Nothing shows up an economic cycle quite like corporate profits. This is particularly true of the U.S. economy, where there are so many firms and such a variety that the "population" precludes any problems with small samples, in statistical terms.

The U.S. economy started to recover after the dot.com collapse in the first quarter of 2002. This was accompanied by a quarter-to-quarter increase in corporate profits. Net earnings continued to climb, with mostly quarter-to-quarter increases and almost nothing but year-over-year increases, through to the end of 2007.

Between fourth-quarter 2007 and first-quarter 2008, profits started faltering again. That time frame was also the beginning of this current recession, according to the National Bureau of Economic Research (NBER), which sets official dates for business cycles. Profits had their sharpest plunge so far between the third and fourth quarters of last year. (story continued below)

Profits in Canada's Corporate Sector (a smaller base)
The pattern of net earnings in Canada's corporate sector (comprised of a smaller base) has been quite similar to the United States. Profits marched steadily upwards from the fourth quarter of 2001 to the third quarter of 2008. Canada's corporate sector continued to perform relatively better through the third quarter of last year due to its strong weighting of companies involved in raw materials processing. World commodity prices topped out in July of 2008. It is clear that Canada still has several quarters to go during which profits will be declining on both a quarter-to-quarter and year-over-year basis.

A Reduced Outlook for Profits
The reduced outlook for profits is happening at the same time as the shock in stock markets. Historically, the relationship between the share value of a company and its profits is often closely entwined, but not always. Timing factors can play a role as well. For example, stock values can move up in anticipation of coming profit gains.

Stock prices in North America had a modern "Black Monday" on September 29 2008, when the U.S. House of Representatives rejected the first financial-sector bailout package. It is tempting to say that stock markets have been encountering problems due to esoteric matters like declining confidence. This has arisen from the world financial crisis and credit crunch. But there are real-world benchmarks that are just as important.

Economic measures seek equilibrium over the longer term. Profits as a percentage of National Income have a tendency to revert to "norm". For this reason, most stock market analysts expect the growth in profits and the growth in share prices to approximate the long-term rate of increase in nominal Gross Domestic Product (GDP). (That is why the dot.com boom in share prices, before the collapse, was such an anomaly − because equities were valued without any regard to price/earnings or most other traditional ratios.) (story continued below)

The Response of Corporate Executives and Managers
Profits as a proportion of total national income are heading downward. It is the job of corporate mangers to rectify this situation. Revenue streams are being curtailed by weak consumer demand. This will take time to reverse. In the meantime, efforts are being concentrated in expenditure areas. To reach earnings targets, executives are cutting staff, rolling back wages, eliminating shifts, mothballing plants and postponing investments.

Statistics Canada's Report on Corporate Earnings
In its latest report on corporate earnings, Statistics Canada notes that declines were registered in 16 of 22 industries nation-wide in the latest quarter. Oil and gas companies, financial sector firms and manufacturers led the declines.

A reinstatement of investment spending plans by oil and gas firms, in western Canada and the Atlantic Region, will depend on a pick-up in global oil prices. As for financial firms and manufacturers, their chief base of operations is in Ontario. That province has just introduced a budget that is lowering the corporate tax rate from 14% to 12% in mid-2010, then to 10% in 2013. These are necessary steps to improve the investment climate.

The Outlook for Profits and Investment
Oil and gas firms have been pummeled by lower prices. Banking and other financial intermediaries have been hurt by trading losses in debt instruments. Manufacturers have been led downward by an auto sector that has seen sales come to a rolling stop.

The prospects for privately-funded investment, which determines job-site construction activity levels, must be considered restrained until stock markets perk up on a sustained basis once again. This will occur about six months ahead of an improvement in net earnings. It is hard to foresee much of a profits pickup before the first quarter of next year.

STOCK EXCHANGES -
PERFORMANCES OF KEY INDICES - MARCH 31, 2009

Sources: New York Stock Exchange (NYSE), Standard and Poor's (S & P), National Association of
Securities Dealers Automated Quotations (NASDAQ), Toronto Stock Exchange (TSE) and Reuters.
Table: Reed Construction Data — CanaData.