19 Jan 2007 Eyes on Earnings and Inflation
In last week’s Brief we asked the question was it time for technology to shine? The answer so far is a resounding ‘not yet,’ as bellwethers IBM, Motorola, Apple, and Intel all disappointed investors with their fourth quarter results in the last few days. The run-up in technology stock prices in the first weeks of January is proving to be premature. Investors who bid the shares up just weeks ago on the notion that 2007 earnings for tech were going to be well ahead of other sectors’ growth having changed their tune as early reports are less than their high expectations. They are now nervous about commoditization and competitive pressures combined with a slowing economy.
But wasn’t it the slowing economy that prompted the interest in technology in the first place? It was said that companies, facing slowing demand, might invest more heavily in technology to improve productivity and reduce costs. But as theUSeconomy slows, other economies are doing quite well. The European Commission expectsEurope’s economy to “remain strong” in coming months and inflationary pressures to be eased by the drop in oil prices and the Euro’s strength. China’s growth “should remain around the 10% mark.” They added “a key uncertainty for the Asian emerging economies relates to the impact of the U.S. slowdown.” So if not at home, at least globally, demand should remain strong for tech.
Each of the companies above also had quite a few strong points in their reports seemingly ignored by sellers. Apple’s net income of $1 billion blew past Wall Street’s estimates. While the fourth quarter results appeared weak for Motorola it is important to point out that they shipped 48% more phones than in the year earlier quarter and they expect the first quarter will be much better. Intel’s earnings are expected to grow 34.5% this year and analysts expect Apple to improve earnings by 24%, but today they stocks are suffering.
Another market mover is the question of inflation and its future trend. Government inflation indicators PPI and CPI, released on Wednesday and Thursday, failed to show inflation was threatening. Fed governors have been out in force this week expressing their views on the subject saying it remains their primary concern. But what got markets roiled all over the world was Ben Bernanke’s comment that the U.S. government faces a “fiscal crisis” in the coming decades if it fails to deal with the rising costs of retirement and medical benefits for the aging population. The market acted as though this statement was a revelation.
The projected budget shortfall results from spending on the Social Security, Medicare and Medicaid programs. While official forecasts may show a stable or narrower budget deficit over the next few years, “unfortunately, we are experiencing what seems likely to be the calm before the storm.” Bernanke told the committee that the economic growth spurring revenue today won’t resolve the budget’s long-term challenges. He repeatedly refrained from recommending what measures Congress and the administration should adopt to raise government income or slow spending growth.
What would help Congress, Bernanke said, is to monitor government spending relative to GDP “or a similar indicator.” In addition, Congress should pay “close attention to measures of the long-term solvency of entitlement programs,” such as the current-value estimates of future Social Security and Medicare liabilities, he said. Without changes to current law, combined spending on Social Security and Medicare will rise from 7% of U.S. GDP today to almost 13% by 2030, Bernanke said. We hope and pray that lawmakers were listening.
A positive indicator of where the Fed is headed on interest rates came when Colorado Senator Wayne Allard asked whether CPI overstated inflation. Bernanke reiterated the Fed’s position that the standard consumer price index “does overstate true inflation.” The gauge probably exaggerates “true” inflation by some degree between 0.5 and 1.0 percentage point, he said. The Fed’s preferred gauge, a Commerce Department measure that excludes food and energy, rose 2.2% in the year to November. Bernanke said the Labor Department’s “chained” CPI is “somewhat more accurate” measure than its regular CPI because it takes into account the notion that consumers may switch to lower-priced goods when prices increase, Bernanke said. So it may be that the Fed may feel better about inflation than they are saying publicly.
While on Barrons’ Roundtable discussion this week, Bill Gross of PIMCO said “oil is about 8% of the total CPI package. When oil prices decline by 20% or so, you see a 1½% to 2% subtraction from core CPI. The consumer-price index will be in the 1% zone, plus or minus, by midyear…” That’s very good news for the Fed, and consequently for stock investors.
What seems clear in the midst of large market moves of recent days is that emotions are running high, as they do during every earnings season. The stocks mentioned above have seen big drops in the hours and days following their earnings announcements, but if history is a guide, their prices will rise to equal or surpass their highs in the coming days and weeks as investors re-focus on the longer term picture. If the Fed reduces rates in the first half of the year, stocks should have a heyday according to experts.