MARKET ACTIVITY/ WEEKEND EDITION OF TRADING NOTES JULY 5, 1998 (5)
LATE BREAKING
Wall Street Week Ahead - Earnings Season Kicks Off
Wall Street's bull run faces its next acid test amid Asia's turmoil this week when second quarter earnings start to roll in.
Investors will also scrutinize events in Japan after Prime Minister Ryutaro Hashimoto Sunday said permanent income tax cuts were still just a debate, dashing world financial market hopes of swift measures to revive the nation's economy.
The financial markets had a lukewarm reaction to the ailing economy's bad bank loans rescue plan, unveiled Thursday, which failed to stem the yen's slide.
"The floodgates on earnings reports will open in earnest," said Chuck Hill, director of research at First Call, a Boston company that tracks earnings.
Wall Street expects the usual rate of pleasant earnings "suprises" after a heavier than usual batch of advance warnings and forecast trimming.
"However, as with the early first-quarter reports, the focus should be more so on what the companies say about the second half of 1998 rather than on what they report for the second quarter," Hill said.
Wall Street is still betting on a second half double digit number rebound in profits. Decent earnings would help keep the Dow industrials above the key psychological 9,000 points mark.
"The market is in summer rally mode," Richard Cripps, chief market strategist at Legg Mason Wood Walker, said. "The path of least resistance is higher."
Thursday, the Dow ended off 23.41 points at 9,025.26, still up 80.72 on the week. The market was closed Friday in observance of Independence Day.
"Certainly attention is going to be directed at earnings in coming weeks, but the companies that report early tend not to be those the market has positive expectations for," Christine Callies, chief investment strategist at Credit Suisse First Boston, said.
"Consumer staples and financial services will be interesting to watch because the market has viewed these as safe havens, and if they fail to deliver, we will see quick rotation out of those to other areas of the market," Callies said.
First Call said the year-on-year S&P500 profit growth estimate for the second quarter has been cut to 2.3 percent, down from 3.6 percent last week.
About 0.7 percentage points of the cut was due to analysts cutting back their profit forecast for General Motors Corp. and others to reflect the strike that has crippled the auto giant's North American assembly plants.
The rest of the reduction is due to Asia's slowdown.
The final second quarter results will likely show growth of 3.0 percent to 5.0 percent, similar to the 3.8 percent in the first quarter, First Call said.
"The GM strike will have trimmed the final results by just over 1 percentage point," Hill said.
Companies due to report this week include Motorola Inc. on Tuesday. The technology giant has already said the second quarter may produce its first quarterly operating loss in 13 years.
Wall Street expects Motorola to lose 4 cents per share.
The Internet sector, which has sizzled in recent weeks, will be looking out for leader Yahoo! Inc.'s earnings due Wednesday. Profits of 9 cents per share are anticipated.
Better-than-expected profits could stoke the Internet rally.
Advanced Micro Devices Inc., a maker of computer chips, is due to report Wednesday. Wall Street expects semiconductor company earnings to be among the weakest in the quarter, partly due to Asia's impact.
Advanced Micro is forecast to show a 19 cents per share loss.
Aluminum Co. of America is forecast to show a profit of $1.15 per share when it announces earnings Tuesday.
This week will be light on economic indicators with Friday's Producer Prices Index among the most important.
Producer prices in June were forecast to rise 0.5 percent compared with a 0.2 percent increase in May.
U.S. Corporate Earnings Slow, Reflecting Econmomic Turmoil In Asia
05-JUL-98
The economic turmoil in Asia has taken a toll on profits of U.S. corporations in the second quarter of 1998 although the effects have fallen unevenly across a range of industries, analysts and fund managers said.
They added that the impact of Asia is not so severe as to hurt U.S. companies that are mainly focused on the domestic economy.
"I don't think it's going to be a big dent," said Michael Manns, a portfolio manager with the American Express Asset Management Group. But he said multi-nationals doing business in Asia have experienced revenue shortfalls and an erosion of operating margins. Before the problems began to unfold in Asia last year, Manns said, business in that part of the world generally meant superior profit margins.
Year-over-year earnings gains for stocks in the Standard & Poor's 500 index are expected to be about 2.5 percent when companies begin issuing quarterly reports in early July. The impact of the strike against General Motors Corp. is also contributing to the lackluster growth rate, analysts said.
Peter Canelo, U.S. equity strategist at Morgan Stanley Dean Witter, believes second quarter earnings will be a little better than people expect. For one thing, he said there is a lot of "low-balling" of numbers going around as companies try to position themselves to deliver a positive surprise when the numbers are reported.
Another positive ingredient in the background is a generally good domestic economy despite weakness in the energy sector, Canelo said. He attributed some problems in the computer industry to completion of a product cycle.
Manns said some sectors that should do well with second quarter earnings include retailers, companies specialising in the software end of the computer business, financial services, pharmaceuticals and consumer non-durables. The pharmaceuticals are benefitting from a robust round of new products, he said.
The energy sector is an example of an area where profits are being squeezed, Manns said. "Obviously the energy companies are not going to come through with stellar earnings this time around," he said. He said even integrated oil companies with "downstream" operations that benefit from lower raw materials prices will not be able to offset the weakness in the price of crude oil. Weakening commodity prices are also affecting industries such as chemicals, papers, metals and mining, Manss said.
Financial service stocks are expected to do well. Salomon Smith Barney analyst Henry Dickson said in a recent report that the median year-over-year increase in a large group of banks is expected to be 13 percent. Fee income and market-related revenue should be strong, the analyst wrote, offsetting compression in net interest margins.
Brokers and investment banks are expected to do well. Lehman Brothers Holdings Inc. , Morgan Stanley Dean Witter & Co. and privately-held Goldman, Sachs & Co. recently reported record earnings for three-month reporting periods ending in May.
Michael Metz, chief investment strategist at CIBC Oppenheimer, finds
that many investors seem to be shrugging off the second quarter with expectations that good times will return in the second half of 1998 and in 1999. "The market today is priced for perfection for the balance of this year and next year," he said
Metz believes the odds are that earnings will continue to be anaemic beyond the second quarter, reflecting not only Asia but excess capacity outside of Asia. "Capital spending growth will slow down not only in the Aisa but in the U.S. as well," he said.
He said the current lofty valuations of the stock market will come under pressure should the weakness in earnings persist.
The Dow Jones Industrial Average ended at 9,025 late Thursday, dropping 23 points for the day on the eve of a three-day break for the U.S. Independence Day holiday.
Analysts Say Slower U.S. Economy Shouldn't Hurt Canada
July 5, 1998
A cold wind is blowing through the U.S. economy, but analysts say it won't cause much more than a few ripples across Canada's economic waters.
The troubles in Asia are already hitting the United States, pushing up the jobless rate, hurting orders for manufactured goods and widening that country's trade deficit with Japan and other battered Asian countries. While a slowing U.S. economy will affect Canadian exports, it won't be enough to damage the robust Canadian domestic economy, which is headed for another year of strong growth and job creation, analysts say.
"Short of a big recession in the United States, I don't think a slowdown in the American economy is going to have a huge impact on growth in Canada," says Mario Angastiniotis, a senior economist at Standard and Poor's MMS in Toronto.
"Conditions remain fairly accommodative in Canada in terms of monetary policy, consumer confidence is still running at a decent level, and we're finally getting some good employment gains. That's going to help self-sustain the domestic side of the economy."
It's consumer spending fuelled by low interest rates that has propelled the construction, retail and auto industries and helped Canada produce 270,000 new jobs in 1997, with forecasts of another 350,000 this year.
"Canada right now has an expansion that's being driven by the domestic economy," says Rob Hoffman, an economist with Royal Bank of Canada.
"It's a made-in-Canada expansion, and our base case forecast is that the domestic economy will be driving the thing forward throughout this year."
Sherry Cooper, chief economist at brokerage Nesbitt Burns, expects the Canadian consumer to help keep the Canadian economy firing on all cylinders again this year. Even with slower export growth and troubles in the forestry sector caused by the Asian crisis, Canada's economy should post the strongest expansion of the G7 industrial countries in 1998, with a growth rate that could rival last year's 3.7 per cent.
"By the end of the year, Canada's jobless rate will be below eight per cent and it could well approach seven per cent by the end of next year," Cooper predicted in a recent report on the economy.
"Leading the pack will be the consumer," she continued. "Personal income is now rising sharply thanks to booming labor markets. Confidence levels have surged as jobs are easier to get, interest rates remain low and the stock market is up 10 per cent year-to-date. Provincial tax cuts have also added to the buoyancy."
South of the border, most analysts predict the U.S. economy will slow substantially over the next 18 months, with more modest growth. Instead of the sizzling 5.4 percent January - March growth rate in the gross domestic product, growth has slowed to about two per cent in the just-completed spring quarter and could stay at that level for the next year or so.
Some economists, however, are more pessimistic, and predict Asia will cause a U.S. recession either this year or next, largely because the troubled region's problems could spread to Russia, Latin America and other developing countries.
Most Canadian economists have forecast the Asian crisis will shave half a percentage point off Canada's growth this year, but that should still leave the economy expanding at between three and four per cent, "a healthy and quite solid growth rate," says Angastiniotis.
"Remember, economies don't turn on a dime," he says. "You don't get five-per-cent growth one quarter and one per cent the next."
On the export front, Cooper predicts Canada's trade surplus will likely fall to about $15 billion this year, down from $24.3 billion last year and a record $42 billion in 1996. That reflects weaker exports, but also strong import growth because of the surging Canadian domestic economy.
Angastiniotis says while trade growth to the United States has slowed, a weak Canadian dollar continues to help exporters shipping to the U.S. market. And while shipments to Asia have dropped sharply -- trade with Japan is down about 50 per cent from last year -- shipments to Europe are growing.
"You're getting some compensation here," he said. "There's weakness in Asia, but you're getting strength in Europe offsetting some of that, so it's not really a one-way picture of doom and gloom."
Canadians' Financial Health Better Than Expected, Says Bank
The financial health of Canadians may be better than expected despite falling family incomes for most of the last decade, says the Bank of Montreal.
A senior bank economist said Friday that measuring net worth instead of income provides a better indication of Canadians' finances. It could also help explain the surge in consumer spending that has helped the Canadian economy post solid gains in the last 18 months.
Since 1989, Canadians' household income has dropped by about one per cent, in part because of the impact of the 1991-92 recession and corporate restructuring as well as higher taxes. The income drop suggests a deterioration in household finances and has raised concerns about whether consumer spending can be sustained to help boost the domestic economy as the export sector weakens.
"Household net worth provides a more upbeat assessment of the financial situation," said Paul Ferley, the bank's assistant chief economist. Since 1989, Canadians' net worth -- the difference between household assets and liabilities -- has remained positive, rising an average of 1.3 per cent a year. A key difference between measuring income and net worth is that net worth captures the change in asset values such as capital gains while the income measure doesn't, the bank said.
The difference is significant because households have changed their savings pattern, said Terry Jackson, Bank of Montreal's executive vice-president of asset management.
"Consumers are shifting from bank deposits and other interest-bearing financial instruments to equities either directly or through mutual funds." Jackson said the per capita value of bank and other deposits in Canada has risen only 0.2 per cent a year since 1989, while growth in shares, including mutual funds, has jumped 5.8 per cent a year.
"Less reliance should be placed on measuring income and more emphasis placed on net worth to provide a clearer picture of people's finances and thus the likely trend in consumer spending," said Ferley.
This will become even more pronounced in the future as the baby boom generation moves into its retirement years and starts to withdraw funds from their RRSPs. Such withdrawal represents a drop in asset value and is not captured by the various income measures. However, these funds will be used to help finance consumer spending.
In Bull Market, Risk Doesn't Go Away
July 5, 1998
While investors in stocks and stock mutual funds are busy counting up the rewards they are reaping from a mighty bull market, they can easily lose track of the risks they are taking.
Sure, they know in an abstract sense that stocks can go down as well as up, that economic and interest-rate trends can turn unfriendly without warning -- and that many other things can go wrong in the turbulent world of the financial markets.
But in times like these, when the markets keep piling one strong year on top of another, it's hard to keep a clear appreciation of those hazards in your head.
The U.S. stock market averages, after racking up two-digit gains in 1995, 1996, and 1997, did it again in the first half of 1998. The Dow Jones industrial average climbed 13.2 per cent from New Year's through the end of June.
Canada's benchmark market indicator -- the TSE 300 composite index -- rose just under 10 per cent during the same period.
Elsewhere on Wall Street, Standard and Poor's 500-stock composite index jumped 16.84 per cent, and the Nasdaq composite index rode a revival of enthusiasm for technology stocks to a 20.66-per-cent gain. This sort of thing has occurred so regularly of late, it has come to seem like the predictable, reliable norm.
Tim Ferguson, senior managing director at Putnam Investments in Boston, suggested in a recent letter to investors in Putnam's large family of funds to be cautious.
"Reacquaint yourself with risk," he said. "If you have invested a good portion of your assets in the last five years and have seen consistent gains, it may feel as though risk has gone out of the market.
"In fact, the risk in your portfolio may have increased as the prices of the stocks in your portfolio have risen to new heights. Make sure you're not taking more risk than you want."
Notice that he didn't say anything about eliminating risk. The way the world of money works, that just isn't possible to do.
You can eliminate all apparent stock-market risk from your life by pulling all of your money out of stocks and stock funds, or never putting any of it there in the first place. But then you face the problem of where else to invest it.
And whatever you decide, you run the real risk that the alternative vehicle won't deliver as good a return. Cash buried in your backyard may be safe from obvious risks like stock market crashes. But it is left unprotected from inflation. And since it cannot grow in its hiding place, it also puts you at risk of not meeting future needs and goals such as amassing an adequate retirement nest egg.
But if risk cannot be avoided, it needs to be recognized and managed. "Make sure your portfolio is fully diversified," Ferguson said.
The alternative to diversifying among different types of stock investments, and beyond stocks to other asset classes like bonds and money-market securities, is trying to figure out what the Wall Street stock market is going to do next.
That job has many analysts right now even more puzzled than usual, if such a thing is possible.
"This market is a maze of contradictions and nonconfirmations," said Norman Fosback, editor of the newsletter Market Logic. "The transports are lagging far behind the industrials, the smaller-cap segment of the market has retreated ...
"Since last October, the average mutual fund has gained less than half as much as the S and P 500, an indication of poor breadth in the advance to new highs. A high level of caution is appropriate."
But anyone who takes too defensive a position risks missing opportunities that a good many optimists insist are still there.
Says Keith Mullins, who follows emerging growth stocks for the investment firm of Salomon Smith Barney: "It's my opinion that smaller cap growth stocks have reached a classic bottom, and are primed to beat the market over the next several months, fuelled by stronger earnings growth and rising valuations."
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