Wall Street is expecting corporate profits to drop this year. But the key question being asked is, "By how much?" Answers cropping up at the various brokerage houses depend on how deep or mild each thinks the economic slump will be. Some of Wall Street's wizards, for example, are expecting only a shallow recession, while an increasing number are expecting a deeper slide, brought about by the record interest rates business is paying.
In the first camp, among those expecting only a mild downturn sits Sam Nakagama, a Kidder, Peabody & Co. economist. Mr. Nakagama, in an interview, said he is projecting a drop in corporate profits of 4 percent this year and then a rise next year of 6 percent. Both are figured on an after-tax basis.
He reasons that the prospect of sliding from a mild recession into a steep decline is so real that "the administration can't afford to let it happen." If the downturn is more serious than the one he is projecting, he says, the situation will become critical. For example, he cites the auto industry, which is expecting a lot of red ink this year. With just a mild recession, Ford Motor Company may lose $1 billion, and Chrysler could also lose a large amount. "So you can see that for the economy to go into a deep slide could cause real problems," he says.
Mr. Nakagama adds that the critical point will be what happens in consumer spending, home sales, auto sales, and the big-ticket items. He expects that consumers will stop spending, now that their credit is being restrained. "Spending should fall like a rock," he predicts. Thus, he concludes that interest rates are probably near their peak and should start down in the next 30 to 60 days.
In a completely different ballpark is Larry Kudlow, an economist with Bear, Stearns & Co. He says bluntly: "The profits outlook for 1980 is very disappointing."
He is expecting what he terms "a hardlanding recession." In his analysis, he finds the consumer being squeezed by high interest rates and declining real estate values.At the same time, business is experiencing significant increases in cost pressures from rising energy prices, soaring raw material costs, and higher financial and labor costs. Thus, profit margins are being reduced and businesses are being forced to cut back on employment.
Mr. Kudlow forecasts that corporate profits will decline 20 percent from peak to trough, from the first quarter of this year to the first quarter of 1981, and that by the fourth quarter the United States will be firmly mired in a recession. "This decline in profits clearly will raise a red flag over the stock market," he says. "We are recommending a very cautious and defensive attitude for the next two quarters."
Instead of buying stocks, Bear, Stearns clients are being told to get ready for a rally in the bond markets in the second or third quarter. Mr. Kudlow says the strong dollar and the recessionary economy will make bonds worth holding.
Jeffrey Nichols of Argus Research finds himself wedged between the positions taken by Mr. Kudlow and Mr. Nakagama. Mr. Nichols is predicting a drop in corporate profits of 15 percent on a yearly basis.
Monetary policy, he says, will result in a deeper recession than that expected by Mr. Nakagama. Exactly how deep it will be is hard to predict, because the effects of the Federal Reserve's interest-rate moves taken last October are still being felt. He maintains that the Fed's moves last month will not work their way through the system for some months to come.
Last week the stock market continued its rebound, gaining 6.48 points to close at 784.13. By the end of the week, however, traders were expecting a test of the lows when the market opens on Monday. The market was closed on Good Friday and trading volume all week was light, in part because of the mass-transit strike in New York. Some traders took the week off rather than walk to work.
There was little in the news last week other than a move by most major banks to a 20 percent prime rate. Unless federal regulations are changed, the rate cannot be raised much further without bumping into federal usury limits. Many analysts believe the rate is at or near its peak, however.