23 Jan 2004 Half Full or Half Empty?
This holiday-shortened week has been a busy one for corporate earnings reports and management comments. The World Economic Forum inDavos,Switzerlandhas also been a major focus of investors. Almost without exception the numbers have been exceptionally positive, but the ever-present cautionary tone kept market enthusiasm in check.
Notable exceptions include Kodak, announcing yesterday that it would lay off 20% of its workforce to cut costs by nearly a billion dollars and enable the company to compete in the fast-growing digital camera market. The stock was up almost 13% yesterday on the news. Ebay gained almost 8% as it reported a 64% jump in 4th quarter earnings and raised this year’s profit and sales forecast.
We are experiencing a ‘rolling correction’ of sorts. The markets have gotten a bit ahead of themselves and as companies announce their earnings, some investors are electing to take their profits and either move to the sidelines or move to what they think will provide the next opportunity. The major indices largely do not tell the story of this underlying volatility.
In the past several days small-cap, mid-cap, and technology stocks have succumbed to profit-taking and doubts of sustainable earnings while the big blue chips like Kodak, WalMart, CocaCola, and Intel have taken the leadership role in the indexes. Worrying about these gyrations is all about the short-term and hardly worth mentioning. But the recent three years of bear market pain have made us all cautious, hyper-sensitive, and especially vigilant so as not to miss any foreshadowing of the next ‘bubble.’
Do CEOs continue to predicate their projections on their painful pasts? The quarterly numbers they post are nothing short of remarkable, but their hyper-reserved comments about their future force investors to reconcile the excellent numbers of fact with the subjective and cautious future projections.
That’s why a long-term view of investing is more important than ever. It should provide a framework within which today’s issues can be analyzed and weighed in their relevance to the major long term trends and themes that we believe will shape the future economy.
We have discussed some of those issues already. The declining dollar is precipitated by very low U.S. interest rates, but is primarily the result of years of global capital flight to safety. The positions are simply being unwound and re-deployed in faster growing developing nations. In my opinion, that’s a global monetary vote that the world, and free trade, are much safer.
The growing U.S. deficit must and I think will be addressed, but there is no valid economic proof (according to numerous economists) that deficits in our country’s history have harmed the economy. The issue is more a political than an economic problem.
More important deficits are looming in our social systems of Social Security and Medicare. Of particular concern is our healthcare system. As the government and insurance companies control more aspects of it, patients become further separated, economically, from their healthcare providers. The pursuit of excellence and innovation, historically spurred by competition, evolves toward a cost-centered low-bidder approach. Costs will actually rise faster in such a system as ‘competition’ declines when participants leave the industry in search of more profitable business models. Needless to say, patient care, will decline as the industry commoditizes its services fight cost increases.
The U.S.trade deficit will correct itself asEuroperecovers. That could certainly be facilitated if its’ leaders would move forward with their reform initiatives in capital and labor as though they wished to fix the problems in this generation. But for all their boast of technology and modernization, the old-world mentality still holds strong influence. While global trade issues continue to be of concern, at least some of the major issues are being resolved successfully, such as steel at home as well as the potential for European retaliation.
The worries we hear expressed by corporate leaders seem to suggest that these long term problems are all going to come crashing down on us tomorrow. That has not happened, in fact, the reverse is true. Of those S&P 500 companies already reporting, earnings are 8.5% ahead of analysts’ expectations. Rising business profits mean higher tax receipts by the government. They also eventually translate into job creation, which also means higher tax receipts for the government. If the President and the Congress hold the line on spending (huge IF right here at the end of the Brief), then we might see the deficit come in considerably smaller than projected so it is not a ‘problem’ some fear it will be in 2006 and later.
We expect the political rancor to be louder than at any time in recent memory this year and for it to have some degree of market impact. But the real message is and always has been EARNINGS. Every CEO I have heard and read is confident (while cautious) that the recovery is for real and that it is sustainable, but measured. We are likely due for a period of consolidation in stock prices while reality catches up to expectations, but we think the bull market is firmly entrenched now and common stocks will be the best performers for 2004.