According to Berner:

“There’s also a darker side to earnings from abroad. I worry about the potential for a vicious circle in transatlantic earnings. The US earnings downturn is already spilling over into weaker earnings abroad, especially in Europe. NIPA data show that US earnings remitted abroad in last year’s third quarter declined by 7% from Q3 2006. No doubt such weakness was a factor in our European strategy team’s recent earnings downgrade; they expect a 16% plunge in European earnings this year compared with the consensus forecast of a 7% increase. The impact of the US earnings downturn on Europe likely will be significant: US direct investment data suggest that about 2/3 of our payments abroad go to Europe.

“Such payments, which are earnings of US affiliates of foreign companies, crashed in the last recession – from a peak of $66 billion in Q1 2000 to a loss of $24 billion in Q4 2001. And for European companies the strength of the euro is a massive headwind: A 13% appreciation of the euro has magnified the earnings downturn in euros for European companies’ US affiliates [as it has magnified US overseas earnings – ed. note). Together with tighter financial conditions, I’m concerned that weak earnings at European companies could contribute to a sharp deceleration in capital spending and in European growth. That would complete the circle, because it would also hurt US earnings abroad. About half of those overseas earnings originate in Europe.”

I have pointed out above that there is now a much higher economic and financial connectivity in the world than has previously been the case. However, I have to confess that I hadn’t thought about, and fully appreciated, how weaker US growth, manifested as declining profits in the United States, would affect the affiliates of foreign companies, which in turn would lead to lower US overseas earnings. Richard Berner’s analysis is very perceptive! Also, I doubt that European stock markets have fully discounted the 16% plunge in 2008 European corporate earnings that Morgan Stanley has estimated!

Berner concludes his exposé of US corporate profits with the following – very politely phrased – remarks:

“Against this backdrop, what’s really perplexing is that Wall Street analysts don’t think that a weak 2008 will cast doubt on the vigor of next year’s results. On the contrary, in what I think is fundamentally flawed logic, they have maintained the level of their 2009 estimates where they were, so that downward revisions to 2008 earnings actually boost the 2009 growth rate. Street estimates for 2009 S&P 500 earnings growth have been revised up to 15.5% from 14.7% at the beginning of January. By comparison, we expect a 5.9% increase in 2009 after-tax economic profits that would leave the level below that in 2007.”

As an aside, a friend of mine, a very savvy and keen observer of economic and financial trends who doesn’t mince his words, calls what the Street has done with 2009 S&P earnings estimates “criminally insane”. I agree. After all, illusion is one of the most pervasive realities of life!

Regards,

Marc Faber
for The Daily Reckoning

Editor’s Note: It’s becoming very clear with each passing day that the U.S. economy is headed for an iceberg… and over the next 12 months…and despite all the bank write-downs, market bombs and “bailout” talk already…there are at least five more devastating new financial shocks ahead.

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