Earnings Time Again

Earnings season stirs the market like few other forces, but especially in these times of economic uncertainty.  Investors and analysts hang on every word uttered as managers discuss their results for the quarter and hint at what their future might bring.  Body language, pauses, annunciations, and emphases are all noted and endlessly scrutinized.  Early in the week, the news was decidedly negative as Intel, Juniper Networks, and RF Micro, followed by General Motors, JP Morgan, and others disappointed with their earnings releases. Then on Wednesday afternoon, the tide shifted with positive earnings news from Advanced Micro, Compaq, Symantec fueling the evening market programs.  On Thursday, the markets turned positive, reversing their four-day slide. 

The market declines of the last week are due to what investors say is an overly bullish market.  Many experts have been talking expectations down, saying that stocks were ahead of themselves and were priced for a stronger and earlier recovery than was likely.  A fact of life on Wall Street is the ‘herd’ mentality.  A few intelligent, influential experts can generally guide the majority of contemporary investment thinking, as their thoughts become the thoughts of the majority.  The ultimate majority, of course, is always the market itself, but in the short run these individuals can and do move the markets with their commentary.  Until recently the stock market has predicted a strong and early 2002 recovery.  The bond markets (extremely good indicators of economic trends) continue to predict a rather healthy recovery this year, sooner rather than later.  The wrestling between the bulls and the bears for control of market prices will likely continue for some time.

Perhaps the most influential of all the herd bosses is our beloved Mr. Alan Greenspan.  On Friday afternoon, before a business crowd in San Francisco, the Fed Chairman took out his shiny six-shooter and blasted a few holes in the fledgling bull-calf market.  His talk was highlighted by remarks like; “Despite a number of encouraging signs of stabilization, it is still premature to conclude that the forces restraining economic activity here and abroad have abated enough to allow steady recovery to take hold.”  As he blew the smoke from his barrel he did offer a few conciliatory remarks to the more optimistic thinkers such as, “there are tentative indications that the contraction phase of this business cycle is drawing to a close.”  Mr. Greenspan pointed out that economic activity would likely pick up, as businesses would likely begin replacing depleted inventory levels in the coming weeks.  He warned though, “that impetus to activity will be short-lived unless the demand for goods and services itself starts to rise.”  In other words, the consumer is still key to the recovery.  All eyes remain on such indicators of consumer confidence, debt levels, income, and unemployment.

Many of the numbers released this week have been positive where the consumer is concerned.  The rate of job losses continues to decline as the latest weekly release of initial jobless claims came in at 384,000, below the prior week’s number of 398,000.  Each week has been well below the peak of 535,000 reached September 28th.  Unemployment is one of the primary drags on consumer confidence, but so far, its effects have been muted.  In fact, if unemployment peaks where many expect, this will be the mildest recession in decades as far as unemployment is concerned.

A concern on the consumption front is that some of the forces driving it so strongly during the past few months are likely waning now.  The low rates on mortgages, that enabled consumers to take equity from their homes and spend it on big-ticket items like cars, are not as abundant as they were.  Consumer borrowing is also high, limiting their ability to spend more.

On the plus side though, energy prices remain low and should stay that way as the mild winter continues.  Short-term interest rates are way down and will likely stay down for months to come.  The Fed’s 11 cuts have placed target rates at 40-year lows and the Chairman’s Friday comments seemed to pave the way for yet another cut after their January 30th meeting.  Inflation will not limit the Fed governors as they deliberate a twelfth cut at the end of this month as indicated by the US consumer price index which fell 0.2% in December, compared to the consensus forecast for an unchanged reading.  The core CPI, which excludes food and energy, rose 0.1%.  The data show the same story on inflation that we have seen over the last few months: goods prices are falling -0.3% year over year, which is lowest since 1961!

On the 16th the Fed released its Summary of Commentary, also known as the Beige Book.  While it recognized that weakness continues, the report was relatively upbeat with scattered reports of improvement throughout the country.  It reported that many Fed Districts indicated that their contacts believed a recovery would begin by mid-year or earlier.  A separate report released on Thursday by the Philadelphia Fed provided one of the most encouraging signs yet.  An index of manufacturing in the Philadelphia area showed business grew in January for the first time in 14 months, signaling the slump in heavy industry may be nearing an end.  The index rose to 14.7 this month, the first positive reading since November 2000 and the highest since the 15.4 reading in August of that year.  Last month’s reading was a minus 12.6.  The Philadelphia Fed’s index measuring the outlook six months from now rose to 53.2 from December’s 46.7 (a number above 50 implies expansion).  The outlook for new orders rose to 51.1, the highest in nine years.   Sounds like inventory re-stocking has begun.

The bears still have most of the airtime on the market shows and they seem pretty pessimistic.  Indeed, it is easy to paint a negative picture right now with the numerous uncertainties facing us, such as a potential war between India and Pakistan, Israel and Palestine (possibly the larger Arab world), government policy mistakes such as increased taxes or international tariffs, additional corporate failures like Enron, and broad-scale terrorist attacks.

Still, through it all we go about our daily lives and do the best we can to improve our lot.  The University of Michigan has conducted a survey that attempts to measure and quantify the mood of consumers since 1966.  It has proven to be an excellent leading indicator for the direction of the economy because the consumer plays such a large role in determining that direction.  Just now, the University announced that the January number increased to 94.2 from a level of 88.8 last month.  The index has a base of 100.  Increases or decreases from that level indicate Americans’ degree of comfort with their finances and the state of the U.S. economy. A graph of the index over the past few years, below, is very instructive.

You can see that confidence appeared to bottom out in April, but the tragedy of September dropped it considerably lower to a ten-year low of 82.  During the 90-91 recession confidence bottomed 64 and 67, respectively.  The longer tem history of the index is notable in that it reflects a generally index since inception in 1966.  The lows reached during each successive recession are higher than the lows reached in the preceding one.   Perhaps education and the free flow of information have had something to do with improving consumer confidence.  However, the analysis of that question is beyond me and certainly beyond the scope of this Brief.

Earnings and company forecasts will continue next week as will the market’s volatility, but I expect things to settle down by the end of the month as investors move closer to a Fed interest decision – even though it has little more than psychological value.