25 Apr 2003 Improving Trend?
The mood on Wall Street is improving, albeit slightly. General market improvement comes ahead of the economic reports provided by the government that substantially reflect the view that the lead-up to the war with Iraq had a significant dampening effect on the economy. Investors seem more optimistic as they learn that many companies are reporting better-than-expected earnings.
This week’s economic news started with the release of Leading Indicators from the Conference Board. The report showed a .2% decline of the index and was the second month of decline. Falling consumer sentiment and rising job losses contributed to the decline, but the biggest drop came in permits to build new homes. Also helping to account for the drop was a decline in the money supply adjusted for inflation, and a narrowing spread between the yield on the Treasury’s 10-year note and the rate banks charge each other for overnight loans. These were only partly offset by an increase in the Standard & Poor’s 500 Index, a jump in new orders for consumer goods and for plant and equipment, and a rise in how long it takes producers to deliver goods — suggesting factories are having difficulty keeping up with orders. According to Bloomberg, the Conference Board’s index of coincident indicators, a gauge of current economic activity, was unchanged in March after falling 0.2% in February. The index tracks payrolls, incomes, sales and production.
Adding to the bad news were the employment reports. As reported by Bloomberg, the number of Americans filing new claims for state unemployment benefits unexpectedly rose last week to the highest in more than a year. States received 455,000 applications for jobless benefits, up from 447,000 in the prior week, the Labor Department said. Claims have held above 400,000 for 10 straight weeks, signaling a deteriorating labor market. There’s no sign of slowing in job-cuts announcements in the airline and travel industries. The Air Transport Association, a trade group whose members include majorU.S.airlines, said the carriers’ traffic for the week ended April 13 fell 11% from a year earlier. Traffic to and from the Pacific region dropped 36%, mainly because of concern about severe acute respiratory syndrome, or SARS, a pneumonia-like illness.
But yesterday, some good news came in the form of a very large increase in the orders for durable goods report. Orders for items made to last at least three years increased 2% to $173.6 billion after dropping 1.5% in February, according to the Commerce Department. Economists had expected orders to fall by .2%. The rise in orders shows that “somehow consumers and purchasing executives are looking past all the bad news,” said Joseph LaVorgna, senior economist at Deutsche Bank Securities. “That tells me that at some point you are going to get job growth.” Hiring historically lags improvement in the economy.
Today, the effects of the war withIraqand terrorism on the economy were most evident in the government’s report of gross domestic profit. TheU.S.economy grew less than expected from January through March with the slowest pace of consumer spending in a decade. Gross domestic product, the sum of all goods and services produced in theU.S., expanded at a 1.6% annual rate last quarter after growing at a 1.4% pace in the previous three months, the Commerce Department said. Economists had forecast a 2.4% gain, based on the median of 67 forecasts in a Bloomberg News survey. The war pushed crude oil prices to a 12-year high and caused consumer confidence to drop to a nine-year low. With the conflict’s end and sentiment improving, the stage is set for faster growth in the second half of the year amid stronger consumer spending, according to the numerous economists followed by Bloomberg.
For the past several quarters companies have been working hard to improve productivity and reduce costs. The firing of workers may be paying off on the bottom line and freeing money for increased business spending. Through Wednesday, companies on the Standard & Poor’s 500 Stock Index reported first-quarter profit averaging 4% above estimates and 10% higher than in last year’s first quarter. Don Hays pointed out in his Wednesday letter that the average earnings estimate for the S&P 500 companies had been nudging upward in recent weeks, but on April 16, it experienced a huge jump, from $12.15 to $12.40 in only two days. According to Don, this was the largest 2-day jump in earnings estimates in “many a year and is the fuel to start jolting the expectations from their recent irrational fear back to at least a normal range.”
The Federal Reserve meets again on May 6th and many expect they will cut rates one final time. There are other measures they may employ as well to boost economic activity.
President Bush has begun in earnest his efforts to get significant tax reduction legislation passed in Congress. He is positioning his tax cut proposals as job-growth stimulation by highlighting that most jobs in this country are created by small business people who pay taxes, not at the lower corporate rates, but at individual rates that are too high to encourage them to grow their businesses. His high approval ratings after a successful war with Iraq combined with the political risk of opposing tax cuts improve the odds that we will get some meaningful income tax reduction, which would provide a boost to stocks.
As noted before, companies are showing better-than-expected earnings in their first quarter reports. Their forward-looking statements about expected results continue to be muted, but much of that is brinksmanship as they attempt to keep analysts’ expectations within ranges that they feel they can meet or beat. Stock prices go up when companies exceed investors’ expectations.
With the war essentially over, (at least the news coverage), historically low interest rates, low stock valuations (in several major sectors, not all), improving investor psychology, the Fed poised to offer further incentives, and the Administration and Congress moving toward significant tax reductions, conditions are excellent for market recovery. We look for volatility to decline as we return to more normal trading patterns. The market will anticipate economic recovery, that is, it will not wait for ultimate proof of GDP growth or job growth. However, given the numerous false starts of the past three years, its anticipation will be muted. The appreciation will occur among individual stocks as companies stand out among their peers. The large stock averages such as the S&P 500 and the NASDAQ will show appreciation, but likely not as much as the best companies in their numbers. In other words, the next few quarters will be a “stock pickers’ market.”