US stocks vulnerable to profit slowdown, warns Smithers

The market is showing clear signs of being vulnerable to a downturn in profits as well as giving off strong long-term danger signals, according to the latest report from Smithers and Co, the asset allocation specialists.

The report, entitled The US corporate cash flow and profit outlook, identifies falling profits as a ‘good indicator’ of market direction when shares are selling at more than 25% above fair value. The market is currently 70% above fair value, Smithers says.

The long-term danger signals come from the reversion of profit margins, currently at record high levels.

The report says it is unlikely America’s budget deficit will decline in 2011 in line with OECD forecasts, saying profits may well hold up, rather than fall, but only if the deficit remains at around 10%. (article continues below)

It is also believed the corporate cash flow net of investment will fall in 2011, and increasingly so in 2012, even without any improvement in the fiscal deficit.

The report is sceptical of profit forecasting based on estimates of future sales and costs, describing it as ‘absurd.’

This method of calculation often operates independently to economic forecasts and can promise massive changes in profits based on tiny differences in assumptions.