Profits for the S&P 500 are showing the first year-on-year decline of the 2002 expansion. Corporate profits for the S&P 500 are down 0.9 percent going into the final stretch of the earnings season (data courtesy of First Call). This is way below expectations for mid-single digit gains of just two weeks ago. The trouble is confined, at least for now, in two sectors: financial and housing. Companies from these two groups, at the front lines of the subprime squeeze, have been missing expectations by about 15 percent.

The third-quarter is a red signal for corporate profits which, in the graph below, have risen without interruption since early 2002 — at least until now. The disappointment of the earnings season is certain to be a topic at the ongoing FOMC meeting. Flat profits will limit business investment and, this is key, will limit employment growth. Flat profits will also slow down stock market gains which have so far helped offset the effect of soft home prices.

Profits have in fact been less and less of a support for the stock market. The graph below tracks the corporate profits of the first graph (dark green bars) with the highlighted light green bars of the S&P 500 Index. After several years of lagging profits, share prices have exceeded profits in each of the last four quarters. The most recent quarter, in red, shows the most separation yet.

The degree of surprise this earnings season is important to note. Companies usually beat expectations by 2 to 3 percent in what is a carefully executed public information process. But this time around last minute changes to earnings, not signaled ahead of the earnings season, hit financials and housing and offer evidence that the effects of August's credit market squeeze are still playing out.

Economic change is an interesting time for the economic calendar especially to see which data signal the change the first. Labor Department data for August were the first evidence, or at least what appeared at the time to be evidence, of the effects of August's credit market squeeze. The data were of course later revised upward. Existing home sales for September was another bad report as was last week's durable goods orders that pointed to flattening in the manufacturing sector. And consumer confidence data released Tuesday by the Conference Board indicate that August's credit squeeze has cut a chunk out of economic optimism. Corporate profits, released one at a time by the nation's companies, may also be offering their own indication.