2Q Is the Economic Bottom, Right? -->
This was from last wednesday, but still a great article to read.
Mid-Week Analysis - By Chad Hudson
from prudentbear.com
May 23, 2001
There is very little economic news out this week. All eyes will be on
Friday's release of the revised first quarter GDP. Economists expect
GDP to be revised down due to the larger trade deficit posted in the first
quarter. Last Friday, April's $31.2 billion deficit shocked economists,
which were expecting a more benign $29.5 billion. For the first quarter the
trade deficit grew to a record $91.3 billion, $6 billion more than last year.
On Monday, the Federal Reserve Bank of Philadelphia released its
Survey of Professional Forecasters. The survey found that economists
have lowered their economic growth forecasts and increased the
probability of a recession. The forecasters slashed their forecasts for the
current quarter to an annualized 1.2% from 2.2%. Growth for the second
half was also dramatically reduced to 2.3% from a previous estimate of
3.6%. Growth rates for 2002 were also adjusted downward to 2.8% from
3.6%. Not surprisingly the forecasters have increased the likelihood of a
recession. A recession in 2001 has a 35% chance, while 2002 is only
20%. Not surprisingly, unemployment is expected to continue to rise, up
to 4.8% by year-end.
The recent Manpower survey does not bode well for the labor markets.
Only 27% of companies expect to increase payrolls in the next three
months, while 9% plan to let go workers. Just a year ago, 35% of
employers expected to add workers with only 5% anticipating reducing
employees. Not surprising the manufacturing sector expects the weakest
hiring forecast. Only 24% of manufacturing companies expect to hire
additional workers compared to 15% that plan to pare back their
workforce. This is the weakest showing since 1982.
To see how U.S. companies are handling the weakening economy as a
whole, I ran a couple reports on aggregate revenue for the first quarter. I
included companies that have reported net income and revenue since the
first quarter 1999 (so there is some degree of survivorship and new issue
bias) and traded on one of the three major exchanges. There were just
over 4,100 companies included with revenue totaling almost $2.3 trillion.
($ in billions)
1q01
4q00
3q00
2q00
1q00
Revenue
$2,283.9
$2,352.3
$2,195.1
$2,139.7
$2,027.5
Y-o-Y Growth
12.6%
14.8%
14.7%
16.6%
18.0%
Net Income
$68.2
$56.6
$122.6
$115.0
$128.7
Y-o-Y Growth
-47.0%
-44.4%
5.6%
0.0%
27.0%
Special Charges
($28.4)
($57.5)
($4.4)
($11.1)
$1.5
While revenue growth has clearly declined, it is far from drastic. The
"profit recession" that so many are discussing appears to be accurate.
However, the degree that accounting charges have reduced the current
period's income must be examined. It is amazing that during the past two
quarters there have been more than $85 billion in special charges. This
only includes items the company places in a line item before taxes. Not all
charges are included. For example, this number only included $1.3 billion
of Cisco's $3.4 billion worth of charges in the first quarter. Compustat
included the $2.25 billion inventory charge in cost of goods sold. There
are probably countless other "missing" inventory charges in the number
above. Just adding Cisco to the special charges would increase the total
by almost 8%. I still find it amazing that less than 90 days from when the
auditors look over the books, there could be so much "excess" inventory,
goodwill, and other assets discovered.
America Online announced a $1.95 increase in access fees. While this
only appears as a 9% jump in prices, it comes at a time when free
providers are changing their business model by limiting access time or
assessing fees, or just leaving the business. This essentially is raising the
total price of access. It also shows that AOL thinks it has pricing power. If
more companies realize they have pricing power, the inflation picture
could get very precarious.
There is starting to be more and more rumblings about inflation, although
the consensus is still not worried about it. But it cannot be too
encouraging for the doves to see the government yields significantly
above the levels before Greenspan's cut-a-thon. The idea of stagflation
sure has been inflating lately. Doing a quick periodical keyword search
using Lexis-Nexis, "stagflation" retrieved 566 references so far this
year. That’s up from 217 last year to May 23. There were a total of 698
references for all of 2000 and 424 in 1999.
Inflation is starting to spook a few out there. Edward Yardeni's concern
should ring familiar to readers of our commentaries; "I'm more concerned
about the potential for another speculative bubble in the stock market."
Yardeni said that reinflating the bubble "could be a lot of fun and very
profitable…But it's not in the best interest of the economy."
We have been discussing the energy problems the Pacific Northwest is
experiencing, especially the Bonneville Power Administration (BPA). In
an unprecedented move, the BPA has spent $500 billion buying back
electricity it has contractually pledged to its industrial customers. The
BPA is hoping to avoid widespread price increases and blackouts by
buying back electricity from its heavy users. The smelters buy a constant
2,000 megawatts of electricity from BPA, which is enough to light two
million homes. So far it has worked, but with ramifications. Many of these
companies are shutting down and laying-off workers. While many of the
agreements call for companies to continuing paying employees while the
plant is idled, it has certainly caused concern about the future. Oregon
reported over 7,000 lay-offs this year, more than double just last year.
The weakening manufacturing sector, soaring energy prices and a strong
dollar continue to take casualties in the steel industry. Northwestern
Steel and Wire Co. began shutting down one of its plants putting 1,400
employees out of work. LTV Corp. is starting to get close to the end of its
rope negotiating with the United Steelworkers of America. Currently LTV
is losing more than $1 million a day and is looking to finish a restructuring
that would save $800 million annually. To what extent LTV is using its
financial condition is unknown, but it says "If the agreement is not made
in the very near future, the company's restructuring plan would not be
able to go forward, and if that were to happen, the company would shut
down permanently."
With the trade deficit running at a record rate it seems the only thing the
US is exporting is inflation and energy problems. Brazil is asking for its
companies and households to reduce electricity consumption by 15% to
20%. Brazil generates about 85% of its electricity by hydroelectric
plants. A recent drought is cutting into the amount power the generation
plants can produce. Today, the FT reported that the proposed plan to cut
electricity consumption hit a couple snags. First, it looks like the courts
are ruling that it is illegal. Second, employees at one of the largest power
distributors, Light, went on strike. Lastly, opposition parties are stepping
up anti-rationing rhetoric.
The semiconductor industry continues to languish. The semiconductor
equipment book-to-bill ratio posted a record low of 0.42 in April. Wall
Street was out saying this must be a bottom in the cycle since it has never
been so low. Funny, I don’t recall them calling a peak when it was at
record levels last March. Stanley T. Myers, president and CEO of SEMI,
did not sound as hopeful, "The severity and depth of this industry
correction is unprecedented." On Monday, Chartered Semiconductor, the
world's third largest chip foundry, reduced its revenue and earnings
forecast for the second quarter. Chartered now expects sales to fall 48%
sequentially compared to earlier forecasts of a 25% decline.
Elsewhere in the semiconductor industry, Hynix Semiconductor, the
second largest memory chipmaker, is desperately trying to raise capital.
Hynix plans to issue $1.5 billion in global depository receipts (GDRs) in
the next couple weeks. The funds are integral part of a restructuring plan.
If the funds are not raised a $4.4 billion financing package by current
creditors will get pulled. Anyone interested can contact Salomon Smith
Barney. Sounds like it might be a tough sell.
In the shadow of the NASDAQ bear market, Wall Street is attempting to
establish a "code of best practice." Additionally, Congress is expected to
hold hearings to determine what degree conflicts of interest lead to the
mania. The Association of Management and Research (AIMR) is helping
to establish the new code. It seems it would be much easier if AIMR
simply just enforced its existing Code of Ethics and Standards of Practice.
Here are three pertinent sections from AIMR's Standards of Practice.
A.1 Reasonable Basis and Representations. Members shall:
a.Exercise diligence and thoroughness in making investment
recommendations or in taking investment actions.
b.Have a reasonable and adequate basis, supported by appropriate
research and investigation, for such recommendations or actions.
A.3 Independence and Objectivity. Members shall use reasonable care
and judgment to achieve and maintain independence and objectivity in
making investment recommendations or taking investment action.
B.7 Disclosure of Conflicts to Clients and Prospects. Members shall
disclose to their clients and prospects all matters, including beneficial
ownership of securities or other investments, that reasonably could be
expected to impair the members' ability to make unbiased and objective
recommendations.
It does not seem that these "Standards" were practiced by many during
the Internet mania. Looking at the first "Standard", it would take a lot of
convincing that an appropriate measure of a company's value was the
number of eyeballs viewing a webpage. The "Chinese Wall" concept of
keeping the investment banking division separate from the research
department is demanded in both Standard A.3 and B.7. To have a
research analyst's pay even partially dependant on the amount of
business he brings to the investment banking division is clearly a violation
of AMIR's Standards.
Speaking of "Reasonable Basis," is it reasonable for a money manager
to buy Cisco just because it is X% of an index? Granted, it might be for
an index manager, but how many managers were buying Cisco because
they "had to" because they are evaluated by relative performance and
Cisco makes up a large portion of an index and it was going up. |
