enough on its own but when it comes along with slowing economic growth, the pain is magnified because cash- strapped consumers often force companies to absorb the bulk of the pricing pressure.

Recent inflation reports suggest that many businesses are doing just that. The rate of inflation at the factory gate far outstripped consumer price increases in both the United States and Britain in November.

This week, investors will get an early peek at inflation data for last month, with surveys of global purchasing managers – the people who make buying decisions for businesses – from both the manufacturing and services sectors.

The November reports showed input prices spiked, as oil, food and other commodities remained stubbornly high, powered by demand from fast-growing emerging markets such as China.

Last month’s numbers are likely to reflect more of the same, and with oil once again approaching US$100 per barrel, inflationary pressures look likely to linger.

Last Friday, Australia’s survey of purchasing managers showed slowing orders and rising input prices for last month.

In Japan, manufacturers’ output and new orders rose but inflation kept creeping up, straining margins.

Mr Jack Ablin, chief investment officer at Harris Private Bank in Chicago, noted that when the difference between producer prices and consumer costs widens, it is often a prelude to an economic downturn.

Wall Street analysts are beginning to trim profit forecasts, and many market-watchers think estimates will fall further this month, when companies start reporting fourth-quarter results and commenting on prospects for the full year.

Earnings for companies in the Standard & Poor’s 500 Index are expected to grow by 6.7 per cent in the first quarter of this year, according to data compiled by Reuters Estimates. As recently as Nov 12, analysts were looking at first-quarter earnings growth of 10.9 per cent.

While the projections have come down sharply, they still look relatively rosy when compared to bleak forecasts for just 0.5 per cent earnings growth in the final quarter of last year.

Those estimates were slashed as financial companies announced billions of dollars in losses tied primarily to bad mortgage loans.

Mr David Rosenberg, an economist with Merrill Lynch, said US corporate profits were likely to have peaked in the third quarter of last year.

‘While the debate rages over whether the real economy is going into a recession, the reality is that the earnings recession has already arrived,’ he wrote in a recent note to clients.

Corporate America is raising prices where it can but must tread carefully for fear of scaring away potential customers as household budgets strain under the weight of rising mortgage payments, petrol prices and other costs.

General Motors (GM) announced earlier this month that it will increase prices by as much as US$1,500 (S$2,172) on its 2008 model vehicles, though it was holding the line on some cars in hotly contested segments such as four-door sedans.

General Mills, the food company best known for Cheerios cereal and Progresso soup, said it planned to raise prices again after inflation outpaced its forecasts.

Kroger, the largest American grocery chain, reported weaker margins for its latest quarter as costs headed up.

European companies find themselves in a similar situation.

Companies such as Nestle have been raising prices to offset rising commodity costs and expect further increases in the coming year.

As European consumer spending shows signs of fading, the worry is that customers may seek cheaper alternatives.

Source: REUTERS (The Straits Times 1 Jan 08)

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