25 Jul 2003 Hot Summer, Hot Earnings
As we begin the 34th day of this hot, hot summer, corporate earnings and government reports are heating up as well. In the prior couple of months stock prices have run up in anticipation of both, defying the normal seasonal pattern of sluggish equity returns.
Almost two thirds, or 303, of the S&P’s 500 index companies have reported their second quarter earnings and most are far better than analysts expected. FirstCall reports that profits have grown 8.8% over last year, exceeding the 5.3% increase analysts were predicting at the start of July. The improvement results from more than cost cutting as overall sales increased by 5.4%. Some notable companies beating analysts’ estimates by wide margins include Goodrich Corp (beat analysts by 137%), Kodak (111%), AT&T Wireless (81%), Caterpillar (76%), Amazon (64%), Apple Computer (61%), Avid Technology (54%), Texas Instruments (45%), JetBlue (35%), Checkers Drive-In Restaurants (16%), and Intel (15%). Continuing from last week, the diversity of industries indicates a broad-based profit recovery. Some 33 of the 42 companies in our model portfolios have reported earnings so far and have beaten analysts’ estimates by an average of 18%. Our Aggressive model is 28% ahead of analysts’ estimates.
Because of the stronger than anticipated earnings reports, analysts are beginning to feel better about the second half of the year. Third-quarter profits are now slated to show growth of 13.6%, up from 12.7% on July 1. And fourth-quarter earnings are seen rising 21.7%, up from 21.3%, all according to FirstCall.
Government reports continue to show improvement as well. TheNew Yorkbased Conference Board reported on Tuesday that the index of leadingU.S.economic indicators rose .1% in June, the third straight monthly increase. The increase was driven by higher stock prices, a rise in the money supply, (more cash available for consumers to spend), and more permits for home construction. A separate report released by the Commerce Department showed that home ownership in theU.S.remained at 68% for the second quarter, even with the first quarter, but ahead of the 67.6% level last year. Rental vacancy increased from 8.4% last year to 9.6% this year as more renters were able to buy houses due to historically low mortgage rates.
Yesterday there was good news on the job front, albeit caution is advised. Initial jobless claims fell to 386,000 last week, much lower than the expected 415,000 and below the benchmark 400,000 for the first time since early February. Economists say that weekly claims below 400,000 signal that the labor market is strengthening. Continuing claims fell by 49,000 as well to 3,605,000.
The numbers are suspect because of seasonal aberrations in the numbers. Auto plants shut down during this time for retooling and maintenance, and employees ineligible for vacation pay may apply for unemployment benefits, which can cause applications to rise early in the month and drop as work resumes. But while Alcoa and Kodak get the headlines for laying off thousands of workers, Microsoft announced that it plans to hire as many as 5,000 additional employees this fiscal year. Small businesses are slowly beginning to add additional employees as well, spurred by improved demand and reductions in personal tax rates.
This morning the Commerce Department reported that June durable goods orders rose by 2.1%, the most since January, led by cars, aircraft, and machinery. The increase was well ahead of economists’ estimates as businesses had to scramble to meet higher than expected demand.
Also reported this morning, June sales of new homes increased 4.7% to a record 1.16 million annual rate of home sales, far surpassing estimates. Existing home sales declined in June, but still held at near record pace. Further rate reductions in June were responsible for sustaining the historic rise in home sales.
The phrase ‘beating analysts’/economists’ estimates’ occurs often in this Brief. Everyone, including investors, prognosticators, managers, and politicians, is quite cautious these days. So badly burned by the bubble burst, the telecom collapse, Fed over-zealousness in 2000, 9/11, corporate scandals, the Iraqi war buildup, and the recession, market re-entry has been slow. But stock prices have risen ahead of volume as former sellers have become buyers and as short-sellers have scrambled to buy to cover their positions as prices rise.
As stock prices rise, money managers remain cautious. Trillions in cash remain on the sidelines. Investors are much more aware of valuations ‘this time,’ effectively limiting market exuberance and the possibility of unsupportable stock prices.
Of course there are examples of inexplicable market over-reactions in specific instances. Last night Ebay announced that they doubled their earnings, meeting analysts’ expectations. But because they didn’t beat those expectations by as much as they had in previous quarters, some holders (traders) are selling their shares, driving the stock down as much as 5% in current trading. In my book, doubling earnings while the country was at war is a pretty good accomplishment. But of those who expected more, one must wonder if they learned anything during the past five years?
As the earnings news subsides in the coming weeks, we will likely see the major stock averages settle into a trading pattern for a couple of months. At the macro level stock prices seem reasonable given the economic growth projections of economists and the Fed. However, there are significant appreciation opportunities for companies that demonstrate superlative performance relative to their peers. Money managers with large cash balances will want to add to their equity investments now that they feel better about the economy’s chances for recovery and will seek out performers. But they will be cautious remembering market carnage of the past three years and will take profits earlier than they might have before. A period of ‘contained exuberance’ in the stock market may seem boring for a while compared to the nineties, but it should prove quite healthy for the long term market.
As we conclude this 100th Brief from our new downtown offices, we sincerely hope these improving trends will bring each of you new prosperity in careers and investments.