19 Apr 2002 Things Not So Bad
Over the past several days, companies have released their calendar first quarter earnings and given their best guesses about near-term prospects. The actual earnings reports have been in rather stark contrast to the more downbeat management projections for business in the coming quarters. Earnings reports seem to support the economic recovery, but they are somewhat below earlier expectations. Thomson Financial/First Call estimates that profits for the S&P 500 companies probably dropped 10.7% in the first three months of 2002, more than the 8.2% drop forecast by analysts at the beginning of March. On the flip side though, 59% of companies reporting to date have beaten earnings projections, a higher percentage than at any time since 1994: a period when the Fed actively promoted expansion as they do now.
There are many explanations for the uncertainty characterizing many of the weak outlooks expressed by managers in the last few days. But keep in mind, managers are generally more reactive than proactive when it comes to projecting their company’s business outlook. They project current difficult times into the future or they project current good times into the future. Characteristically, they await proof of a slowdown or a pickup before committing or withdrawing capital resources. This quarter’s earnings reports show that business conditions are indeed improving, but not as fast as hoped.
Mr. Greenspan, in his testimony before the Joint Economic Committee of Congress, said The Federal Reserve can leave the benchmark U.S. interest rate at a 40-year low for now because inflation is “largely absent,” helping ensure an “uncertain” recovery gains strength. The Fed “should have ample opportunity to adjust policy to keep inflation pressures contained once sustained, solid, economic expansion is in view.”
The recent increases in the price of oil probably have negligible impact on the recovery even if sustained. But if oil prices were to be sustained above the $30 per barrel level, there could be a more significant impact on the economy. It is a safe bet that the Fed will constrain its interest rate increases while oil prices remain high. Greenspan said “we are very fortunate in that there is little if no evidence of inflationary pressures building; that means that the urgency of responding to economic events is less than it would be.”
Employment, the “most central” factor in the economic outlook, “has improved some in recent months,” Greenspan said. While unemployment has lagged growth “in typical fashion,” the pace of layoffs has “diminished noticeably.” There’s also evidence that “recovery in at least some forms of high-tech investment is under way,” he said. Semiconductor production is up, as are expenditures on computers. Still, overcapacity remains “substantial” in telecommunications, and aircraft investment will “presumably” remain weak, he said.
“On balance, the recovery this year in overall spending on business fixed investment is likely to be gradual,” Greenspan said. That’s another reason the Fed is likely to leave the overnight rate unchanged for now, he suggested. Because consumer spending didn’t falter through the recession, which began in March 2001, there isn’t much pent-up demand. That means corporate investment will determine the speed and scope of a recovery. During the recession, companies focused on making their existing workforces more productive, “and here the most recent readings have been very encouraging,” Greenspan said. “This development augurs well for firms’ ability to grant wage increases to their employees without putting upward pressure on prices,” he said.
Greenspan closed by saying that “prospects have brightened” for the economy. With interest rates low, productivity “well maintained” and inflation in check, “the foundation for economic expansion has been laid.”
So, interest rates are low, will likely remain low, mortgage rates are falling again, business is recovering – albeit slowly, employment declines are slowing if not reversing, and the consumer continues to be healthily engaged in the economy. All these trends bode well for a better investing climate. Volatility remains an issue and will likely be a so indefinitely, but the summer months historically offer the lowest volatility. It’s quite possible that the summer could bring gradual stock price improvement as investors seek better than money market returns among reasonably priced companies expected to perform well given today’s realities. We think we own just such companies.