Hello Jay,
riding in an breadwagon
Grab me a loaf of sourdough and a loaf of pumpernickel please... Thanks...
online.wsj.com
SUNDAY JOURNAL
Don't Expect Your Stocks To Reach the Sky Just Yet
By HENNY SENDER
Staff Reporter of THE WALL STREET JOURNAL
The worst appears to be over for stocks. But that doesn't mean investors have such an easy road ahead.
Sure, there's ample reason to be encouraged. Last week, a preliminary report put economic growth for the second quarter at an unexpectedly strong 2.4% annual rate -- evidence that the recovery is under way. And in July, the Dow Jones Industrial Average finished with its fifth consecutive monthly gain, a feat it hasn't accomplished since the late '90s.
Stocks at one point last week touched their highest levels in more than a year, but proceeded to stumble and finish the week in the red. Such pullbacks are a reminder that recoveries in post-bubble worlds tend to be sober affairs.
"Not all the imbalances were purged during the recession, and that puts a cap on growth," says David Rosenberg, chief North American economist for Merrill Lynch & Co.
Here are some of the hurdles stocks face that could determine whether the rally keeps rolling.
Interest Rates
As more people believe the recovery is for real, interest rates are bound to rise -- which in turn gets in the way of more growth.
Moreover, almost half of the growth in the past quarter is tied to military spending. And as the government borrows more to cover those costs, demand for money from the government alone is expected to fuel higher interest rates. Last week the 10-year Treasury note yield, which moves in the opposite direction of price, briefly touched 4.5%, a level not seen in two years.
Higher rates will hurt companies whose results have been supported up to now by cheap money. And, after both corporate America and consumers have piled up sizable debts, rising rates will make it more expensive for them to pay back many of the loans.
This makes it especially risky to assume that stellar second-quarter earnings in some sectors will recur in the third quarter. Banks' results, for example, have been buoyed by mortgage lending. But rising interest rates are already having an impact: Mortgage applications have plunged more than 30% in recent weeks, according to data from Merrill Lynch.
"There is enough momentum for the next six to nine months," says Bruce Kasman, chief U.S. economist for J.P. Morgan Chase, who a few days ago revised growth estimates for the third quarter up to an annual rate of 4.5%. "GDP growth for the second half of the year should be decent," he says. "But given how much we overextended ourselves earlier, will it be enough to get us over the hump?"
Pricing Power
In a world where supply still exceeds demand for most things, global competition is fierce. Companies with good prospects are those that command premium pricing so that improved sales figures translate into improved profits.
"We have seen few companies showing real pricing power," says Shigeki Makino, a managing director at Putnam Investment Management in Boston. "Overcapacity is still an issue."
Car companies are a good example of the pressures on manufacturers and the possibly modest nature of the recovery. For all of the Big Three car companies, General Motors, Ford Motor, and DaimlerChrysler, core automobile operations were "barely profitable" in the second quarter, according to a recent report from Stephen Girsky, industry analyst with Morgan Stanley. "With inventories above normal and market share under pressure, we think financial results are likely to continue to lag in any recovery," he says.
Indeed, a large part of the car-company profits in the second quarter came from their finance units. Attractive financing terms meant that consumers continued to buy cars despite a weak economy and rising unemployment -- both during the recession and in the months after when growth remained anemic. But the fact that consumers continued to buy cars means there is very little pent-up demand today to fuel a strong recovery for the car makers. "With interest rates continuing to rise...and mortgage refinancing starting to decline, we think the current earnings of finance subsidiaries are likely unsustainable," Mr. Girsky's report warns.
Revenue Growth
Market pros have been scouring second-quarter corporate results for proof that the economic recovery is on solid ground. Not everyone is convinced.
"Earnings haven't yet confirmed the advances that this market has made," says Benjamin Pace, a managing director at Deutsche Bank AG's Private Wealth Management unit in New York. "The scenario that a little growth in revenues would lead to big profit growth is just starting to unfold."
Meanwhile, some earnings reports continue to overstate income by failing to include costs such as the expense of employee stock options in the earnings data. Many others either inflate pension returns or mask the true burden by assuming artificially high rates of return on pension investments. "In our view, the quality of earnings for the S&P 500 from an accounting standpoint is the worst it has been in more than a decade," says a team of UBS analysts led by David Bianco, head of accounting research, in a recent report.
Consumer Spending
Consumer spending has been a bright spot these past three years, as people faithfully bought everything from toothpaste to trucks. But not all the companies catering to consumers have been equally buoyed by those purchases.
Consider the diverging fortunes of two companies in the sector, Procter & Gamble and Sara Lee.
Procter & Gamble's earnings for its fiscal fourth quarter testify to the sort of improvement that heartens the optimists. Sales rose 5%, excluding the impact of a weaker dollar and various acquisitions and divestitures. More important, net income also climbed 5%. Analysts like to see growth both in sales and profits because that suggests the business is really strong and earnings are coming not just from volume growth and cost cutting but from real pricing power. P&G's powerful brand name insulated it from the pressure to cut prices that hurt other companies.
But the same day P&G reported its strong performance, Sara Lee, a food and apparel company, announced very different results: a 16% fall in quarterly profit. In announcing its earnings last week, the company said it expected the next quarter to be grim as well. Steven McMillan, the chief executive officer of Sara Lee, said that sales for the fiscal year ending in mid-2004 would rise only 2% to 4%.
Do you think the economic recovery is here to stay? Drop us an e-mail at forum.sunday03@wsj.com.
Updated August 3, 2003
KJC |
