interactive.wsj.com
June 28, 2001
Despite Fed's Rate Cuts, the Mood
In Boardrooms Continues to Darken
Corporate Cutbacks Concern the Fed,
But They Could Be Sign Bottom Is Near
By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
WASHINGTON -- Despite Wall Street's widespread hopes for an
economic recovery in the second half of 2001, America's business leaders
have adopted a decidedly gloomier view.
At companies across the nation, sales and
earnings continue to fall below
already-lowered expectations. Federal
Reserve officials attempted to drive away
that storm cloud Wednesday by cutting
interest rates by a quarter percentage
point, their sixth rate cut in as many
months. The Fed lowered its target for the
federal-funds rate -- the rate banks
charge on overnight loans -- to 3.75%
from 4%. It also lowered its largely
symbolic discount rate to 3.25% from
3.5%. Though the cut was the smallest
this year -- the previous reductions were
half-point moves -- Fed officials, citing the risks of "economic weakness in
the foreseeable future," sent a clear signal that they were poised to keep
easing credit conditions through the summer.
The nation's businesses, meanwhile, have dealt
with those same uncertainties by cutting
spending, closing facilities and laying off
workers -- actions that, in turn, further dim the
prospects for an imminent turnaround and
complicate the Fed's job of keeping the
economy out of the ditch.
Back in March, executives at Thomasville
Furniture Industries Ltd., for example,
believed they had done enough belt tightening
when they decided to close two factories and
eliminate 390 of the company's nearly 8,000
jobs. At the time, interest rates were falling, consumer confidence was
stabilizing, the stock market appeared to have bottomed out, and housing
starts were holding up relatively well. Thomasville thought it would benefit
from those trends "a few months down the line," says Chief Financial
Officer Paul Dascoli.
But as the second quarter draws to a close, the high-end furniture
manufacturer has yet to see any sign of a pickup. Customers are still
visiting stores that carry its furniture, but buyers are getting scarce. Last
week, the company, a unit of Furniture Brands International, of St. Louis,
said it would have to close its factory in West Jefferson, N.C., and lay off
239 employees there in addition to 375 other workers across the state.
"We had hoped to be seeing a rebound about now, and we're just not
seeing it," says Mr. Dascoli.
In recent months, U.S. corporate
profit expectations have gone into a
free fall. At the beginning of April,
Wall Street analysts expected that
third-quarter profits of companies in
the Standard & Poor's 500-stock
index would rise by 2% from a year
earlier. By early May, they had
revised that estimate to a 3%
decline. Now, they are looking for
an even steeper drop, of 6%,
according to Thomson
Financial/First Call, whose research
director, Chuck Hill, thinks the
year-over-year profit decline will
end up closer to 15%.
From McDonald's Corp. to Merrill Lynch & Co. to Merck & Co., the
bad earnings news has cut a broad swath through the nation's boardrooms.
And even companies such as Gap Inc. and International Paper Co., --
which haven't recently warned about weaker profits -- are announcing
layoffs, cuts in capital spending or both.
The vicious cycle of weaker earnings and corporate cutbacks is one of the
trends the Fed considers most worrisome right now. In their statement
Wednesday, Fed officials placed "declining profitability and business
capital spending" among the primary reasons for Wednesday's rate cut.
Nonetheless, the stock market has remained
relatively stable in recent weeks, despite the
downbeat profit picture. Late Monday, for
example, Applied Micro Circuits Corp., which
makes integrated circuits for computer
networking gear, cautioned investors that its
revenue in the current quarter could be as
much as 45% below analysts' expectations.
But on Tuesday, the San Diego-based
company's shares managed to gain sharply.
Even the Fed's decision to scale back the
pace of its rate cuts -- a disappointment to
many analysts who had been predicting
another half-point move -- didn't jar markets.
The Dow Jones Industrial Average finished the
day down just 37.64 points at 10434.84, and the Nasdaq Composite
Index rose 10.12 points to 2074.74.
Indeed, the Fed's decision to slow down its pace of rate reductions
suggests some officials inside the central bank feel the easing since January
should go a long way toward sparking a recovery later this year and that
going much further would risk stoking inflationary pressures. Some of those
inflation "hawks" may have preferred no rate cut at all. But other Fed
officials, including Chairman Alan Greenspan, have played down those
risks. Some of these officials, emphasizing the economy's fragility, may
have advocated a half point cut. The quarter point move and relatively
terse statement struck many analysts as a compromise.
The consensus among major forecasters is that the economy, after growing
at just a 1.3% annual rate in the first quarter and possibly even shrinking in
the current quarter, will climb back to a 3% growth rate by the fourth
quarter, according to Blue Chip Economic Indicators, a Kansas
City-based research publication. And less than 10% of those forecasters
surveyed think the U.S. is either in a recession or likely to enter one.
The odd split between the hopes reflected by the stock market and in
economists' forecasts and the pessimism in the nation's corporate corridors
isn't unusual at economic turning points. "It looks that way at bottoms and
at tops," says Peter Hooper, Deutsche Bank's chief U.S. economist.
"That's a reason to sit back and wonder, how quickly could things turn
around here?"
Economists point out that interest-rate cuts usually take six to nine months
to boost the economy, which means the rate cuts that began in January are
only now about to be felt. Wednesday, commercial banks lowered the
prime rate, to which many consumer and business loans are linked, to
6.75% from 7%. Moreover, a tax cut is on its way later this summer.
Deutsche Bank estimates that could boost consumer spending by 1% over
the next several quarters. Meanwhile, the spike in energy prices that took a
toll on consumer spending this past fall and winter is rapidly unwinding;
gasoline, natural gas and western wholesale electricity prices now all are
below year-earlier levels.
It's easy to let high-profile bad news in some sectors such as technology
obscure the fact that much of the economy remains healthy. Business
spending may be in full retreat, but household spending has continued to
grow, though more slowly. Sales of homes and autos -- the most
interest-sensitive sectors -- remain healthy. And the Conference Board
said Tuesday that consumer confidence, though still sharply below
year-earlier levels, rose in June to its highest level this year.
Main Street, as well as Wall Street, seems to continue to have faith that
Mr. Greenspan is pulling the economy back from the brink. A new Wall
Street Journal/NBC News poll shows that the percentage of Americans
who have a positive opinion of the Fed chairman has held steady at 55%
this year, despite the stream of bad economic news.
But many corporate executives are finding it difficult to share that optimism.
In the telecommunications-equipment industry, for instance, interest-rate
cuts have done little to halt the carnage. "We're somewhat confounded by
the magnitude of the downturn," David Rickey, chief executive officer of
Applied Micro Circuits, told analysts Monday. "There's such an inventory
overhang that it clouds any optimism ... We've seen cancellations slow, but
it's because we have a lower backlog, and there's less to cancel."
Applied Micro Circuits, which employs 1,200 people, has promised to
streamline its cost structure, saying it expects to record a restructuring
charge for the current quarter. "Although I believe stabilization and
beginning of a recovery in our revenue will occur yet this calendar year,"
Mr. Rickey said, "it is difficult to see tangible signs that allow me to call a
bottom."
Over the course of the year, what many companies thought was a
short-lived retrenchment in spending has turned into outright collapse.
While capital-equipment orders did edge higher in May, economists
dismissed the rise as barely significant after a steep drop in April. J.P.
Morgan estimates that business spending on equipment and software fell at
a 20% annual rate in the current quarter.
'Lots of Opportunities'
Nortel Networks Corp., which is based in Brampton, Ont., but has
operations throughout the U.S., first warned of slowing sales growth earlier
this year, then later expressed hope that the slowdown would be over by
the end of 2001. But two weeks ago, when it disclosed that it would have
a $19.2 billion loss in the second quarter, it conceded that the recovery
mightn't come until the second half of next year.
"We're finding there are lots of opportunities, unfortunately, for our
customers to meet the capacity needs of their networks without additional
equipment purchases," Nortel CEO John Roth told analysts then. "How
long this trend will continue is a topic of conjecture."
Back in January, Nortel announced plans to cut its world-wide work force
of 94,500 by 4,000, or 4.2%, this year. In February, that estimate rose to
10,000, in March to 15,000, in April to 20,000 and by two weeks ago,
the number was 30,000, or 32%. Nortel also plans to idle 8.8 million
square feet of production space.
The impact of those types of cuts is now seeping into the broader national
economy. Jobless claims are beginning to rise in California as the
technology slump takes hold there. And Midwest states, such as Michigan,
already have been hit hard by auto plant and other heavy industry
showdowns.
As corporate cutbacks ripple through the economy, they eventually reach
consumers. After Alan White took a $125,000-a-year job last fall as
marketing director for a division of Nortel Networks, his wife set her sights
on buying an $18,000 silver Chrysler PT Cruiser. Even as the company
went through a few waves of layoffs earlier this year, Mr. White, who
works for Nortel from his Alabama home, was spared.
In May, however, Nortel shut down the high-speed Internet-equipment
business Mr. White worked for, which it had purchased just a year earlier.
Nortel's first, selective layoffs seemed like the kind of retrenchments Mr.
White had seen before. But the cuts that claimed his job were different, he
says. "There was some shock ... at the concept they would just dump the
entire business, without selling it off or severely downsizing it." Now his
family's new-car plans are on hold. Lower interest rates? He says they will
mean little to him "unless I decide to buy something, and I'm not going to
buy something until I have permanent employment."
That's partly why Fed officials say they are worried about "weak
expansion of consumption," and why spending isn't growing at the pace
that many store chains had expected, forcing a new wave of retrenchment
in the retailing sector.
Until last week, Gap, the clothing retailer, had been planning to increase
the total store square footage in its stores by 15% a year in the next two
years. Now, it has lowered that goal to 10%. That suggests that the
company will open about 200 fewer stores than previously planned next
year. At the same time, it has vowed to cut its headquarters staff of 10,000
by 5% to 7%. A spokesman calls the job cuts "an acceleration of
cost-cutting initiatives we've been looking at from the start of the fiscal
year."
Steeper Markdowns
Upscale retailer Neiman Marcus Group Inc. said earlier this month that
soft sales were forcing it to take steeper markdowns to clear inventory.
Chief Executive Burton Tansky blames "all the factors we've been dealing
with since November: a softening economy, a stock market that has
declined sharply," especially the Nasdaq Stock Market, as well as the
weather. The Fed's interest-rate cuts might have been some help, but he
says it's hard to tell. "Those cuts take some months before they take hold,"
he says. In the meantime, he adds, the chain is being conservative in its
inventory ordering. And if sales do better and his stores run out of stock of
a particular item? "We have plenty of other things we can sell," he says.
On their checklist of economic potholes, Fed officials Wednesday noted
"slowing growth abroad." Many businesses, too, are citing slowing foreign
economies, especially in Europe, as reason for their renewed gloom.
Chemical companies should be among the biggest beneficiaries of the big
drop in energy prices. But they are seeing profit prospects darken because
of weakening European markets and rising capacity, says Lehman
Brothers analyst Sergey Vasnetsov.
In February, Houston-based Equistar Chemicals LP closed a plant at Lake
Charles, La., in part because of high energy and raw-material prices, but
kept enough staff on hand to bring it back into production in just a few
weeks. Last week, the company said it was extending the shutdown until
markets recover, terminating 50 contract workers and redeploying 100
employees elsewhere in the company. It will now take months, not weeks,
to bring it back into production.
The Europeans, meanwhile, are blaming deteriorating economic conditions
in the U.S. for further weakening their economies. European Central Bank
Vice President Christian Noyer said Wednesday that he is "quite
confident" that the European economy will grow faster than that of the
U.S., but he suggested that the ECB realizes it failed to gauge the potential
effect of the U.S. slowdown on the euro zone.
"What we probably underestimated was the impact of more big companies
operating world-wide," Mr. Noyer told reporters in Stockholm. "No
matter where they're based, a sudden weakening of the U.S. economy
prompts them to cut investment elsewhere -- in Europe and in Asia."
Meanwhile, even sectors of the U.S. economy that so far have been
sheltered from the downturn are starting to feel the damping effects of new
corporate cutbacks. The commercial real-estate market may not be as
overbuilt as it was a decade ago, but it is still facing a surge in supply as
failing high-tech businesses bring sublet space back onto markets such as
the San Francisco Bay area and northern Virginia. In recent months, that's
prompted many developers to slow down existing developments or quietly
abandon projects that they hadn't already started to build.
In February, Dallas-based commercial real-estate developer and manager
Trammell Crow Co. broke ground on two 162,000-square-foot buildings
along northern Virginia's tech-heavy Dulles corridor, with plans to open
both by next May. Now, only one will open in May; the other has been
delayed until August to give Trammell Crow more time to sign up tenants
and allow it to save money by delaying deliveries of steel and glass.
Tom Finan, a principal at Trammell Crow, says bond and stock markets
turned off the spigot to new projects at the end of 2000. Though a healthy
10.8 million square feet of property is under development now in northern
Virginia, he says, "I see very few starts in the remainder of 2001, unless
there's a compelling story."
-- Rupini Bergstrom of Dow Jones Newswires contributed to this
article.
Write to Greg Ip at greg.ip@wsj.com
KJC |
