09 May 2003 The Best Leading Indicator Is Improving
Have you noticed that the stock market is doing consistently better in spite of the continuing dreary economic news? One reason is that we have largely escaped the first quarter earnings cycle without a single major blowup or negative surprise; corporate earnings are coming in better than expected. What’s more, analysts have shown no signs of cutting their second, third, or fourth quarter earnings estimates.
Charles Hill, Director of Research at First Call, says “the analysts have not reacted to the past quarter reports in a way that negated the high expectations for the upcoming quarter. As we said last week, this is no guarantee that the 3Q03 expectations will be met but it certainly means it is more likely than at any other point since the onset of the recession.” According to First Call. “not only do first quarter ‘03 earnings continue to beat the estimates by far more than normal (6.6% vs the 2.7% average of the last nine years), but the final results (likely to be closer to 14% than 13%) will be well above the 11.7% expected at the beginning of the quarter.”
Paddy Jilek of Credit Suisse First Boston sees the outlook for our market as follows:
1. “Better balance sheets, pent up demand, plenty of external finance and improved free cash flow add up to a substantial recovery in capital spending over the coming year.
2. Growth in consumer spending is likely to remain sluggish at about 2% but that’s all that is needed to eventually deliver 10% capex growth. Call it the “two-ten rule.”
3. Inflation will remain low indefinitely and perhaps fall further. The Fed will keep short rates pegged at historically low levels and long rates will overlook a recovery in business spending.
4. The bear market ended on October 9th. Stocks and bond yields are reasonably valued, and are therefore trading a range.
5. A mild cyclical recovery is already being factored into stock prices. But stronger business spending and lower inflation could break the nexus between stocks and bonds. It would provide a platform for stocks to puncture the top end of the current range without bond yields following suit. That would be a virtuous circle indeed.”
The excesses of the nineties are being rooted out of this economy and of Wall Street. Elliot Spitzer’s crusade is having an impact on corporate governance and will eventually improve the way investors view corporations and Wall Street analysts and brokers.
Don Hays points out that information has been made instantly available to all. He says “I believe the Technology Revolution really began to come out from under its camouflage in 1995-96 when the internet browser and increased band-width began to make the computer user friendly and more efficient. From that point on, it began to make life much more productive. It also began to totally change the transparency of corporations, governments, and all other previously autocratic organizations. It began to offer “perfect pricing” information.”
In the past, the analyst and the broker stood between corporations and the investor. Today, investors have access to almost any information they seek on corporations without the delay or filtering that was the norm just a few years ago. Combine that with more stringent regulations from the SEC and other regulatory agencies for corporations to publish information more uniformly and to make it instantly available to anyone who is interested in a simultaneous manner and you have the ‘democratization of information.’
Markets move on information and there is now more of it than any time in history. But, investors are adapting themselves to the breadth and currency of information as evidenced by the declining volatility of stock prices. This week the market held up well in spite of mixed economic reports.
Monday, the government reported that U.S. service industries unexpectedly expanded in April as the war inIraqwound down, helping boost consumer spending and lifting the biggest part of the economy. The Institute for Supply Management’s index for retail, financial services, construction, and other non-manufacturing businesses rose to 50.7 last month from 47.9 in March. The median forecast of 46 economists polled by Bloomberg News was 49. Readings above 50 indicate expansion.
Services account for 85 percent of the U.S.economy and a sustained increase may reinforce some economists’ expectations for an acceleration of growth later this year. The numbers bear out the premise that the economy would return to growth once the war was over.
On Tuesday the Fed helped the bond markets with their view that the economy was weighted more toward risk of falling prices, or disinflation, than that of inflation. They noted that companies were getting squeezed by the inability to raise prices. In their view, companies’ capital spending and profits were being restricted partly because they couldn’t raise prices even as costs were increasing for insurance, pensions, energy, and health benefits. The Federal Open Market Committee said that further declines in inflation would be “unwelcome,” language that indicated a willingness to cut rates further if inflation indicators fell substantially.
Sales at U.S. retailers increased twice as much as inventories did in March. Wholesale sales rose 1%, double February’s .5% increase, according to the Commerce Department. Coincidentally, inventories increased only .5%, following a .3% rise in February. That brings inventories at wholesalers to a record-low 1.21 months’ supply of goods in stock at the current sales pace. This level indicates continued concern about the demand outlook.
Consumer borrowing slowed in March to $931 million from $1.3 billion in February. The increase was due to a rise in credit card borrowing, but was the smallest increase since a decrease in November of last year when the war withIraqwas looming. People worried about the future, their jobs specifically, tend to borrow less.
Jobs, a lagging indicator of the economy, do not yet show any significant improvement. The pace of applications for initial unemployment benefits dropped from 448,000 to 425,000 for the week ended May 3rd, a weak, yet positive sign of improvement. However, it was the 12th straight week that initial claims exceeded 400,000, the longest stretch since theU.S. economy was emerging from the recession of 1991-92.
The economy is not yet creating jobs as confirmed by the continuing claims report yesterday. The number of people continuing to collect jobless claims rose to 3.665 million in the week ended April 26th. That’s the highest level in six months, exceeding the prior week of a revised 3.659 million.
The government data reported this week continues to be largely affected by events leading up to and including the war with Iraq. It will be several more weeks before we get a clear read on the economy apart from the war factors. As pointed out earlier, the service industry expanded faster than expected after the war. Corporate earnings were better than analysts expected, and they indicate continued improvement. Finally, the best barometer for future expectations, the stock market, is signalling better times are ahead.