WASHINGTON (Bloomberg) — US corporate profits are in a recession, and the entire economy may not be far behind.

Slower sales and higher energy and labour costs are forcing companies from Bear Stearns Cos. to Pitney Bowes Inc. to reduce spending and hiring. Their efforts to keep earnings from eroding even further raise the risk that the economy, already weakened by the steepest housing slide since 1991, may shrink some time next year.

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

Corporate profits, as measured by the Commerce Department, fell at an annual rate of $19.3 billion in the third quarter from the second, as domestic earnings dropped by $41.2 billion. The drag from sagging US sales and huge writedowns offset robust earnings abroad, fuelled by the weak US dollar. The fourth quarter may be an even bigger bust.

"In the third quarter, the tide shifted, and for the worse," says Joseph Quinlan, chief market strategist for Bank of America Corp. in Charlotte, North Carolina. "The domestic-profits squeeze is in its early stages and will be severe enough to overwhelm strong foreign earnings."

Caterpillar Inc. of Peoria, Illinois, the world's largest maker of bulldozers and excavators, shocked investors in October when it said it expected the economy to be "near to, or even in recession" in 2008. At the time, Dearborn, Michigan-based Ford Motor Co., the second-largest US automaker, was still "optimistic," chief executive officer Alan Mulally said in October. "There's a lot to be positive about," he told reporters.

Little more than a month later, in a November 19 interview, Ellen Hughes-Cromwick, Ford's chief economist, said the economy was "in some dicey territory," though would likely "edge by" without a recession.

Profits for the Standard & Poor's 500 companies fell almost 25 percent on a per-share basis in the third quarter, the biggest year-over-year decline in almost five years. David Wyss, S&P's chief economist, expects their earnings to fall as much as 30 percent in the fourth quarter as companies take more writedowns for bad investments. Excluding such extraordinary items, operating profits may fall as well, he says.

Consensus estimates compiled by Bloomberg indicate S&P 500 operating profits may rise just 1.1 percent in the current quarter.

That's down from the 8.8 percent increase analysts foresaw a month ago. Operating profits fell 2.5 percent in the third quarter, the first drop in more than five years.

Even if profits have peaked, that doesn't mean the economy is about to turn down, says Steven Wieting, managing director of economic and market analysis at Citigroup Global Markets Inc. in New York. In the last expansion, profit margins began contracting in late 1997; there was no recession until March 2001.

What's troubling this time is that much of last quarter's damage came in the financial sector, where operating earnings fell 25 percent, as banks and brokers were hurt by losses from subprime mortgages and related investments. Analysts' estimates compiled by Bloomberg indicate the industry's profits this quarter may decline more than 25 percent.

The plunge in financial profits is a triple whammy for the economy as banks and other institutions pare payrolls, cut capital spending and become stingier with loans.