Threat of War Restrains Growth

As we head into earnings season, the top international news stories, mostly about Iraq, continue to steal the thunder from some pretty good company earnings.  By the end of today, 95 of the S&P 500 will have reported their earnings.  First Call reports that the number of reports beating expectations is well ahead of this time last year.  Granted, the comparisons are pretty easy, but hey, let’s enjoy a little good news.  Many of the major banks reported strong results this week.  Bank of America’s 4th Quarter net income rose 27% and beat average analysts’ estimates by $.06.  BB&T reported a 21% increase in earnings. 

Six Dow Jones average companies reported this week: Intel on Tuesday, IBM, Microsoft, General Motors, and United Technologies on Thursday, and General Electric today.  Until today, all but United Technologies (slightly below) beat analysts’ estimates.  General Electric will likely be a drag on the market today as it reported its largest drop in profitability in nine years on reinsurance costs.  The company’s profit rose just over 7% for the year, well below the 15% average achieved during better economic times, but still up.

Big news comes from tech bellwether, Microsoft as they announced their first dividend since the company came public in 1986.  While it barely registers from a yield standpoint ($.08 x 4/55.00=.29%) it says something about the company’s change of philosophy.  Until now company management implied by paying no dividend that they believed they could find better uses for their cash than they felt their shareholders could.  Microsoft currently holds over 43 billion dollars in cash and marketable securities.  By instituting the dividend policy, management is demonstrating its confidence in the company’s ability to maintain a dividend for years to come.  A growing dividend is a matter of corporate pride and a sign of strength.  Other cash rich tech companies such as Cisco, Oracle, and Intel may well follow suit and declare dividends.

During the next two weeks about half of the S&P 500 will be heard from.  But most of investors’ attention will be fixed onIraq.  Will ‘so damn insane’ take up his neighbors’ offer to cut-and-run or will he stand behind his people in an invasion?  If we simply listen to his bellicose we might expect that war is a foregone conclusion.  But when has the man ever done what he said he would do?  At any rate, some resolution to this situation will be forthcoming in the coming months if not weeks.  Even Blix is feeling the heat for results as he appears to be turning up his rhetoric, imploring Iraq to cooperate.

Iraq remains the single greatest impediment to the economy’s recovery.  In a speech before the Charlotte Economic Club, Alfred Broaddus, president of the Federal Reserve Bank of Richmond said business spending was the “key factor” in the health of theU.S.expansion.  It will not accelerate until the nation’s conflict withIraqis resolved.  In an interview Broaddus said “The stars are starting to come into alignment, but we haven’t really seen or heard a lot of convincing or compelling evidence that attitudes are changing.  I don’t think you are going to until the uncertainty with regard to Iraq reaches a greater degree of resolution.”  He added that anecdotal evidence is growing that businesses are replacing “worn-out equipment,” while consumer spending continues to be buoyed by low interest rates and higher incomes.

The weakness of retail sales less autos received some attention this week, but we should be careful to avoid reading too much into it.  Further, the government uses the autos figure to calculate GDP growth, so the 4th Quarter’s expected rate of growth will not be affected by the lower retail sales number.

A release this morning showed that U.S. Industrial production unexpectedly fell to the lowest level in nine months making 2002 the second straight annual decline in production, the first time that has happened since the recession of 1974 and 1975.  Slower economic growth and rising levels of productivity have restrained capacity utilization.  The level of industrial capacity in use in this county has dropped to 75.4%, near the 18-year low reached this time last year.

Businesses remain concerned about the economy’s near-term future and are keeping a tight rein on inventories and business investment until they feel more comfortable about sales and profitability.  We believe demand and profitability expectations will improve dramatically once there is some resolution of the situation inIraq. North Korea and Venezuela pose uncertainty too, but they have not held the sway over investors’ future expectations as possible war with Iraq has.

Looming war withIraqhas also likely taken a toll on consumers.  The Michigan Sentiment Index which polls consumers unexpectedly fell to 83.7 against an expected level of 87.  Last month’s report was 86.7.

Today’s markets feel eerily similar to mid to late 1990 as the U.S. and her allies were preparing for the first invasion of Iraq.  The difference this time is that we have a much better understanding of Iraq’s capabilities, or lack of them, while Hussein must remember the capabilities of the forces on his doorstep.  Will he give up without a fight? We all hope so.  But the world economy is being held hostage and those with the power to free it are running out of patience.  Resolution over Iraq will come soon and with it better economic times.

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