18 Jul 2003 Lazy Summer Days

The earnings reporting season is in full swing now with a quarter of S&P 500 companies reporting this week.  The results were quite good on balance as numerous companies soundly beat analysts’ estimates.  Those companies beating analysts’ estimates span a broad range of industries.  They include Caterpillar, SanDisk, Boise Cascade, Georgia-Pacific, Bank of America, Merrill Lynch, USA Truck, Marriott Int’l, Coca Cola, Ford, Johnson & Johnson, Stryker, New YorkTimes, and BB&T.  The list of companies surprising negatively is much shorter.  But it includes some notables like Kraft Foods, Fannie Mae, FleetBoston, Hershey Foods, Sears, and Microsoft.  

More important to investors than the actual numbers has been the focus on what management says about their coming quarter or quarters.  For instance, Microsoft missed their earnings estimate because of a $.05 legal settlement charge, but management was quite sanguine about earnings and revenues for the upcoming quarter.  Last night and this morning, Microsoft shares inEuropehave responded positively to the news.  On Wednesday shares of Intel Corp., the world’s biggest maker of computer chips, rose as much as 5.1% after the company said sales this quarter would increase by at least 6% while production were expected to decline.

On the flip side, Nokia made its estimates and declared gains in market share, but warned that the next quarter would be difficult for them.  Nokia’s stock was trounced yesterday.  Other notable negative comments have come from cyclicals like GE and Alcoa sending their stocks down.  But these negative comments have, thus far, represented the minority.  Corporate earnings for most American companies reporting so far are improving.

As corporate earnings are turning positive, so are government reports on the economy.  The New York Fed delivered its Empire Manufacturing index on Tuesday indicating that conditions improved for that state’s manufacturers for a third consecutive month in July.  The index was only slightly below last months’ attention-getting level of 27.6.

Retail sales reports beat economists’ estimates again this month as they showed that the consumer continues to drive this economy.  Building materials, furniture and apparel led the sales numbers.  The coming tax cuts, rising stock prices, improving consumer confidence will only help strengthen the growth trend.

Consumer prices rose by .2% in June boosted primarily by natural gas and gasoline prices.  But inflation is not a problem for this economy.  The core consumer price index was unchanged last month, up 1.5%, from June 2002, matching the smallest increase since 1966.  The slow rise in prices continues to worry some economists and analysts prompting Greenspan to emphasize in his testimony before the Senate on Tuesday that the chances for deflation remained “quite remote”, but that the Fed is ready as needed to “successfully address the problem and fend it off.  It will continue to engage our attention until we take it off the table,” Greenspan said.

The complaint from many economists and politicians though is the lack of bounce demonstrated in the numbers.  Previous recoveries have witnessed more effervescent snap-backs.  On Tuesday Mr. Greenspan addressed the issue by saying that this economy has been extraordinarily resilient in the face of major shocks over the past three years, any one of which could have severely damaged historical economies.  Previous recoveries came from deeper troughs than this economy suffers.  There is no spring effect to give the bounce many hoped for -the recovery will be more gradual.

In his remarks the Chairman was uncharacteristically candid about the Fed’s willingness to do whatever it takes to get and keep this economy moving.  He tried to placate nervous bond traders by hinting that rate increases would not come as early in the recovery phase as in previous cycles.  He said the Fed “stands prepared to maintain a highly accommodative stance of policy for as long as needed to promote satisfactory economic performance.”  He made the point twice in his prepared remarks.

Nowhere is the gradual pace of recovery more apparent than in the industrial sector of the economy.  Industrial Production, as reported by the Federal Reserve, rose .1% in June.  However, it represented the second month of increase indicating a trend.  In a separate report, Capacity Utilization, showing plant use, remained steady at 74.3% matching May’s twenty year low.

Unemployment showed improvement as both initial jobless claims and continuing claims were below last month and considerably better than economists expected.  Finally, theUniversityofMichiganconfidence number was just released.  The University’s preliminary July sentiment index rose to 90.3 from 89.7 last month.  It represents the third increase in four months.

The message in all these reports is ‘gradual recovery.’  While a gradual recovery is probably best for the overall long-term health of theU.S.economy, it’s not welcome news for those currently unemployed or for many small businesses that are looking for business improvement – sooner rather than later.  Low rates and tax cuts help make the waiting easier, but the high energy snap-back, typical of economic recoveries, is less likely this time.  Accordingly, investors must lower their expectations somewhat.  Stock indexes may be a bit ahead of themselves, but the next couple of weeks will add light to that question.  In the coming two weeks we will hear from many of the remaining management teams of the S&P 500 companies as they share their outlook for the future.

Summer may finally take a toll on this market, but, if Mr. Greenspan, Microsoft, Intel, Caterpillar, and others are right, things could look much better by fall.