Yet another Quarter of Better-Than-Expected
Earnings Growth
Dr. Charles Lieberman, Chief Investment Officer

We are still in the early stages of earnings reporting season for the third quarter, but the
preliminary indications suggest that corporate profits will exceed expectations for the third consecutive time, as we have been expecting. Q3 should not be a total surprise. The real surprise came in Q1, when economic growth contracted at a horrific 6% annual rate, yet profit margins increased. Now, profits are growing in response to the first signs of economic expansion. Companies have sharply reduced costs and operations are very lean. Even small increases in sales translate into solid increases in earnings, yet expectations are low. We expect more of this going forward, helping justify the sharp rally in the equities market that began in March.

The credit crisis that followed Lehman’s failure sparked a sharp retrenchment in consumer spending, but also a massive increase in corporate layoffs. Firms were very aggressive in their efforts to reduce costs to preserve their businesses. Companies reduced employment significantly more than sales declined, as documented by the record liquidation of inventories in the first half of the year. It is now evident that these cuts are unsustainable. Businesses must rehire just to prevent inventories from falling even more. But before they resume hiring, it is critical that they experience some rise in sales, so they can project an economic recovery. As recovery prospects improve, hiring will pick up at a more meaningful rate.

In the meantime, profit margins have increased sharply, as costs have fallen more than sales. With a moderate increase in sales—GDP is expected to rise about 3-1/2% in Q3—corporate profits should exceed the modest expectations of investors. In fact, the early reports suggest that sales and operating profits are coming in nicely above expectations. The next two weeks will see an avalanche of earnings reports and we expect those to reinforce the positive message already implied by the companies that have reported.

The pickup in corporate profits has not been a total surprise to the market, as demonstrated by the sharp rally seen since the early March lows. This is actually typical for the early stages of recovery, where the equity market rallies before the economic recovery or the profits recovery becomes evident, suggesting that the market’s rally is well grounded. It is especially well grounded, if the recovery becomes well entrenched and becomes a solid expansion, as

we expect. That will take longer to become evident. Still, profits appear to be right on track.

Advisors Capital Management, LLC (ACM) is a provider of privately managed portfolios for industry professionals and their clients. Although the information included in this report has been obtained from sources ACM believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. ACM is a registered investment advisory firm. Web Address: ww.advisorscenter.com. 777 Terrace Avenue, Hasbrouck Heights, NJ 07604. Phone: (800) 977-4424

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