31 Jan 2003 Opportunity Just Beyond the Clouds of War
It was a big week for news as President Bush laid out his initiatives in his State of the Union message and the government released a number of important statistics on the health of the economy. As of this morning the Dow is down 2.3% from Monday and was more volatile than usual. During the last two weeks it has fallen 10.4% from its peak of 8869 to close at 7945 yesterday.
The markets’ declines accompanied relatively good reports of business earnings. But it was the forward-looking comments of the same CEO’s that spooked investors. Their uncharacteristically conservative near-term outlooks from a business standpoint rattled investors’ building gradually building confidence. While some referred to it outright and others in more general terms, most suggested the impending war with Iraq significantly clouded, even darkened, their near-term business outlooks.
During his speech, President Bush put a timetable on the war. IfIraqfailed to comply with U.N. resolutions in the coming weeks, not months, then theU.S.and its allies would act militarily. On Wednesday the Mr. Market showed his hand. After two days of steep market declines leading up to the State of the Union message, the markets staged an 87 point rally on some clarity of the war’s timetable. UNCERTAINTY is what markets react to most negatively, not so much the events themselves. The past few weeks’ market activity closely resemble the days leading up toIraqI. Stocks actually rallied when the war began and rallied significantly before the outcome was certain.
As we near some resolution of the Iraqi problem equity markets will likely begin anticipating and discounting future economic events rather than reacting to emotions of the here and now. First Call tells us that of the S&P 500 companies reporting earnings so far, 131 have posted upside surprises, 43 have reported in line, and only 57 have disappointed. Don Hays points out that analysts are starting to view the future a bit more positively. In his Wednesday email to clients he noted that for the first time since August 15th, his daily posting of stock rating upgrades to downgrades by Goldman Sachs analysts (over a 30-day moving average) is now showing as many upgrades as downgrades for the first time since August 15th of last year.
The government reports for the week were mixed and some areas that had previously showed improvement declined. However, remember that a month’s data does not make, or break, a trend.
The housing juggernaut continued its historic romp demonstrated by government reports thatU.S.sales of existing homes rose more than expected in December, completing the best year ever for residential real estate. Previously owned single-family homes sold at a 5.86 million unit annual pace last month, the National Association of Realtors said. That was the fastest rate since February and was up 5.2% from a revised 5.57 million rate in November. Some 5.56 million existing homes were sold in 2002, surpassing the previous year’s record 5.3 million.
According to Bloomberg, with mortgage rates dropping below 6% this month, some economists say that the housing market will stay strong early this year, providing an important support for economic growth. U.S.consumers will buy an estimated 5.34 million existing homes this year, according to a Jan. 8 forecast from the National Association of Realtors. That would still be above the 5.3 million homes sold in 2001 and enough to provide the economy with a source of stability. Our holdings of Bed Bath & Beyond have participated fully in the housing rally as the company reported last month said that earnings were 42% higher in the third quarter than the same period a year earlier.
The Economy’s softness was highlighted by the government’s report of orders for durable goods. The measure rose less than expected in December and was held back by reduced bookings for autos, communications equipment and fabricated metals according to Bloomberg News. Orders for equipment ranging from lathes to computers to aircraft rose 0.2% to $170.1 billion, the Commerce Department said, after falling a revised 1.3% in November.
The all-important consumer is hanging in there, but the government’s measure of his and her confidence showed another drop in January to its lowest point in nine years. The measure fell to 79, the lowest since November 1993. People also said they expect fewer jobs, less income, and a weaker economy six months from now. The University o fMichigan Confidence number, just released showed a similar decline as it dropped from 83.7 in November to 82.4 in December, below expectations of 83.5.
But consumers may be saying one thing and doing another. December New Home Sales were released on Wednesday and echoed the history-making noise of Existing Home Sales. They rose to a record in December as the lowest mortgage rates in four decades lured buyers and made 2002 the best ever year for builders, the Commerce Department said.
The Fed came out yesterday and said they were equally biased toward recovery and recession, but made no policy changes. Unemployment remains stubbornly high as spotty reports of layoffs continue and most employers demand greater productivity from their existing workforces through increased hours worked and more efficient use of their capacity.
The 94% of Americans who are working are seeing their incomes rise and they are spending more of it. Today the Commerce Department announced that U.S. personal spending increased .9%, the most in five months, while incomes improved by .4% in December. Disposable income, or money left over after taxes, increased 5.9% last year. That compared with 3.8% in 2001 and underscored how President George W. Bush’s tax cuts helped put more money into people’s pocketbooks.
Finally and most dramatically, today’s release of the Chicago Purchasing Manager index showed better-than-expected improvement. The measure of Midwestern manufacturing activity provides an excellent measure of the near-term future health of business across the nation. An index reading above 50 means manufacturers reporting improved business outnumbered those reporting deteriorating conditions.
World business leaders gathered for an annual summit inDavos,Switzerlandthis week. In his address to them, Cisco’s John Chambers summed up the state of the economy and its future quite well:
“The economy has been remarkably strong in spite of a number of setbacks. And a huge part of that has been driven by productivity. I believe you can drive an economy at 1 to 2 points over productivity gains. I think you can drive this economy for the decade at 3 to 5% per year productivity increases. High tech will play a key role in the productivity leverage that occurs, but it will occur after our customers’ businesses turn up. Coming out of this economic slowdown most CEOs understand that leverage on productivity is going to occur. However, the risk reward factors are a little bit more conservative than I’ve ever seen them in my business career. The majority of CEOs I talk to across America are going to be conservative in their budgeting for this year, especially on employment, even on capital spending, until they see the economy turn up. I think you’re going to see the economy turn up first, when business profits turn up. And the last two years businesses have done a lot better on productivity, getting rid of the excesses. We’re unlikely to see the layoffs we’ve seen before. When profits start to occur, then I think they’ll spend two to four months later. It’s almost a show-me economy from the CEO perspective.” He closed by saying, “I’m very optimistic about the U.S. economy over the next decade, and I’m actually very optimistic about the global economy over the next decade. Unlike the industrial revolution, where you had to be in the right city, in the right place to participate, it’s going to be different this time. It’s going to happen much faster than people expect.”
The long-term is very bright indeed.