Corporate Profits Dwindle Even as GDP Surges

By Jennifer Yousfi
Managing Editor

A mixed report from the Commerce Department indicates the U.S. economy continues to grow even as corporate profits start to show the strain of a weakening domestic market.

The report cited preliminary estimates for third quarter 2007 gross domestic product (GDP) and corporate profits. GDP was revised upward to 4.9%, an increase from the advance estimate of 3.9%. This is the largest increase at an annual rate for 2007 year-to-date, up 1.1% from the second quarter increase of 3.8%.  Investment in inventories and exports were the key contributors to the increase for the quarter. 

Meanwhile, corporate profits from current production dropped $19.3 billion for the quarter. Domestic profits declined $41.2 billion, of which financial corporations accounted for over 70% of the decrease with a decline of $29.1 billion over second quarter.

The decline in financial profits does not even include the large write-downs recently taken by many banks to account for sub-prime related investments.

Profits from outside the U.S. showed the only signs of growth, posting a positive $21.9 billion, a $5.2 billion increase over second quarter. 

Leading economists are still at odds over what this means for the economy.  Some feel the decline in corporate profits is the first sign of a coming recession.

"The earnings recession has already arrived.  We are going to see an economic recession in '08," David Rosenberg, North America economist for Merrill Lynch & Co. told Bloomberg

Others remain optimistic that the economy will be able to skirt the textbook definition of a recession: Two consecutive quarters of negative GDP growth. 

"We continue to see signs of healthy economic growth, which only underscores the resilience of our economy despite continued challenges in the housing sector," White House chief economist Edward Lazear said in a statement released last Thursday, the same day the GDP and corporate profit numbers were released. 

Fourth quarter's GDP number is likely to be weaker, as inventory expenditures will be lighter after the third quarter build-up. And it is unlikely foreign profits can remain strong enough to compensate for falling domestic profits as international markets also begin to feel the effects of the softening U.S. economy.

The market is counting on another rate cut at the Fed's December 11th meeting, but even a 50-basis point cut may not be enough to offset the ever-mounting list of economic concerns. 

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