The Bull Market Weekly Advisory
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The Bull Market Weekly Advisory
MARKET COMMENTARY
(from February 3, 2003)
THE BIG PICTURE -- WHAT'S HAPPENING OUT THERE?
MARKET UPDATE
Although Friday was a positive day for the Dow and the S&P 500, both up about 1%, the three major indices lost ground for the week. Moreover, the Nasdaq joined the Dow and S&P in negative year-to-date territory. Since slicing through the October lows several days ago, the market is in the process of establishing a new trading range. The likely bottom of the range is the October low, or 768 for the S&P 500, with the December low of 870 the likely top.
The economic goodies in the President's State of the Union address might have stimulated stock prices last week were it not for the probable declaration of war with Iraq. War could happen by early March, since the weather works against a later attack despite the administration's insistence that our forces can fight year-round in the desert. That means another month of uncertainty, which will continue to undermine any positive market momentum.
However, a positive economic new is unlikely for now. We have reviewed many of the negatives in the U.S. economy in past columns. And, foreign markets won't provide much help for stock prices either. Europe's economy is in worse shape than ours, with Germany -- Europe's largest market -- providing the biggest drag. Europe's January manufacturing numbers will be announced on Monday and should show continued contraction. Tuesday could provide additional dismal news for a European recovery when December labor figures are issued.
Nonexistent growth and weak labor markets mean that Europe won't take up leadership of the global economy. That is still up the United States. U.S. consumer spending is keeping the economy somewhat buoyed, but without eventual help from corporate capital spending we won't lead the way either.
So, we remain pessimistic about the near-term future of the market at The MoneyFlow Weekly. And we remain content to stay primarily SHORT in this market.
MARKET OVERVIEW
MARKET DOESN'T PROFIT IN THE LATEST WEEK
It wasn't a good week for investors, as war jitters and mixed economic news took the market for a loss. After falling below the 8000 barrier last week, the Dow made it back above the mark on Monday. However, the blue-chip index lost its gains throughout the rest of the week and once again ended below the 8000 level. For the week, the Dow dropped 2.3%, the S&P 500 fell 3.0%, and the Nasdaq posted a 2.9% decline.
Earnings season is still in full swing, but economic and geopolitical news were the big issues weighing on the minds of investors. The data painted a mixed picture of the struggling economy. The Institute for Supply Management came out with the latest readings from its manufacturing and non-manufacturing indices. Though both remained above the 50% level (which indicates an expansion in the sector), manufacturing activity slowed its improvement in December.
Productivity fell in the latest quarter from its breakneck pace in the previous period. It was the largest productivity decline since early 2001. However, productivity for the full year was at its highest level in over 50 years. And the future direction of the job market is also uncertain. The jobless rate posted an unexpected drop on Friday, and companies added the most jobs since November 2000. But these numbers were misleading, as seasonal factors skewed the figures. Most of Corporate America looks to be holding off from adding to their payrolls until the economy improves.
Geopolitical concerns were the other big issue this week. Secretary of State Colin Powell started things off on Wednesday with his speech to the United Nations. The Secretary provided the U.N. with what he referred to as "irrefutable and undeniable" evidence of Iraq's disregard for the disarmament resolution. Powell urged the U.N. to consider taking military action against Iraq.
Friday, things heated up when the Bush administration raised the national terror level from yellow to orange, the second-highest warning level on the scale. Attorney General John Ashcroft cautioned the country that lightly-guarded buildings like apartment complexes and hotels could be in danger of terrorist attack.
All of this negativity dragging stocks into the doldrums, and we're not seeing investors taking their focus away from these situations any time soon. In fact, as earnings season comes to a close the market will pay even more attention to non-corporate news. The chances for a prolonged rally are getting smaller and smaller every day.
ECONOMY WATCH
1. MANUFACTURING ACTIVITY INCREASES
The Institute for Supply Management released its latest business index reading. The index fell from 55.2% to 53.9% in December, reflecting a slower improvement in manufacturing activity. Still, the number remained above 50%, so factory activity is expanding. The reading matched economists' expectations. Once again, this is a mixed signal about the economy's potential recovery.
2. FACTORY ORDERS RISE
A day after the Institute for Supply Management's index showed an increase in factory activity in December, the Commerce Department reported that factory orders rose 0.4% to $320 billion. As has been the case with all of the latest economic indicators, government spending led the way. Civilian aircraft orders surged 22% to $6.9 billion. But the 4Q rise wasn't enough to boost orders to a gain for the full year, as they fell 0.8% from 2001's levels. Government spending is carrying the Manufacturing sector right now, but it can only do so much before needing help from other areas.
3. SERVICES SECTOR RISES
The Institute for Supply Management released its non-manufacturing index reading for January. The index rose slightly, from 54.2% to 54.5% in the latest month. As with the manufacturing index, the reading remained above 50%, signaling an expansion in the sector. This report was more upbeat than the manufacturing one, as the index rose in addition to staying above the 50% barrier. The manufacturing index fell from the month before but stayed above 50%, as we reported Monday.
4. PRODUCTIVITY FALLS IN THE FOURTH QUARTER
The Labor Department reported that U.S. productivity fell 0.2% at an annual rate in the fourth quarter of last year. That's the largest drop since a 1.4% slide in 1Q01. Economists expected a 0.5% gain in productivity for the quarter. In contrast, 3Q productivity rose 5.5%. The final tally for 2002 productivity was 4.7%, the biggest gain since 1950. Comparatively, productivity rose 1.1% in the year before. For 2003, economists expect productivity to rise 3%, with a 1Q annual rate of 3.5%.
5. JOBLESS RATE FALLS
The U.S. unemployment rate fell to 5.7% in January, according to the Labor Department, after rising to an eight-year high of 6% in the prior month. The improvement surprised economists, who expected the rate to remain at its previous level. Additionally, businesses added over 140,000 jobs last month, the most since November 2000. Over 100,000 of those jobs came in the Retail sector, more than making up for the industry's losses in December. Still, seasonal factors likely muddled the numbers for the past two months, so the job increase isn't an accurate reflection of the current hiring environment. Overall, data from the last few months suggest a flat job market.
IN THE NEWS
I. MATTEL TOYS WITH EARNINGS
MATTEL (MAT, $21, up 1) on Monday reported a 35% increase in earnings for the fourth quarter of last year. The toy maker achieved net income of $185 million, or 42 cents per share, vs. a profit of $140 million, or 31 cents a share, a year ago. Excluding one-time items, Mattel earned 43 cents, easily topping estimates for a 38-cent profit. Sales of boys toys fell 3% year-over-year, as gains in sales from Hot Wheels and Matchbox toy cars couldn't overcome weakness in Tyco and Harry Potter revenue. Girls products fared much better, with sales of Barbie dolls rising 17% from the year-ago quarter. Overall, sales rose 10% to $840 million for the quarter. But Mattel acknowledged the tough business market that lies ahead this year.
This is quite a different story than the one from FAO Schwarz, which recently filed for bankruptcy.
II. WENDY'S EATS EXPECTATIONS
WENDY'S INTERNATIONAL (WEN, $25, down 2) posted a 9% rise in earnings when it released its 4Q02 financial results on Friday of last week. The fast-food chain reported net income of $50 million, or 44 cents a share, vs. a year-ago profit of $45 million. The results met the Street's estimates. Revenue increased 11% to $2.4 billion, while comparable-store sales rose 1% at Wendy's U.S. restaurants and 3% at its franchised outlets for the quarter. The nation's #3 hamburger chain raised its profits by offering an expanded menu of healthier choices, such as salads, and staying out of the price war between market leader MCDONALD'S (MCD, $13.55, down 0.29) and #2 chain Burger King. However, the company issued 2003 earnings growth projections of 7-10%, down from its long-term goal of 12-15% annual expansion. Earlier last week, McDonald's reported the first quarterly loss in its history, as its Dollar Menu offerings lowered profits.
III. U.S. AIRWAYS EARNINGS TAKE A DIVE
U.S. Airways Group became the latest airline carrier to report earnings, releasing its 4Q02 financial results Monday afternoon. The company posted a net loss (surprise, surprise) of $795 million, or $11.67 a share. Even excluding one-time charges, the company still would have lost $295 million. However, the firm actually narrowed its $1.2 billion loss in the year-ago quarter. The company's CEO summed up the prospects of the Airline industry, saying, "Our disappointing results reflect an industry that continues to operate in uncertain economic times with weak passenger demand, escalating fuel prices, and the threat of war." Fuel costs rose 9% for the quarter, while price competition cut the firm's monthly revenue by $10 million. The Airline industry is still reeling from the effects of the weak economy, and don't expect all of the existing companies to make it through this troubled time.
IV. SPRINTING TO A PROFIT
Sprint turned a loss into a profit in the fourth quarter of 2002, the firm reported Wednesday. The company's long distance and local phone business, FON GROUP (FON, $12.05, down 0.09) earned 28 cents a share, compared to a loss of $1.06 in the year-ago quarter. Revenue, however, fell from $3.9 billion to $3.7 billion. Sprint's wireless unit, SPRINT PCS (PCS, $3.91, down 0.15), continued to lose money, posting a 25-cent loss after a 32-cent loss in 4Q01. Overall, Sprint earned $39 million for the quarter, up from a $1.23 billion loss a year ago. Consolidated revenue rose slightly, from $6.52 billion to $6.53 billion. The company stood by its guidance for FON Group earnings of $1.40-1.45 this year. Earnings were up even though revenue was flat: This is another example of a company posting higher earnings on the back of extensive cost-cutting.
V. ELECTRONIC DATA SYSTEMS (EDS, $16.49, down 0.46) posted a fall in quarterly profits after the bell Thursday. The company reported 4Q02 net income of $360 million, or 75 cents a share, vs. a $405 million profit in the year-ago quarter. Revenue also slipped in the period, from $5.8 billion to $5.5 billion. Excluding one-time items, the firm earned 51 cents, beating expectations for a 48-cent profit. However, the firm slashed its outlook for the current quarter and year. The company now expects to earn 30-35 cents in the first quarter and $1.90 for all of 2003. It's this kind of "guarded view" -- in the words of the firm's CEO -- that keeps us away from EDS and other Tech firms.
VI. JOHNSON & JOHNSON IN TALKS TO BUY BIOTECH
JOHNSON & JOHNSON (JNJ, $52, down 2) is in talks to acquire biotech firm SCIOS (SCIO, $42, up 9). J&J could pay as much as $2 billion for the company, which currently has a heart failure drug, Natrecor, on the market and is developing a treatment for arthritis. Natrecor, which had $95 million in revenue last year, could produce sales of $700 million in 2007. The drug, used to treat congestive heart failure, would complement J&J's current angina treatment, ReoPro. This would be the first major deal between a pharmaceutical company and a biotech firm since BRISTOL-MYERS SQUIBB (BMY, $23, down 1) took a $2 billion stake in IMCLONE SYSTEMS (IMCL, $9.39, up 0.13). Nothing's set in stone yet, but we think that this deal will go through.
VII. GOODYEAR'S DIVIDEND GOES FLAT
GOODYEAR TIRE (GT, $4.04, down 1.26) decided to eliminate its quarterly dividend. The company lowered its dividend in October 2001 from 30 cents to 12 cents/quarter. Recent financial troubles, however, caused the firm to get rid of it completely. On the announcement, the stock dropped 15%. The move is expected to increase the company's cash flow by $85 million per year. Analysts predict that Goodyear will report break-even results for 2002 after losing over $200 million in 2001.
VIII. RETAIL SALES ROUNDUP
A number of retailers reported their January sales figures on Thursday, including #1 retailer WAL-MART (WMT, $47, down 1). The discount chain said that same-store sales (sales at stores open for at least a year) rose 2.3% in the month, at the low end of previous 2-4% sales growth guidance and far below the 8.5% gain experienced in January 2002. However, the company backed its forecast for full-year earnings of $1.80 a share, 2 cents above the consensus estimate.
Elsewhere, TARGET (TGT, $27, down 1) reported a same-store sales decline of 0.4%. The number missed estimates for a 0-2% sales increase. Still, total sales rose 7.7% year-over-year and earnings are expected to remain on track due to improving margins. The company experienced lagging demand for its men's apparel and sporting goods.
COSTCO WHOLESALE (COST, $29, unch.) experienced the best month of the three, reporting a 5% jump in same-store sales. Total sales rose from $2.7 billion in January 2002 to $3 billion last month, as the firm overcame stiff competition from Wal-Mart's Sam's Club stores and BJ'S WHOLESALE (BJ, $14.17, down 1.23). The company remains on track to hit previously-lowered earnings estimates.
Though these numbers are a little slack, we're not worried. January typically is a slow month, as retailers put huge discounts on leftover holiday merchandise in order to clear shelf space for spring products. We would like to see Target improve sales at its department store chains, but overall we're confident that business will recover this year. Discount is the way to go when the economy's in the dumps.
IX. TREASURY BRINGS THE 3-YEAR BACK
As the government is faced with rising budget deficits, the Treasury Department announced that it will bring back the 3-year Treasury note, currently on a five-year hiatus. Also, the Treasury will increase its offerings of the 5-year note, selling them eight times a year instead of the normal four. There are no plans as of now to issue new 30-year Treasury bonds. Note that the country's debt is on track to reach its ceiling of $6.4 trillion on February 20, and Congress WILL HAVE TO increase the debt ceiling before then or the government will shut down, like it did in 1995. The Bush administration expects the deficit to hit $304 billion this year and $307 billion in fiscal 2004. [And governments are ALWAYS low in their estimates.]
It is our very strong opinion that this news is VERY BAD for our economy and the stock market. We have written many times that investors like fiscal responsibility, and conversely, dislike deficits. You cannot run a small business with $1 million of revenue and $1.1 million of expenses. You cannot survive. And this is what we are doing. It is our strong opinion that the budget deficits will ultimately hurt the economy and the stock market. Buyer beware. [Gosh, I hope I'm wrong!]
1. SECTOR-RELATED NEWS
TECHNOLOGY
CISCO BEATS ESTIMATES BUT EXPECTS LOWER SALES
CISCO SYSTEMS (CSCO, $12.85, down 0.52) came out with earnings after the bell Tuesday. The Networking equipment firm earned fiscal 2Q (ended January 25) net income of $990 million, or 14 cents per share, vs. a $660 million, 9 cent per-share profit in the year-ago quarter. Excluding one-time items, the firm earned 15 cents, topping estimates by 2 cents. However, revenue slipped from $4.8 billion in both the year-ago period and the previous quarter to $4.7 billion.
TODD'S TAKE: Tech investors held their breath as Cisco released its fiscal 2Q earnings. What they got was another one of those "past was good, future looks bad" reports. Sure, Cisco beat estimates by a couple of pennies, but the real news was that the company experienced a decline in revenue.
What's more, Cisco expects sales to be flat at best in its fiscal third quarter (ending April 26). In fact, revenue could drop 2-3% year-over-year.
Comments from Cisco's CEO, John Chambers, supported a discouraging outlook for this year. The chief executive confirmed that geopolitical tension caused a "dampening effect" on the economy, as corporate customers practiced even more spending thrift. Customers had "even more conservative attitudes from executives than we heard a quarter ago," he said. Where corporate spending goes, Cisco follows. And, the Tech sector is right behind the firm. With this kind of gloomy outlook, it's not looking good.
Some analysts point to Cisco's improvement in gross margins as a source of optimism. The firm increased its gross margin slightly in the second quarter, from 69.3% to 70.4%. That just means that Cisco was effective in cutting costs. Good for Cisco, yes. But it means nothing for the rest of the Tech sector, since it's not certain that other companies can enact cost-cutting as effective as Cisco's efforts. You can only cut costs for so long before there's nothing left to cut, and making your business smaller isn't exactly what investors are looking for from a high-growth Tech firm. In fact, Cisco expects gross margins to fall next quarter to 68-70%, so even its cost-cutting is beginning to falter.
Cisco's latest earnings report convinces us even more that the Tech sector will struggle again this year. And with corporate spending expected to remain in the doldrums, a Tech recovery is far over the horizon. We don't recommend any Tech stocks right now.
INSURANCE
RESERVES COULD BE A PROBLEM FOR MORE THAN AIG
Admission from AMERICAN INTERNATIONAL GROUP (AIG, $47, down 7) that it had underfunded its reserves for old claims by $3.5 billion has hurt the insurer's stock -- and it bodes ill for the company's rivals. AIG blamed its reserve shortfall on rising medical insurance claims, an increase in shareholder lawsuits against U.S. corporate executives, and excessive court awards. All insurance companies, including leading firms like ST. PAUL (SPC, $30, down 3) and CHUBB (CB, $49, down 5), face these same problems, though none had the reputation for preparing for them as well as AIG.
TODD'S TAKE: Post September 11, rate hikes became one of the hottest topics in the insurance business. And this had insurers talking about rising profits. Eighteen months later AIG has moved on to a new, less appealing topic: Explaining that a good portion of those profits are going to cover underfunded reserve positions. You should expect many other insurers to join the conversation.
In the mid to long term, we expect the Bush administration to produce some remedies. These likely will come in the form of legal reforms that limit court awards in areas such as worker's compensation. Short-term, however, the industry could take a tough hit, as too many in the business joined in cutthroat price wars in the mid-1990s. Those claims, without the reserves to cover them, are now popping up. It is just a matter of time before some of these companies own up to it, as AIG has.
In many ways AIG's competitors have a tougher time ahead. They cut premiums more aggressively in the past, and few if any can match the expertise AIG puts into its insurance operations. Looking ahead, their shortfalls could be much greater. Be careful in this sector.
For its part, AIG won't move on unscathed. The firm's reputation for astute and assiduous attention to detail earned it a premium valuation compared to its rivals. This calculation undermines that reputation, and that premium valuation now means that its stock could drop a long way to fall in line with rivals.
We're eager for more info, but the firm is pretty tight-lipped with guidance. It did state that insurance losses would grow $4-5 billion in 2003 (bad news), but that it won't slow its insurance rate increases (good news). We'll watch this stock closely between now and February 13, the day it reports 4Q earnings.
GOLD
ON SCHEDULE, NEWMONT REMAINS TOP GOLD CHOICE
The highly touted benefits of two major acquisitions made by NEWMONT MINING (NEM, $28, down 1) last year are coming to fruition, according to the company's chief executive. The firm's purchase of Normandy Mining has given Newmont a strong toehold in Australia, and its acquisition of cash-loaded Franco Nevada has helped the firm reduce debt. Newmont announced that its integration process is ahead of schedule, with over $220 million worth of assets sold and its acquired hedge-book substantially reduced in size.
Now the world's largest gold mining company, Newmont is working with a larger budget, the world's largest mining land base, and the highest gold price in about six years. The firm has set out in 2003 to boost its reserves (which at the end of 2002 totaled 83 million ounces), to bring more of its assets closer to production, and to further reduce the amount of gold it holds in a hedged position.
TODD'S TAKE: Gold has been a warm topic over the past year, and in all the discussions Newmont's name comes up. This is not just because it is a gold giant that cannot be ignored, but also because it is a QUALITY gold giant.
As noted above, those qualities are coming home to roost. But we think that the "warm" gold topic is set to become very hot in 2003, and Newmont will benefit further.
By most metrics the U.S. economy and stock market are facing another difficult year. (The same can be said for the global economy and stock markets.) The gloom is pervaded by worries that things could grow worse. When we throw a war (whether real or simply an ongoing threat) onto the heap of trouble, things get ugly. People are losing confidence in the U.S. dollar. They are seeking safety, and the price of gold is rising. If it continues to rise and the global problems persist, then watch out. It doesn't matter whether gold is at $400 an ounce or $500; if investors are worried that their assets are about to drop in value -- and take note that Asia in general is VERY heavily weighted on the U.S. dollar -- they will move to preserve their wealth no matter what. That means more demand for gold.
This is the market Newmont is operating in, the market that justifies its high PE. (Gold stocks typically trade at higher PEs than most stocks.) Newmont is the world's largest gold producer, and its focus on non-hedged selling means that it will sell its gold at market prices, fully benefiting from the rising price of gold.
We feel that aggressive investors have plenty of opportunity to profit from Newmont stock at its current levels. We expect great gains from the stock this year.
PROFITS
4Q PROFITS ARE UP -- OR ARE THEY?
TODD'S TAKE: Earnings results from the fourth quarter of 2002 looked generally positive in the aggregate, which may make one believe the economy is on its way to a quick recovery. That, however, may be too hasty of a conclusion and a bit of wishful thinking on the part of the economists that predict such things.
Profits may be up, but why? It's certainly not due to the strong economy and consumer confidence. The economy and business conditions in general remain weak. Profits may have been up for the quarter, but by and large this wasn't due to significant increases in sales, which are up only slightly compared to profits. The increase in GDP slowed to an anemic 0.7% annual rate during the quarter, compared to a 4% rate for the third quarter. The deceleration in growth was attributable to a sharp downturn in personal consumption expenditures and downturns in inventory investments, according to the Bureau of Economic Analysis.
A major reason for better profits last quarter is that corporations, realizing that sales are going to remain flat in the short term, are focusing their efforts on cost-cutting. Corporations are wringing more profit out of the same number of dollars by cutting jobs, putting tight limits over capital spending, abandoning major projects, and keeping tight control over inventories. Companies started buckling down last year, and now they are reaping the benefit of their lean-and-mean initiatives. Investors realize where corporate profits are coming from, and stock prices reflect this overall, with the Dow closing out 4Q02 still significantly lower than 4Q01.
The fourth quarter also saw some major dotcoms taking their first profits, which caused some undue optimism in the tech marketplace. The pseudo-charge was led by AMAZON (AMZN, $21, down 1) making its second consecutive profit. That sounds like great news, until you take into account the fact that the company's very slim profit was actually less than its benefit from foreign exchange. If the euro had gone a point or two in the other direction, it would have been a return to losses for Amazon.
As far as corporate earnings are concerned. one major reason for the positive comparative increase is what the latest earnings are being compared to. In 4Q01, earnings were down significantly (over 50% in general) over 2000, not only because of the slowing economy but because of the after-effects of September 11 that caused 4Q01 earnings to dive. 4Q02 results may be up significantly over the prior year's, but that's not saying much considering that 4Q01 was such a poor quarter.
So just remember to take these earnings with a grain of salt.
(from February 3, 2003)
THE BIG PICTURE -- WHAT'S HAPPENING OUT THERE?
MARKET UPDATE
Although Friday was a positive day for the Dow and the S&P 500, both up about 1%, the three major indices lost ground for the week. Moreover, the Nasdaq joined the Dow and S&P in negative year-to-date territory. Since slicing through the October lows several days ago, the market is in the process of establishing a new trading range. The likely bottom of the range is the October low, or 768 for the S&P 500, with the December low of 870 the likely top.
The economic goodies in the President's State of the Union address might have stimulated stock prices last week were it not for the probable declaration of war with Iraq. War could happen by early March, since the weather works against a later attack despite the administration's insistence that our forces can fight year-round in the desert. That means another month of uncertainty, which will continue to undermine any positive market momentum.
However, a positive economic new is unlikely for now. We have reviewed many of the negatives in the U.S. economy in past columns. And, foreign markets won't provide much help for stock prices either. Europe's economy is in worse shape than ours, with Germany -- Europe's largest market -- providing the biggest drag. Europe's January manufacturing numbers will be announced on Monday and should show continued contraction. Tuesday could provide additional dismal news for a European recovery when December labor figures are issued.
Nonexistent growth and weak labor markets mean that Europe won't take up leadership of the global economy. That is still up the United States. U.S. consumer spending is keeping the economy somewhat buoyed, but without eventual help from corporate capital spending we won't lead the way either.
So, we remain pessimistic about the near-term future of the market at The MoneyFlow Weekly. And we remain content to stay primarily SHORT in this market.
MARKET OVERVIEW
MARKET DOESN'T PROFIT IN THE LATEST WEEK
It wasn't a good week for investors, as war jitters and mixed economic news took the market for a loss. After falling below the 8000 barrier last week, the Dow made it back above the mark on Monday. However, the blue-chip index lost its gains throughout the rest of the week and once again ended below the 8000 level. For the week, the Dow dropped 2.3%, the S&P 500 fell 3.0%, and the Nasdaq posted a 2.9% decline.
Earnings season is still in full swing, but economic and geopolitical news were the big issues weighing on the minds of investors. The data painted a mixed picture of the struggling economy. The Institute for Supply Management came out with the latest readings from its manufacturing and non-manufacturing indices. Though both remained above the 50% level (which indicates an expansion in the sector), manufacturing activity slowed its improvement in December.
Productivity fell in the latest quarter from its breakneck pace in the previous period. It was the largest productivity decline since early 2001. However, productivity for the full year was at its highest level in over 50 years. And the future direction of the job market is also uncertain. The jobless rate posted an unexpected drop on Friday, and companies added the most jobs since November 2000. But these numbers were misleading, as seasonal factors skewed the figures. Most of Corporate America looks to be holding off from adding to their payrolls until the economy improves.
Geopolitical concerns were the other big issue this week. Secretary of State Colin Powell started things off on Wednesday with his speech to the United Nations. The Secretary provided the U.N. with what he referred to as "irrefutable and undeniable" evidence of Iraq's disregard for the disarmament resolution. Powell urged the U.N. to consider taking military action against Iraq.
Friday, things heated up when the Bush administration raised the national terror level from yellow to orange, the second-highest warning level on the scale. Attorney General John Ashcroft cautioned the country that lightly-guarded buildings like apartment complexes and hotels could be in danger of terrorist attack.
All of this negativity dragging stocks into the doldrums, and we're not seeing investors taking their focus away from these situations any time soon. In fact, as earnings season comes to a close the market will pay even more attention to non-corporate news. The chances for a prolonged rally are getting smaller and smaller every day.
ECONOMY WATCH
1. MANUFACTURING ACTIVITY INCREASES
The Institute for Supply Management released its latest business index reading. The index fell from 55.2% to 53.9% in December, reflecting a slower improvement in manufacturing activity. Still, the number remained above 50%, so factory activity is expanding. The reading matched economists' expectations. Once again, this is a mixed signal about the economy's potential recovery.
2. FACTORY ORDERS RISE
A day after the Institute for Supply Management's index showed an increase in factory activity in December, the Commerce Department reported that factory orders rose 0.4% to $320 billion. As has been the case with all of the latest economic indicators, government spending led the way. Civilian aircraft orders surged 22% to $6.9 billion. But the 4Q rise wasn't enough to boost orders to a gain for the full year, as they fell 0.8% from 2001's levels. Government spending is carrying the Manufacturing sector right now, but it can only do so much before needing help from other areas.
3. SERVICES SECTOR RISES
The Institute for Supply Management released its non-manufacturing index reading for January. The index rose slightly, from 54.2% to 54.5% in the latest month. As with the manufacturing index, the reading remained above 50%, signaling an expansion in the sector. This report was more upbeat than the manufacturing one, as the index rose in addition to staying above the 50% barrier. The manufacturing index fell from the month before but stayed above 50%, as we reported Monday.
4. PRODUCTIVITY FALLS IN THE FOURTH QUARTER
The Labor Department reported that U.S. productivity fell 0.2% at an annual rate in the fourth quarter of last year. That's the largest drop since a 1.4% slide in 1Q01. Economists expected a 0.5% gain in productivity for the quarter. In contrast, 3Q productivity rose 5.5%. The final tally for 2002 productivity was 4.7%, the biggest gain since 1950. Comparatively, productivity rose 1.1% in the year before. For 2003, economists expect productivity to rise 3%, with a 1Q annual rate of 3.5%.
5. JOBLESS RATE FALLS
The U.S. unemployment rate fell to 5.7% in January, according to the Labor Department, after rising to an eight-year high of 6% in the prior month. The improvement surprised economists, who expected the rate to remain at its previous level. Additionally, businesses added over 140,000 jobs last month, the most since November 2000. Over 100,000 of those jobs came in the Retail sector, more than making up for the industry's losses in December. Still, seasonal factors likely muddled the numbers for the past two months, so the job increase isn't an accurate reflection of the current hiring environment. Overall, data from the last few months suggest a flat job market.
IN THE NEWS
I. MATTEL TOYS WITH EARNINGS
MATTEL (MAT, $21, up 1) on Monday reported a 35% increase in earnings for the fourth quarter of last year. The toy maker achieved net income of $185 million, or 42 cents per share, vs. a profit of $140 million, or 31 cents a share, a year ago. Excluding one-time items, Mattel earned 43 cents, easily topping estimates for a 38-cent profit. Sales of boys toys fell 3% year-over-year, as gains in sales from Hot Wheels and Matchbox toy cars couldn't overcome weakness in Tyco and Harry Potter revenue. Girls products fared much better, with sales of Barbie dolls rising 17% from the year-ago quarter. Overall, sales rose 10% to $840 million for the quarter. But Mattel acknowledged the tough business market that lies ahead this year.
This is quite a different story than the one from FAO Schwarz, which recently filed for bankruptcy.
II. WENDY'S EATS EXPECTATIONS
WENDY'S INTERNATIONAL (WEN, $25, down 2) posted a 9% rise in earnings when it released its 4Q02 financial results on Friday of last week. The fast-food chain reported net income of $50 million, or 44 cents a share, vs. a year-ago profit of $45 million. The results met the Street's estimates. Revenue increased 11% to $2.4 billion, while comparable-store sales rose 1% at Wendy's U.S. restaurants and 3% at its franchised outlets for the quarter. The nation's #3 hamburger chain raised its profits by offering an expanded menu of healthier choices, such as salads, and staying out of the price war between market leader MCDONALD'S (MCD, $13.55, down 0.29) and #2 chain Burger King. However, the company issued 2003 earnings growth projections of 7-10%, down from its long-term goal of 12-15% annual expansion. Earlier last week, McDonald's reported the first quarterly loss in its history, as its Dollar Menu offerings lowered profits.
III. U.S. AIRWAYS EARNINGS TAKE A DIVE
U.S. Airways Group became the latest airline carrier to report earnings, releasing its 4Q02 financial results Monday afternoon. The company posted a net loss (surprise, surprise) of $795 million, or $11.67 a share. Even excluding one-time charges, the company still would have lost $295 million. However, the firm actually narrowed its $1.2 billion loss in the year-ago quarter. The company's CEO summed up the prospects of the Airline industry, saying, "Our disappointing results reflect an industry that continues to operate in uncertain economic times with weak passenger demand, escalating fuel prices, and the threat of war." Fuel costs rose 9% for the quarter, while price competition cut the firm's monthly revenue by $10 million. The Airline industry is still reeling from the effects of the weak economy, and don't expect all of the existing companies to make it through this troubled time.
IV. SPRINTING TO A PROFIT
Sprint turned a loss into a profit in the fourth quarter of 2002, the firm reported Wednesday. The company's long distance and local phone business, FON GROUP (FON, $12.05, down 0.09) earned 28 cents a share, compared to a loss of $1.06 in the year-ago quarter. Revenue, however, fell from $3.9 billion to $3.7 billion. Sprint's wireless unit, SPRINT PCS (PCS, $3.91, down 0.15), continued to lose money, posting a 25-cent loss after a 32-cent loss in 4Q01. Overall, Sprint earned $39 million for the quarter, up from a $1.23 billion loss a year ago. Consolidated revenue rose slightly, from $6.52 billion to $6.53 billion. The company stood by its guidance for FON Group earnings of $1.40-1.45 this year. Earnings were up even though revenue was flat: This is another example of a company posting higher earnings on the back of extensive cost-cutting.
V. ELECTRONIC DATA SYSTEMS (EDS, $16.49, down 0.46) posted a fall in quarterly profits after the bell Thursday. The company reported 4Q02 net income of $360 million, or 75 cents a share, vs. a $405 million profit in the year-ago quarter. Revenue also slipped in the period, from $5.8 billion to $5.5 billion. Excluding one-time items, the firm earned 51 cents, beating expectations for a 48-cent profit. However, the firm slashed its outlook for the current quarter and year. The company now expects to earn 30-35 cents in the first quarter and $1.90 for all of 2003. It's this kind of "guarded view" -- in the words of the firm's CEO -- that keeps us away from EDS and other Tech firms.
VI. JOHNSON & JOHNSON IN TALKS TO BUY BIOTECH
JOHNSON & JOHNSON (JNJ, $52, down 2) is in talks to acquire biotech firm SCIOS (SCIO, $42, up 9). J&J could pay as much as $2 billion for the company, which currently has a heart failure drug, Natrecor, on the market and is developing a treatment for arthritis. Natrecor, which had $95 million in revenue last year, could produce sales of $700 million in 2007. The drug, used to treat congestive heart failure, would complement J&J's current angina treatment, ReoPro. This would be the first major deal between a pharmaceutical company and a biotech firm since BRISTOL-MYERS SQUIBB (BMY, $23, down 1) took a $2 billion stake in IMCLONE SYSTEMS (IMCL, $9.39, up 0.13). Nothing's set in stone yet, but we think that this deal will go through.
VII. GOODYEAR'S DIVIDEND GOES FLAT
GOODYEAR TIRE (GT, $4.04, down 1.26) decided to eliminate its quarterly dividend. The company lowered its dividend in October 2001 from 30 cents to 12 cents/quarter. Recent financial troubles, however, caused the firm to get rid of it completely. On the announcement, the stock dropped 15%. The move is expected to increase the company's cash flow by $85 million per year. Analysts predict that Goodyear will report break-even results for 2002 after losing over $200 million in 2001.
VIII. RETAIL SALES ROUNDUP
A number of retailers reported their January sales figures on Thursday, including #1 retailer WAL-MART (WMT, $47, down 1). The discount chain said that same-store sales (sales at stores open for at least a year) rose 2.3% in the month, at the low end of previous 2-4% sales growth guidance and far below the 8.5% gain experienced in January 2002. However, the company backed its forecast for full-year earnings of $1.80 a share, 2 cents above the consensus estimate.
Elsewhere, TARGET (TGT, $27, down 1) reported a same-store sales decline of 0.4%. The number missed estimates for a 0-2% sales increase. Still, total sales rose 7.7% year-over-year and earnings are expected to remain on track due to improving margins. The company experienced lagging demand for its men's apparel and sporting goods.
COSTCO WHOLESALE (COST, $29, unch.) experienced the best month of the three, reporting a 5% jump in same-store sales. Total sales rose from $2.7 billion in January 2002 to $3 billion last month, as the firm overcame stiff competition from Wal-Mart's Sam's Club stores and BJ'S WHOLESALE (BJ, $14.17, down 1.23). The company remains on track to hit previously-lowered earnings estimates.
Though these numbers are a little slack, we're not worried. January typically is a slow month, as retailers put huge discounts on leftover holiday merchandise in order to clear shelf space for spring products. We would like to see Target improve sales at its department store chains, but overall we're confident that business will recover this year. Discount is the way to go when the economy's in the dumps.
IX. TREASURY BRINGS THE 3-YEAR BACK
As the government is faced with rising budget deficits, the Treasury Department announced that it will bring back the 3-year Treasury note, currently on a five-year hiatus. Also, the Treasury will increase its offerings of the 5-year note, selling them eight times a year instead of the normal four. There are no plans as of now to issue new 30-year Treasury bonds. Note that the country's debt is on track to reach its ceiling of $6.4 trillion on February 20, and Congress WILL HAVE TO increase the debt ceiling before then or the government will shut down, like it did in 1995. The Bush administration expects the deficit to hit $304 billion this year and $307 billion in fiscal 2004. [And governments are ALWAYS low in their estimates.]
It is our very strong opinion that this news is VERY BAD for our economy and the stock market. We have written many times that investors like fiscal responsibility, and conversely, dislike deficits. You cannot run a small business with $1 million of revenue and $1.1 million of expenses. You cannot survive. And this is what we are doing. It is our strong opinion that the budget deficits will ultimately hurt the economy and the stock market. Buyer beware. [Gosh, I hope I'm wrong!]
1. SECTOR-RELATED NEWS
TECHNOLOGY
CISCO BEATS ESTIMATES BUT EXPECTS LOWER SALES
CISCO SYSTEMS (CSCO, $12.85, down 0.52) came out with earnings after the bell Tuesday. The Networking equipment firm earned fiscal 2Q (ended January 25) net income of $990 million, or 14 cents per share, vs. a $660 million, 9 cent per-share profit in the year-ago quarter. Excluding one-time items, the firm earned 15 cents, topping estimates by 2 cents. However, revenue slipped from $4.8 billion in both the year-ago period and the previous quarter to $4.7 billion.
TODD'S TAKE: Tech investors held their breath as Cisco released its fiscal 2Q earnings. What they got was another one of those "past was good, future looks bad" reports. Sure, Cisco beat estimates by a couple of pennies, but the real news was that the company experienced a decline in revenue.
What's more, Cisco expects sales to be flat at best in its fiscal third quarter (ending April 26). In fact, revenue could drop 2-3% year-over-year.
Comments from Cisco's CEO, John Chambers, supported a discouraging outlook for this year. The chief executive confirmed that geopolitical tension caused a "dampening effect" on the economy, as corporate customers practiced even more spending thrift. Customers had "even more conservative attitudes from executives than we heard a quarter ago," he said. Where corporate spending goes, Cisco follows. And, the Tech sector is right behind the firm. With this kind of gloomy outlook, it's not looking good.
Some analysts point to Cisco's improvement in gross margins as a source of optimism. The firm increased its gross margin slightly in the second quarter, from 69.3% to 70.4%. That just means that Cisco was effective in cutting costs. Good for Cisco, yes. But it means nothing for the rest of the Tech sector, since it's not certain that other companies can enact cost-cutting as effective as Cisco's efforts. You can only cut costs for so long before there's nothing left to cut, and making your business smaller isn't exactly what investors are looking for from a high-growth Tech firm. In fact, Cisco expects gross margins to fall next quarter to 68-70%, so even its cost-cutting is beginning to falter.
Cisco's latest earnings report convinces us even more that the Tech sector will struggle again this year. And with corporate spending expected to remain in the doldrums, a Tech recovery is far over the horizon. We don't recommend any Tech stocks right now.
INSURANCE
RESERVES COULD BE A PROBLEM FOR MORE THAN AIG
Admission from AMERICAN INTERNATIONAL GROUP (AIG, $47, down 7) that it had underfunded its reserves for old claims by $3.5 billion has hurt the insurer's stock -- and it bodes ill for the company's rivals. AIG blamed its reserve shortfall on rising medical insurance claims, an increase in shareholder lawsuits against U.S. corporate executives, and excessive court awards. All insurance companies, including leading firms like ST. PAUL (SPC, $30, down 3) and CHUBB (CB, $49, down 5), face these same problems, though none had the reputation for preparing for them as well as AIG.
TODD'S TAKE: Post September 11, rate hikes became one of the hottest topics in the insurance business. And this had insurers talking about rising profits. Eighteen months later AIG has moved on to a new, less appealing topic: Explaining that a good portion of those profits are going to cover underfunded reserve positions. You should expect many other insurers to join the conversation.
In the mid to long term, we expect the Bush administration to produce some remedies. These likely will come in the form of legal reforms that limit court awards in areas such as worker's compensation. Short-term, however, the industry could take a tough hit, as too many in the business joined in cutthroat price wars in the mid-1990s. Those claims, without the reserves to cover them, are now popping up. It is just a matter of time before some of these companies own up to it, as AIG has.
In many ways AIG's competitors have a tougher time ahead. They cut premiums more aggressively in the past, and few if any can match the expertise AIG puts into its insurance operations. Looking ahead, their shortfalls could be much greater. Be careful in this sector.
For its part, AIG won't move on unscathed. The firm's reputation for astute and assiduous attention to detail earned it a premium valuation compared to its rivals. This calculation undermines that reputation, and that premium valuation now means that its stock could drop a long way to fall in line with rivals.
We're eager for more info, but the firm is pretty tight-lipped with guidance. It did state that insurance losses would grow $4-5 billion in 2003 (bad news), but that it won't slow its insurance rate increases (good news). We'll watch this stock closely between now and February 13, the day it reports 4Q earnings.
GOLD
ON SCHEDULE, NEWMONT REMAINS TOP GOLD CHOICE
The highly touted benefits of two major acquisitions made by NEWMONT MINING (NEM, $28, down 1) last year are coming to fruition, according to the company's chief executive. The firm's purchase of Normandy Mining has given Newmont a strong toehold in Australia, and its acquisition of cash-loaded Franco Nevada has helped the firm reduce debt. Newmont announced that its integration process is ahead of schedule, with over $220 million worth of assets sold and its acquired hedge-book substantially reduced in size.
Now the world's largest gold mining company, Newmont is working with a larger budget, the world's largest mining land base, and the highest gold price in about six years. The firm has set out in 2003 to boost its reserves (which at the end of 2002 totaled 83 million ounces), to bring more of its assets closer to production, and to further reduce the amount of gold it holds in a hedged position.
TODD'S TAKE: Gold has been a warm topic over the past year, and in all the discussions Newmont's name comes up. This is not just because it is a gold giant that cannot be ignored, but also because it is a QUALITY gold giant.
As noted above, those qualities are coming home to roost. But we think that the "warm" gold topic is set to become very hot in 2003, and Newmont will benefit further.
By most metrics the U.S. economy and stock market are facing another difficult year. (The same can be said for the global economy and stock markets.) The gloom is pervaded by worries that things could grow worse. When we throw a war (whether real or simply an ongoing threat) onto the heap of trouble, things get ugly. People are losing confidence in the U.S. dollar. They are seeking safety, and the price of gold is rising. If it continues to rise and the global problems persist, then watch out. It doesn't matter whether gold is at $400 an ounce or $500; if investors are worried that their assets are about to drop in value -- and take note that Asia in general is VERY heavily weighted on the U.S. dollar -- they will move to preserve their wealth no matter what. That means more demand for gold.
This is the market Newmont is operating in, the market that justifies its high PE. (Gold stocks typically trade at higher PEs than most stocks.) Newmont is the world's largest gold producer, and its focus on non-hedged selling means that it will sell its gold at market prices, fully benefiting from the rising price of gold.
We feel that aggressive investors have plenty of opportunity to profit from Newmont stock at its current levels. We expect great gains from the stock this year.
PROFITS
4Q PROFITS ARE UP -- OR ARE THEY?
TODD'S TAKE: Earnings results from the fourth quarter of 2002 looked generally positive in the aggregate, which may make one believe the economy is on its way to a quick recovery. That, however, may be too hasty of a conclusion and a bit of wishful thinking on the part of the economists that predict such things.
Profits may be up, but why? It's certainly not due to the strong economy and consumer confidence. The economy and business conditions in general remain weak. Profits may have been up for the quarter, but by and large this wasn't due to significant increases in sales, which are up only slightly compared to profits. The increase in GDP slowed to an anemic 0.7% annual rate during the quarter, compared to a 4% rate for the third quarter. The deceleration in growth was attributable to a sharp downturn in personal consumption expenditures and downturns in inventory investments, according to the Bureau of Economic Analysis.
A major reason for better profits last quarter is that corporations, realizing that sales are going to remain flat in the short term, are focusing their efforts on cost-cutting. Corporations are wringing more profit out of the same number of dollars by cutting jobs, putting tight limits over capital spending, abandoning major projects, and keeping tight control over inventories. Companies started buckling down last year, and now they are reaping the benefit of their lean-and-mean initiatives. Investors realize where corporate profits are coming from, and stock prices reflect this overall, with the Dow closing out 4Q02 still significantly lower than 4Q01.
The fourth quarter also saw some major dotcoms taking their first profits, which caused some undue optimism in the tech marketplace. The pseudo-charge was led by AMAZON (AMZN, $21, down 1) making its second consecutive profit. That sounds like great news, until you take into account the fact that the company's very slim profit was actually less than its benefit from foreign exchange. If the euro had gone a point or two in the other direction, it would have been a return to losses for Amazon.
As far as corporate earnings are concerned. one major reason for the positive comparative increase is what the latest earnings are being compared to. In 4Q01, earnings were down significantly (over 50% in general) over 2000, not only because of the slowing economy but because of the after-effects of September 11 that caused 4Q01 earnings to dive. 4Q02 results may be up significantly over the prior year's, but that's not saying much considering that 4Q01 was such a poor quarter.
So just remember to take these earnings with a grain of salt.
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