Hang in There

The last two days of trading have been the worst since August 5th and 6th of last year. They have taken the blue-chip index to its lowest level in five months.  What changed so drastically in the last few days?  The economy was growing, but not so fast as to worry the inflation-guardians at the Federal Reserve; interest rates were holding steady, even falling a bit; and corporate profit margins were still fat enough to absorb some unforeseen shocks, like oil remaining above $50.00 a barrel for an extended period. 

In a word, fear has driven expectations for the economy and earnings lower.  Those with the shortest of outlooks including traders, hedge fund manages, and stock analysts, now suddenly fear the economy might be slowing faster than earlier thought.  While the hard numbers do not indicate significant slowing, the tender for the fire was provided by General Motors’ news that the unions will not negotiate with them regarding their overly-generous benefit packages.  GM is down 7.5% in the last three days.  But, inflated (relative to competitors) benefit packages should not be news to anyone familiar with the American auto industry.

IBM added to the bad news last night when it said that while it had slight revenue growth, it had trouble closing deals at the end of the quarter.  The announcement from IBM followed poorer results from struggling rival Sun Microsystems and Unisys Corp. that together were the latest evidence that big technology companies are having a tough time meeting the still-inflated expectations of analysts and investors.

While it seems many would rather dwell on the negative, there’s some good news too.  Oil prices are going down.  General Electric,America’s largest company, reported today that its earnings rose 25% in the first quarter, helped by a big gain from the sale of Genworth Financial Inc. stock, and double-digit earnings growth in nine of its 11 businesses.  Citigroup reported a 3.2% increase in net, helped by 10% growth in corporate and investment banking revenue and strong consumer-banking activity.  Wachovia’s profit rose a whopping 30%.  Tribune’s net rose 18% on strong advertising revenue.  Pepsi’s earnings rose 13%, aided by strong snack and beverage sales in China, Russia and other emerging markets.  And UnitedHealth reported a 41% rise in its net profit.  Finally, of the 215 companies reporting so far among the Dow Jones U.S. Total Market Index, average earnings are up 15% over last year’s same period.  That’s not bad.

We’ve experienced ill markets before.  The most recent was August of last year.  The market rallied 11% through December.  I’m not suggesting that will happen again, but it is reasonable to think that the selling is overdone and that things aren’t really so bad as a few reflexive traders and hedge funders fear.  The point here is that the data support the conclusion that stocks are cheap relative to other investment options.  If the American consumer is indeed slowing in his spending, where will he put those extra dollars?  Will they go to buy a SECOND vacation home, pay off a 4.75% mortgage, buy CD’s yielding 3% or money markets at 1.5%?  Maybe, but probably not indefinitely.

Mr. Greenspan and company most likely have it right.  The economy is not in danger of overheating as so many were saying not so long ago.  Oil is likely not headed for $100 per barrel as Goldman Sachs predicted not long ago.  In fact it is on the way down.  Commodity prices are declining too.  Copper, aluminum, and steel have all peaked and are headed down with a vengeance.  And remember how many times in the past five years have economists sounded the death knell for the consumer only to be ‘surprised’ by his/her indefatigable nature?  Reports of this economy’s demise are greatly exaggerated my friends.