Investors' profit tailwind losing strength

For 11 straight quarters, beginning in late 2009, corporate profits have gone straight up. For most of that time, the big companies that make up the Standard & Poor's 500 index delivered double-digit increases.

In the second quarter of this year, though, the increase was just 0.2 percent. Analysts expect third-quarter earnings, for which results have just begun to come in, to decline by a fraction of a percentage point.

The plateauing of profits isn't a surprise. Cost-cutting efforts generated much of the boom, and there's a limit to how much efficiency companies can squeeze out of their workers and equipment.

“By now, you need some top-line growth for most companies to deliver earnings per share growth,” says Ken Crawford, a managing director at Argent Capital Management in Clayton.

With the U.S. economy growing only about 2 percent a year, it's hard for corporate America as a whole to show much top-line, or revenue, growth. And our multinational companies have been hurt by a recession in Europe and a slowdown in China.

Jeffrey Kleintop, chief market strategist at LPL Financial, says investors will have to get used to mediocre earnings seasons like this one. “I think profit growth is going to be very sluggish, close to flat, for the next year,” he said. “We've squeezed all we can out of every single worker, and the companies don't feel the need to hire yet.”

Scott Wren, senior equity strategist at Wells Fargo Advisors, says the winning streak might have lasted longer if we were in a normal economic recovery. “Typically you get to a point in the cycle where sales growth starts to ramp up, but I don't think that is going to happen in this cycle,” Wren said.

The numbers for this quarter could still turn positive, he points out – companies' final results have beaten analysts' estimates in most of the recent past.

That isn't guaranteed, however. Just ask Google, whose shares lost 8 percent of their value after a disappointing earnings report on Thursday.

Norman Conley, chief investment officer at JAG Advisors in Ladue, thinks the current earnings season is more of a pause than a turning point. “Profit margins probably have peaked, but I don't think in most industries sales have peaked or are anywhere close to peaking,” he said.

Companies also have record amounts of cash on their balance sheets. If they use some of that cash to buy back their own stock, they can make per-share earnings rise even in a lackluster economy.

For investors, these quarterly earnings counts are important. Kleintop points out that in the current bull market, stock prices have risen almost in lockstep with profits. S&P 500 earnings are up about 70 percent since 2009, and the index has delivered a total return of 66 percent since the beginning of that year.

The stock market can still go up in an era of slower earnings growth. Investors, for instance, could shift money into stocks because they're disappointed with low yields in the bond market.

The earnings winning streak, though, provided a powerful tailwind for stock prices. Going forward, investors can expect only a gentle breeze at their backs, not a stiff gale.