Report: Profit margin recovery "may not be sustainable"

From Bloomberg News

Rough patch ahead for stocks?U.S. corporate earnings that are beating analysts’ estimates at the highest rate since at least 1993 are driven by a recovery in profit margins that may not be sustainable, according to Morgan Stanley strategists.

Tumbling labor costs have offset disappointing sales growth to help companies exceed third-quarter earnings projections, Gerard Minack and Jason Todd wrote in a report Monday. That trend may slow in the next quarters as an uneven economic recovery may force companies to spend more, they said.

Better-than-estimated profits have helped push the Standard & Poor’s 500 Index to the highest level in more than a year this month, extending the rebound from a 12-year low on March 9 to more than 60 percent. The rally had stalled in October, when the index had its first monthly loss since February amid concern prices have outpaced the prospects for economic growth.

“We can’t see how firms can increase revenues without adding to costs,” Sydney-based Minack and New York-based Todd wrote. “We may now be at the stage where revenues drive profits, or margins do -- but forecasts for the best of both may be too optimistic.”

About 80 percent of companies in the S&P 500 that have reported results for the previous quarter surpassed profit estimates, data compiled by Bloomberg show. That’s the highest rate since records began in 1993. For the final quarter of 2009, analysts expect a 71 percent gain in per-share earnings in the measure on average, according to Bloomberg data.

Labor costs fell at a 5.2 percent annual rate in the third quarter, the Labor Department said Nov. 5, capping the biggest 12-month drop since records began in 1948 and exceeding the median forecast for a 4.2 percent drop predicted by economists in a Bloomberg survey. Costs in the prior quarter declined 6.1 percent, more than previously estimated.

“There’s a natural limit to how far labor costs -- which is consumers’ key income source -- can be squeezed without affecting sales,” Minack and Todd wrote in the report. “Can corporates keep beating earnings forecasts even as revenue disappoints? We have been skeptical.”

The jobless rate in the U.S. jumped to 10.2 percent in October, the highest level since 1983, casting a pall over the prospects for a sustained recovery. Confidence among U.S. consumers unexpectedly declined in November for the second consecutive month as the surging unemployment shook households.