New Business July 30, 2009, 5:00PM EST

U.S. Companies Are Still Stuck in Recession's Fog

Despite positive news, executives at companies such as Honeywell and Home Depot are holding off on hiring and other investment

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Illustration by Henrik Drescher

By Christopher Palmeri and Jena McGregor

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The stock market is up. Corporate profits are beating Wall Street's expectations. And for the first time in more than two years, more analysts raised than lowered their forecasts for Standard & Poor's (MHP) 500-stock index companies. With all the good news in the air, one might assume the fog over the economy is finally lifting and managers are positioning their companies for renewed growth.

But executives remain skittish about predicting their fortunes. In a typical downturn, this would be the time when they start to think about rebuilding—after months of cost-cutting and depleted inventories. Instead, many are bracing themselves for new rounds of painful cuts. The problem: Cost-cutting boosted earnings in the second quarter but few can predict when sales will bounce back. If companies become too spooked to respond to sparks in the economy, the result may be moves that extend the length and depth of the downturn.

Right now, many feel trapped in a waiting game. Honeywell International (HON) CEO David M. Cote says he wants to avoid layoffs and is asking many of his 120,000 staffers to prepare for weeklong unpaid furloughs in the coming months. Atlanta-based Home Depot, which began to feel the impact of softer home prices in 2006, has done everything from exit businesses to revamp its procurement process to manage costs. "We will have a harder time planning for the up than we did for the down," says Chief Financial Officer Carol B. Tomé. With sales expected to drop 9% this year and signals mixed in the housing market, she's not sure when demand will come back. Tomé admits that it will take courage to "step out and say, 'O.K., I think sales are going to increase.'"

THE CONSUMER MYSTERY

While it may be hard to manage through the current state of uncertainty, economists predict most companies will see improvement in the second half. Over the past 18 months, U.S. businesses have radically slashed inventory, payroll, and capital spending. That was both a response to the cratering economy and a major factor in the speed of its decline. The first step in every recovery is to reestablish profits without a rebound in sales, notes James W. Paulsen, chief investment strategist of Wells Capital Management. About 77% of the companies reporting so far have beaten analysts' earnings estimates, according to Thomson Reuters. As profitability returns, investors feel more confident about getting back into the stock market. "And there's nothing better to get a CEO to hire somebody or make a capital investment than their stock price going up," argues Paulsen. The problem now, he explains, is that on Main Street and in the C-suite, panic has merely given way to purgatory.

The biggest unknown is what to expect from consumers. With credit in short supply and unemployment on the rise, they remain reluctant to spend. Supermarket giant Safeway (SWY) witnessed that phenomenon in the second quarter. It posted a worse-than-expected sales drop of 6.5% as customers traded down to lower-priced generic products. And Americans are unlikely to open their wallets until they feel certain about their own job security. Says Ed Yardeni of Yardeni Research: "The important thing is for businesses to stop firing."

As long as the external environment remains in doubt, companies will continue to focus on what they can do internally. Ari Bousbib, president of commercial companies at United Technologies (UTX), says he is starting to see signs of life in areas like China and the refrigerated trucking business in the U.S. But overall constraints on credit have curbed major construction projects and orders. "We can only control our costs [and] cannot really control the top line," says Bousbib.