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To: JakeStraw who wrote (8124)	5/14/2001 5:22:07 PM
From: John Madarasz	Read Replies (1) \| Respond to of 10934

MARKET EARNINGS To quote Gabriel Heater, that famed newscaster of the glory days of radio, "Ah, there’s good news tonight". "Tonight" was Thursday and Friday of last week. Thursday the monthly retail sales numbers came in somewhat better than expected, and a few retailers actually upgraded their outlook for sales and earnings. Also, the unemployment claims for the week before showed a decline. Friday the government data on April retail sales confirmed what the retailers were reporting, as did the rise in the University of Michigan consumer sentiment numbers. Last week we raised the caution flag on the consumer cyclical sector. The concern was that the slowdown that began in early March in negative pre-announcements and downward estimate revisions might be in jeopardy. In late April and early May, expectations for S&P500 2Q01 earnings growth slipped from a 16% decline to a 19% decline and there was a stirring in warnings. The immediate worry was that the monthly same store sales results could be accompanied by earnings warnings as they were in February ahead of 4Q01 earnings reports. There is another hurdle to get over this week and next, as most of the retailers report 1Q01 earnings and comment on the outlook going forward. However, given the strength of April same store sales and the government retail data, it seems unlikely there will be much bad news. Whether this positive trend in the consumer area will continue into the summer is the big question, but the odds are now much better. The other hurdle this week is in the technology sector. The several major tech companies reporting are all on an April ending quarter, so their comments will be based on an additional month of data compared to the great majority of tech companies that have already reported 1Q01 results. These include Dell Computer, Hewlett-Packard, Applied Materials, Ciena, Analog Devices, Sycamore Networks, Network Appliance, Brocade, and Agilent. The news likely will not be as good in this sector. The most ominous item in the earnings area remains the continuing acceleration in warnings. Negative pre-announcements set a record in 4Q00, well above the prior record set in 3Q98. Warnings in 1Q01 broke by a good margin the record just set in 4Q00. Negative pre-announcements for 2Q01 are on a pace to again break the record by a good margin. The number for 2Q01 stands at 317. That is 30% ahead of the 1Q01 warnings at the equivalent point in that quarter. The worry engendered by the warnings data is that the pace may not decelerate soon enough or fast enough to keep 3Q01 and 4Q01 earnings from being slashed. Meanwhile, the final 1Q01 earnings reports continue to trickle in. It still looks as if the final results for S&P500 earnings growth will be a decline of just over 6%. With 90% of the S&P500 having reported, and using estimates for the remaining 10%, the year-over–year earnings decline is at 6.5%. The average amount companies are beating the sharply downward revised 1Q01 estimates by has risen to 4.0%. That is meaningfully above the 3.0% average of the last seven years. The number of companies beating estimates, however, remains at 56%, slightly below the seven year average of 58%. The earnings decline continues on track to be deeper than that of 1Q01. Expectations have dropped to a decline of 11.4%, and we still expect the final results to show a decline of 11% to 13%. Current expectations for 3Q01 stand at a decline of 2.8% but will likely drop to close to the 2Q01 decline level. The 4Q01 expectations are at 8.9%. To borrow the phrase of the day, there is no visibility that far out, so it is difficult to make a good estimate. It is likely that 4Q01 expectations will drop to the point 4Q01 earnings show a decline from the week year ago quarter. Assuming that our projections for the rest of the year are roughly correct, earnings for 2001 would only have dropped down to the long term 7% earnings growth trendline for S&P500 earnings. The widest divergence above trendline took place in 3Q00, when the actual earnings were 20% above the trendline earnings at that time. If one believes in reversion to the mean, than sometime in the not too distant future, earnings should spend some time below trendline. The decline in earnings this time is not as steep or as deep as in 1991. That correction took earnings down to a level 27% below the 7% trendline. Year-over-year earnings growth bottomed at 24.2% in 2Q91. Following the 1991 drop it took three years of well above average growth until the actual earnings line crossed back over the 7% trendline. The First Call valuation model (comparing the forward four quarter P/E ratio to the inverse of the interest rate on the 10-year Treasury) indicates the market was about fairly valued on 30 March. However, the April and May surge in stock prices, particularly in the technology sector, along with the continued slippage in earnings forecasts, again particularly in the tech sector, pushed the P/E ratio to 22.9, compared to the implied fair market P/E of 18.9. That means the market is 21% overvalued, unchanged from last week. The market may prove even more overvalued if the expected 3Q01 and 4Q01 earnings come up short. www1.firstcall.com