13 Jun 2003 Profits Will Tell the Story

During the next two weeks, as the second quarter comes to a close, we will hear from those corporations who wish to better prepare their shareholders for the actual results they expect to report later in July and August.  The ‘pre-announcement’ season is typically used by corporations to soften the blow of bad earnings news.  Pre-announcements can be vague and, therefore, cause a less a dramatic impact on the stock than the reporting of actual results might.  At this point the companies themselves don’t know their final results, so they must be somewhat vague.

Lately, an increasing number of companies have begun pre-announcing good results.  They have learned during this bear market that no news is often taken as bad news so they report the good to sustain their stock prices.

But, tide of negative news may be changing.  Don Hays points out that pre-announcements are used by analysts to shape their projections for the coming twelve months.  The pre-announced earnings of the first quarter were good enough that for the first time in two years analysts did not reduce their twelve-month forward projections.  This factor has in large part fueled the market’s advance.

We will closely watch corporate announcements in all sectors.  Together, they will validate or call into question the growing consensus that our economy is growing.

On Wednesday, the twelve Federal Reserve Districts presented their ‘Beige Book’ report.  It indicated some signs of increased economic activity in April and May, but reported that conditions remained sluggish in most districts.  However, no district suggested that economic conditions had deteriorated since the last Beige Book report.  Economic activity increased or showed signs of improving in theDallas,KansasCity,New York, and Minneapolis Districts.  The Philadelphia and Cleveland reports characterized activity as mixed, while other Districts generally saw sluggish, sub par, or subdued economic growth, according to Bloomberg.  The report suggested that the unwinding of war-related concerns appears to have provided some lift to business and consumer confidence, but most reports suggested that the effect has not been dramatic.

Yesterday the government reported that U.S .retail sales rose in May, led by more purchases of furniture, electronics and clothing, suggesting consumer spending is on the mend.  Consumer confidence reached a six-month high in May, reflecting the end of major combat inIraq, lower gasoline prices and mortgage rates, and rising stock prices. The government’s decision to accelerate tax cuts may give households the money needed to boost spending and help the economy gather momentum heading into the second half of the year according to Bloomberg news reports.

Woes continue on the job front.  Filings for state unemployment benefits held above 400,000 this week, confirming continued labor market weakness.  Continuing claims rose to the highest level in 20 years as companies continued to cut costs amid weak demand.  The numbers of jobless in the week that ended May 31 rose to 3.8 million, the highest level since early April, 1983, from 3.68 million a week earlier.  Companies are still in a cost cutting mode, but if the economy continues to grow, as it is showing signs of doing, the more powerful profit motive will induce them to begin hiring again.

This morning the government announced that the U.S.trade deficit narrowed in April from a record level as imports fell, reflecting the biggest decline in oil prices in 12 years, according to Bloomberg.  The U.S.economy, the world’s largest, is projected to grow more than twice as fast asJapanandEuropethis year. That may restrain foreign appetite for American goods, which have been made cheaper by a 6% decline in the dollar since the end of 2002, economists say.

Earlier in the week Mr. Greenspan warned of higher natural gas prices and the need to import more liquid natural gas to address the coming shortages of supply.  “The up drift and volatility of the spot price for gas have put significant segments of the North American gas-using industry in a weakened competitive position, “Greenspan told the House Committee on Energy and Commerce.  Gas costs have cut “a couple of tenths off of profit margins” in certain industries, he said.  The price of natural gas, which is used to run power plants, heat homes and make chemicals, will be 80% higher on average this year than in 2002, the U.S. Department of Energy said last week.  Natural-gas inventories held by utilities and large commercial users at the end of May were more than a third lower than a year earlier.  “Access to world natural gas supplies will require a major expansion of LNG terminal import capacity,” Greenspan said.  Liquid natural gas imports are, “a crucial safety value in maintaining price stability.”  These factors and others led to our recent purchase of Dover Corp. and EOG Resources, leaders in the field of transport and discovery of petroleum products.

Finally, consumer confidence in June, as measured and reported by the University of Michigan, surprised to the downside.  It fell to 87.2 (a preliminary reading that may change), in contrast to expectations of 93 by economists and down from 92.1 in May.  The survey represents a continuing sampling of consumers as to their views of the present situation and their future expectations regarding economic conditions.  The level of consumer sentiment is related to the strength of consumer spending – a majority of our economy.  The weakest part of the June survey was in consumers’ expectations.  Economists say that consumers remain worried about their prospects in the face of rising unemployment.  But, remember, it is important what consumers do, not what they say.  The latest statistics show they remain engaged in this recovery.

The initial market reaction to the disappointing confidence report is negative as might be expected.  But, during this latest multi-week rally, investors have largely shrugged off the bad news as it occurs and instead focused on the improving potential of this economy.  The next real test is upon us as corporations begin to confess their shortfalls or celebrate their accomplishments.  Investors’ eyes and ears will be acutely tuned to the body language of every presenter and everything they say and don’t say.  The coming weeks represent a major re-fueling junction for this rally train.  If it is to be sustained in the short-run, good news must significantly outweigh the bad.  We remain optimistically cautious.