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THE LAST HURRAH?

Enjoy the first quarter's profits- it may be downhill from here

Shareholders, enjoy it while it lasts. The surging economy of 1997 is lifting Corporate America's bottom line to new highs. The 70 companies in business week's flash report on first-quarter profits cranked out a 30% increase in earnings over the same period in 1996 on just a 9% gain in sales. Profit reports that exceeded analysts' midquarter expectations outnumbered disappointments by two to one. When the final results are in from all companies, the overall increase will wind up below that of the flash sample. But there should still be a healthy double-digit increase--enough to give investors a respite from the barrage of bad news that has dogged Wall Street in recent weeks.

A breather, but a brief one. The first quarter may be the last this year to deliver such robust earnings gains. Rising labor costs, slowing productivity growth, and the strong dollar's hit on overseas earnings all signal a profit squeeze ahead. And the surprisingly strong earnings reports suggest an overheating economy--some economists estimate that growth hit a blistering 5% annual pace from January through March.

That's likely to reinforce the Federal Reserve's determination to rein in the economy before inflation hits. Benign news on inflation--the consumer price index rose only 0.1% in March--lifted the Dow Jones industrial average by 228 points on Apr. 15 and 16. But that won't keep the Fed from pulling the lever for a second rate hike on May 20. That expected increase, says Allen Sinai, chief economist of Primark Decision Economics, will guarantee that ''the first quarter was the last hurrah for extraordinary growth.'' Profits will keep growing, but gains will slow to 6.7% for all of 1997--and 5.8% in 1998--according to a survey of investment strategists by First Call Corp.

What does this mean for Wall Street? With earnings up and the Standard & Poor's 500 index down--off 7.5% from its Feb. 16 peak--stocks now trade at 15.7 times expected earnings, down from 17.2. But that's not necessarily a buy signal. ''People are selling the companies with good earnings because they figure profits aren't going to get better,'' says Ronald C. Ognar, portfolio manager for the Strong Growth Fund.

Wall Street's forward spin on earnings was clear in the market's treatment of Intel Corp. With technology driving both the boom economy and the bull market, the chipmaker that's inside 90% of all personal computers has been a bellwether. Intel boosted first-quarter profits by 122% on a sales gain of 39%, thanks to a shift toward pricier Pentium mmx microprocessors. Earnings per share, at $2.20, exceeded analysts' mid-quarter expectations by 7%, according to Wall Street-watcher i/b/e/s International Inc.

TECH SLIDE? But more telling was what Intel said about the future: Second-quarter revenues will be flat, executives say, and gross margins will shrink under pricing pressures and the costs of rolling out the Pentium II chip on May 7. Compaq Computer Corp. told a similar story. Its first-quarter profits rose 65% on a revenue gain of 14% as it sold more high-margin servers and workstations. But second-quarter profits will be flat, says CFO Earl Mason. Beleaguered Apple Computer Inc. lost $708 million, including $530 million of charges. Little wonder that despite the uptick in the Dow, high-tech stocks continue their slide. The NASDAQ Composite Index dropped 3.1% from Apr. 8 to Apr. 16.

Another key bull-market sector--financial services--enjoyed a solid first quarter. Profits rose at double-digit rates for brokers such as Merrill Lynch & Co. (up 13%) as well as banks such as First Chicago NBD (up 12%). One worrisome note: Credit-card chargeoffs rose, hitting 5.9% of outstanding card loans at Citicorp and 7.4% at First Chicago. And higher rates later on can only hurt bank profits.

Detroit burned rubber in the first quarter. General Motors Corp., bouncing back from a strike-afflicted first quarter of 1996, posted a 125% gain in profits from continuing operations. GM's North American operations contributed $764 million to the bottom line--the best return in more than a decade. Ford Motor Co. boosted net profits 125%--beating analysts' expectations by 33% with strong sales and $800 million in cost cuts. Still, carmakers doubt that they'll maintain what has been a 15.5 million-unit annual pace. ''The first quarter is probably the strongest we're going to see,'' says Ford CFO John Devine.

Some spots already show signs of a profit slowdown. Multinationals fret about the dollar, up 9% against the yen and 12% against the mark so far this year. DruGMaker Pfizer Inc. posted a solid 16% gain in first-quarter profits--but investors sold off its shares on management's warnings that the dollar would dampen growth in sales and earnings. For Eastman Kodak Co., the buck is already biting: Currency adjustments cost the bottom line more than $22 million, contributing to a 46% drop in earnings.

Meanwhile, costs are rising at home for many businesses. With unemployment at a low 5.2%, unit labor costs are starting to climb faster than prices. ''As employers dig deeper in the labor pool, they have a harder time finding productive workers,'' says Mark M. Zandi, chief economist for Regional Financial Associates Inc. Nor can companies count on low medical inflation to offset wage gains: Employers' health-care costs will rise 4% this year and could soar 10% or more in 1998.

RATE HIKE? Companies hoping to pass on these rising costs to ever-richer customers may be let down. Fed Chairman Alan Greenspan ''has guaranteed us he's going to slow the economy,'' says investment strategist Charles J. Pradilla of Cowen & Co. That portends slower revenue growth and little tolerance for price hikes.

Disappointing? Well, if the prognosticators are right about single-digit profit growth ahead, we'll not likely see the bull of '96 return. But if the Fed can prolong the low-inflation economy, earnings should be strong enough to keep the bear at bay. And that, in an expansion heading toward its seventh year, ought to be success enough.

By Mike McNamee in Washington, with Jeffrey M. Laderman and Frederick F. Jespersen in New York and bureau reports



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