WHAT PROFIT IT THE DEMOCRATS?:

The stars are aligned, market's up. Go profits! (Charles Stein, 10/19/2003, Boston Globe)

It is a good bet that no one running for president -- not even President Bush -- will make a speech applauding the strong corporate profits that have been reported lately. The phrase "fatter profits" conjures up an image of a greedy chief executive stuffing his pockets, perhaps illegally. But the truth is the earnings numbers are good news and important news -- not just for chief executives and investors, but for the rest of us. Profits always matter. Given the events of the past three years they matter more than ever. The economic slump that began in 2000 was first and foremost a profits recession. During the boom of the late 1990s corporate America overspent and overinvested. When the slowdown hit, companies were stuck with expenses that were far out of line with sales. The result: a profits meltdown. Allen Sinai, the chief economist with Decision Economics, says the profit decline of the past few years was the steepest since World War II. In 2001 profit margins -- profits divided by sales -- reached their lowest level on record.

Businesses reacted predictably. They stopped spending money -- on people, computers, air travel, and paper clips. When they did spend money it was for technology that further cut their costs and allowed them to get more out of their existing work force. Ken Heebner watched the retrenchment process and sensed opportunity. Heebner, who is with CGM Funds, is one of Boston's smartest money managers. Heebner figured that the belt-tightening and productivity improvements meant that corporate America was sharply reducing its break-even point. Heebner reasoned further that once the economy picked up even modestly -- a sure thing given lower interest rates, tax cuts, and a weaker dollar -- profits wouldn't just grow. They would explode.

EMC Corp. offers a textbook case of what Heebner was talking about. Last Thursday, the Hopkinton technology company reported that its sales rose 20 percent in the third quarter. Yet profits rose 650 percent, thanks to several years of cost-cutting, including a reduction in staff of 7,000 people. Profits for the firms in the Standard & Poor's 500 index are expected to be up 16 percent in the third quarter from the same quarter a year ago, the best performance in three years. The profit bump explains why the stock market is up almost 20 percent this year.

By now you are asking the question: What does all of this have to do with me? The answer is pretty straightforward. If the disappearance of profits caused companies to spend less, the return of profits should prompt them to spend more.

October just gets blacker and blacker for the Democrats...

Posted by Orrin Judd at October 19, 2003 8:52 AM