15 Nov 2002 Progress Continues
News that retail sales, excluding automobiles, improved by the most in six months sent the market averages up yesterday over 1.7% for the DOW and 2.5% for the S&P 500. The .7% rise in sales was more than twice what economists had expected. Treasuries fell and stocks rose as investors gained confidence that the consumer, hence the economy, might just be hanging on.
Alan Greenspan, in this Congressional testimony, told lawmakers that the Fed did not expect a double dip recession, but warned that uncertainly remained about the strength and timing of recovery. Referring to the latest rate cut of .5% Chairman Greenspan said the monetary stimulus was a form of “insurance” against a possible further downturn. He added that if necessary, the Fed would cut rates further and that Fed analysis shows little danger of inflation, making that option more feasible should it be necessary.
According to Bloomberg News, Greenspan outlined factors responsible for the slowing of the economy. They included a drop in investor confidence caused by corporate scandals and concern over potential conflict with Iraq. Greenspan noted that while “economic growth was relatively well maintained over the past year, several forces have continued to weigh on the economy: the lengthy adjustment of capital spending, the fallout from the revelations of corporate malfeasance, the further decline in equity values, and heightened geopolitical risks.” Households have become more cautious in their purchases, while business spending has yet to show any substantial vigor,” he added.
As usual, Greenspan was upbeat about productivity, which he said continues at a strong pace since taking off in the late ’90s. Over the past seven years, hourly output has been growing at an annual rate of more than 2.5%, on average, compared with a rate of about 1.5% in the preceding two decades, he said. “Although we cannot know with certainty until the books are closed, the growth of productivity since 1995 appears to be among the largest in decades.”
U.S. Treasuries and corporate bonds fell yesterday on the news of increased retail sales. Signs of stronger growth reinforced speculation among bond buyers that the Federal Reserve ended its series of rate cuts last week, damping demand for notes with the shortest maturities that are more sensitive to changes in interest rates. We expect that the gap between short-term and longer-term (then-year bonds) to narrow. Short-term bond yields will likely rise while ten-year yields and longer will likely hold.
Since this stock market rally began on October 10th, the S&P 500 index has risen by 12.5% while the NASDAQ is up over 21%. The best-performing industry groups have been Wireless Service Providers (Nextel, AT&T, and Sprint) up 83%, Office Electronics (Xerox) up 71%, Computer Storage (EMC, Network Appl., and Lexmark) up 46%, and Semiconductor equipment (Applied Materials and others) up 43%. We hold companies in these and other categories that have performed similarly. These industries are leading indicators of economic strength. That they are moving up so strongly suggests that investors are voting with their money that the business side of the economy is finally coming to the aid of the consumer to keep the world’s largest economy afloat.
However, we must remember that the recovery, by all signs, will be gradual and bumpy. Michael Dell, CEO of Dell Corp. yesterday said that demand personal computer related goods would likely remain flat for the near future. Other similar warnings will be healthy as they will serve to govern or restrain market exuberance.
Another factor sure to weigh on markets in the coming weeks is the phenomenon among brokerage firms to “get honest” with their research. Increasing attention is being paid to the distribution of buys, holds, and sells within the universe of analysts’ coverage. Research has historically been excessively optimistic, and not reflective of the real world. In light of recent scandals, brokers and other research providers have become over-zealous in their efforts to get real. As a result, we are seeing an unusually large number of downgrades. The market though, as it always does, is adapting. An example is Intel. This morning Merrill Lynch downgraded Intel from “neutral” to “sell.” The stock is off 3.7% in Instinet (pre-market) trading. In the days of yore, such a downgrade might have sent a stock tumbling by double-digit percentages.
As we read or hear about company or industry downgrades, it is imperative that we bear in mind the market to which the analyst addresses his remarks. One unquestionable result of the past three-year bear market has been the extreme shortening of the investment horizon of so many investors. The average holding period of stocks has dropped from eight years to eleven months according to CNBC. The number of hedge funds is estimated to be above 5,000 according to the SEC. These funds trade very actively and attract the attention of numerous brokerage firms. It is reasonable to expect those firms seeking hedge fund business to color their research to match the more pessimistic bent of these customers. Finally, the market will remain bumpy as it encounters year-end profit-taking and tax-loss selling.
But, just over the horizon, investors are beginning to realize that there are numerous compelling reasons to own stocks and to hold them for more than a few weeks. Government indicators this morning continue to add proof. The Empire Manufacturing Index, a survey of manufacturers in NY State, showed significant improvement this month, rising by 9.6 points, as compared to a drop of 14.6 points last month and an expectation of a 5-point drop by economists. Business inventories expanded, contrasted with last month’s drop. The Producer Price Index, released this morning, revealed no evidence of inflation.
Finally, the University of Michigan Confidence indicator is due out at 9:50 this morning, but after the publishing time of this Brief. Futures markets show investors’ expectations that it will rise modestly, showing that consumers remain engaged and that recovery will continue on track. Steady as she goes.