Bull Market Weekly Advisory
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Bull Market Weekly Advisory
THE BIG PICTURE -- WHAT'S HAPPENING OUT THERE?
MARKET UPDATE
For the past several months we have been very negative about the market's medium-term prospects for extremely good and specific reasons. Two weeks ago we saw some hopeful signs of a firming economy. Those hopes may be getting dashed in the face of continued weak demand for technology, state and federal budget deficits, poor earnings forecasts, and looming global threats. With more weak numbers issued last week, such as December's fall in industrial output and a staggering November trade deficit, the strength of the economic recovery is in doubt.
After two positive weeks, last week's 2-5% sell-off for the indices we watch in this column should not be a serious concern. But, the major indices have tried and failed to assault the top of the near-term trading range. The S&P 500 reached 935 on January 13th -- only 15 points from the December 2nd high of 950 -- and has pulled back to Friday's close of 902. With little good news in sight, the market is probably heading back to the December lows. If so, the S&P would reach 870. The Dow would shed 240 points and hit 8340, and the Nasdaq would hit 1330 -- just 50 points from Friday's close. Support should hold at those levels. But, a war or other major event could send the markets to the next level of resistance, which would mean a drop of another 15% for the major indices.
Only 56 of the 240 Sectors in our database ended up last week compared to 166 the previous week. Hospitals, Computer Based Systems, Music & Video Stores, Shipping, and Farm Products were the leaders. Techs headed the losers, which included Printed Circuit Boards, Semiconductor Equipment & Materials, Semiconductor Memory Chips, Semiconductors, Specialized, Application Software, and Semiconductor Broadline.
Commodity prices including gold and oil are rising in the face of anticipated supply disruptions, as a peaceful solution to the Iraqi crises appears remote. The UN inspectors' next report to the Security Council is due on January 27th. Expect a lot of volatility this week leading up to it. In fact, expect volatility until global tensions ease.
This is no time to take big chances on new LONG positions; and tightening stops -- as we advise below for several open Trading Account positions -- is prudent. We have had a profitable year to date in the Trading Account, and we want that to continue.
COMMENTARY:
MARKET OVERVIEW
MARKET EARNS ITS PAIN
Though this trading week was a day shorter than normal, investors felt the most pain of the year this week. The market tanked on three of the four trading days, with the Dow sinking by triple digits in all three losing sessions. A mix of cloudy earnings reports and geopolitical tensions formed a tight grasp from which the market couldn't escape.
Though many of the high profile financial results met or beat earnings estimates, the market feel sharply this week. That's because a bunch of companies reported better-than-expected earnings but failed to provide bright outlooks on future profits.
That's what this week's market told investors: Companies that aren't positive on the future will be punished. A number of Dow companies fell into that category this week. For instance, JOHNSON & JOHNSON (JNJ, $54, down 1) on Tuesday beat earnings estimates but offered cautious comments on the future. CATERPILLAR (CAT, $44, down 3) did the same thing two days later. Both stocks subsequently traded lower on the news.
Other Dow stocks both missed estimates and offered cautious outlooks. EASTMAN KODAK (EK, $32, down 7) recovered from a year-ago loss to turn a profit, but the photography film company missed estimates by 3 cents and announced a new round of layoffs and lower 1Q estimates. J.P. MORGAN CHASE (JPM, $24, down 2) missed estimates and offered a cautious outlook as well.
Earnings coming out of the Tech sector were a bit more positive. A number of firms continued to post losses, but many of them issued positive projections for 2003. For example, LUCENT TECHNOLOGIES (LU, $1.98, up 0.34) posted its 11th straight quarterly loss but reaffirmed its higher revenue estimates for the upcoming quarter. Additionally, EMC (EMC, $7.14, up 0.24) reported a narrower loss in 4Q02 but predicted higher-than expected earnings in the first quarter. Add to that solid earnings reports from QUALCOMM (QCOM, $37, unch.) and AMAZON (AMZN, $22, up 1), and the Tech-heavy Nasdaq sold off by less than the other two indices.
War concerns took over on Friday, and the market tanked. The all-important United Nations Iraqi arms inspection report will be released on Monday. A day later, President Bush will deliver his State of the Union speech. The U.N. is expected to speak positively on Iraq's disarmament efforts. But it looks like the market thinks that war is inevitable. On Friday, gold and oil surged while the dollar sold off. The jitters led to a 200+ point drop in the Dow.
Not only did the market post losses this week. All of the gains that the market earned in 2003 were wiped out after Friday's gloomy session. Expect investors to keep their attention on geopolitical developments, at least early next week. But with a number of companies left to report earnings, the market will shift its focus back onto Corporate America soon after.
For the week, the Dow Jones plunged 456 points, a huge 5.3%, to end at 8131.
The S&P 500 sank 40 points, a big 4.4%, to close at 861.
And the Nasdaq held its ground a little better, falling 34 points, or 2.5%, to finish the week at 1342.
ECONOMY WATCH
1. HOUSING STARTS REACH A 16-YEAR HIGH
New housing starts soared to a 16-year high, according to a Commerce Department report. New starts rose 5% in December to an annual rate of 1.84 million new homes. Building permits jumped 8% to 1.88 million, the highest rate in 24 years. Economists were expecting housing starts to remain at an annual rate of 1.69 million. This is another piece of evidence that the housing market will continue to sizzle in 2003.
2. TRADE GAP WIDENS
The U.S. trade deficit expanded to $40 billion in November, the Commerce Department announced on Friday last week. Exports clocked in at $83 billion, while imports rose from $117 billion to $123 billion. The gap increase was fueled by a surge in imports, as American consumers bought more foreign-made computers, clothes, toys, and furniture. However, a large chunk of the rise was due to the port lockout on the West Coast, which delayed imports from making it to shore until November. That boosted import numbers for the month.
3. JOBLESS CLAIMS MIXED
Initial jobless claims rose slightly in the latest week, according to the Labor Department. Claims increased by 18,000 to 381,000. However, the four-week average, seen as a more stable measure of the job market, slipped 2,000 to 386,000 claims. Both numbers remained below the key 400,000 mark. But there are a number of seasonal factors that lessen the importance of these figures. A more accurate jobless claims report may be a few weeks away.
4. LEADING INDICATORS POINT TO SLOW ECONOMIC GROWTH
The Conference Board released its latest index of leading economic indicators. The index moved up 0.1% in December, the third straight monthly rise in the numbers. Eight of the index's 10 indicators rose last month, including building permits and consumer expectations. Jobless claims and stock prices were the two falling indicators. Since December, however, both of those have improved. Persistent increases in the index can signal an economic turning point.
IN THE NEWS
I. 3M LOWERS COSTS TO RAISE EARNINGS
Manufacturer and Dow component 3M (MMM, $126, unch.) announced a year-over-year rise in 4Q earnings Tuesday. The company, which produces a variety of products ranging from Scotch tape to asthma inhalers, earned $510 million, or $1.29 a share, in the fourth quarter, rising 34% from 4Q01's 96-cent profit and beating the consensus estimate by a penny. Revenue rose 7% to $4.14 billion, driven by a 12% increase in international sales. Sales in Asia surged 22%. The company expects to earn $1.40 a share in 1Q03, a slightly higher range than the $1.37 that analysts are projecting. Overall, a strong, if not impressive, quarter for 3M.
II. J&J EARNINGS RISE
JOHNSON & JOHNSON (JNJ, $54, down 1) announced a profit rise of 30%. Johnson & Johnson posted net income of $1.4 billion, or 48 cents per share, improving upon a profit of 36 cents in the year-ago quarter. Analysts were expecting the firm to earn 47 cents. Sales jumped almost 15% to $9.4 billion. The solid 4Q results were driven by strong sales of medical devices and arthritis treatments. Sales of the company's arthritis drug Remicade surged 80% to $380 million, while revenue from medical devices jumped 16% to $3.3 billion. Looking ahead, Johnson & Johnson expects to boost sales by 11-12% in 2003. However, the firm doesn't see the 17% earnings growth in 2002 as a long-term trend.
III. J.P. MORGAN POSTS A WIDER LOSS
Dow component J.P. MORGAN CHASE (JPM, $24, down 2) reported a net loss of $385 million, or 20 cents a share, in the fourth quarter of 2002, wider than its 4Q01 loss of 18 cents. Last year, the company took big charges on loan losses in the troubled country of Argentina. This year, the bank took a $1.3 billion charge to cover Enron-related costs and legal costs, as well as $390 million related to its J.P. Morgan-Chase Manhattan merger. Excluding costs, the firm earned 36 cents a share. Profits dropped 2% for the full year, the second straight time this has happened. A rise in commercial credit costs hurt results as well, as loan charge-offs rose from $445 million in 2001 to $645 million. The company expects these costs to remain high in 2003.
IV. EASTMAN KODAK TAKES A BAD EARNINGS PICTURE
Fellow Dow company EASTMAN KODAK (EK, $32, down 7) posted lukewarm results as well. The photography film giant posted net income of $130 million, or 39 cents a share, turning around a 4Q01 loss of 71 cents. However, excluding a cost-cutting charge, the company earned 65 cents and missed Wall Street expectations by 3 cents. And excluding all one-time items, the company earned just 13 cents a share in the fourth quarter. Additionally, Kodak announced another 2,900 layoffs to occur this year, slicing its work force by 3%. Because of the job cuts, the company will take $75-100 million in charges and miss 1Q estimates. These two earnings reports helped drag the Dow lower in Wednesday's session.
V. AMR POSTS LARGEST-EVER LOSS FOR AN AIRLINE
AMR (AMR, $3.26, down 2.39), the parent company of American Airlines, announced a 4Q02 loss of $530 million, or $3.39 a share, beating expectations for a $3.73 loss and improving upon the year-ago loss of $5.17. But "improving" is a subjective word in this case, as the new loss remained steep. And the firm reported the largest yearly loss in the history of the Aviation industry -- $3.5 billion. That's $9.6 million EVERY DAY. As the company's CEO put it, these results are "unsustainable."
VI. NO DIAL TONE: AT&T GIVES DISAPPOINTING OUTLOOK
Shares of AT&T (T, $20, down 6) plunged Thursday, as the company released its latest financial results. The country's largest long-distance telephone company turned last year's loss into a profit, reporting 4Q02 net income of $515 million, or 66 cents a share, compared to a 4Q01 loss of $1.39 billion, or $1.97 a share. The results, however, included gains from the sale of its cable TV business to COMCAST (CMCSA, $26, down 1). The company reported a loss of 79 cents a share from continuing operations (which factors out the one-time gains), more than doubling last year's corresponding loss.
In addition, the firm announced that it would stop offering quarterly and annual earnings guidance, instead focusing on providing more detailed financial statements. But the company did say that it expects Telecom spending to decline again this year. That's enough information for us to stay away from the stock. With the proliferation of the Internet and email communication, as well as wireless phones, long distance is a dying business.
VII. EMC LOSES LESS THAN LAST YEAR
EMC (EMC, $7.14, up 0.24) announced a smaller loss in the fourth quarter of last year. The data storage company reported a net loss of $64 million, or 3 cents a share, down from a $70 million loss in the year-ago period. The results were in line with estimates. Excluding a layoff-related charge and other one-time items, the company turned a profit of 2 cents a share. Revenue declined from $1.51 billion to $1.49 billion in 4Q02 but clocked in above previous estimates for $1.28 billion in sales. Additionally, the company offered guidance on the first quarter, projecting earnings of a penny per share on revenue of $1.35-1.4 billion. Currently, analysts expect the firm to break even on the low end of the revenue range.
VIII. TEXAS INSTRUMENTS LOSES BUT EXPECTS GAINS
Chipmaker TEXAS INSTRUMENTS (TXN, $15.86, down 1.31) on Wednesday posted a loss in the fourth quarter of last year on higher revenue. The firm reported a net loss of $590 million, or 34 cents a share, compared to a 7-cent loss in the same quarter a year ago. However, the results included a big $640 million charge related to the company's holding in MICRON TECHNOLOGY (MU, $8.23, down 0.93). Excluding items, the firm actually posted a profit of $100 million, or 6 cents a share, improving upon a loss of 6 cents a year ago. Revenue jumped 20% to $2.15 billion. Both numbers surprised analysts, who were looking for a profit of 3 cents on $2.08 billion in revenue. Texas Instruments expects similar results in the first quarter, with revenue remaining flat sequentially over the fourth quarter and earnings coming in at 6 cents.
IX. STARBUCKS TAKES ITS EARNINGS BLACK
Coffee brewer STARBUCKS (SBUX, $23, up 3) reported a 17% jump in earnings Thursday after the bell. The company earned fiscal 1Q (ended December 29) net income of $80 million, or 20 cents per share, up from a 17-cent profit in the year-ago quarter. Analysts expected the firm to earn 18 cents a share. Sales surged 25% to $1 billion, while same-store sales jumped 9% for the quarter. The company expects the strong sales to continue in January, boosting same-store sales above its expected 3-7% monthly growth range. Due to the unexpected sales jump, Starbucks raised its 2003 earnings projections by 2 cents to 67-68 cents a share.
X. AMAZON POSTS ANOTHER PROFIT
E-tailer AMAZON (AMZN, $22, up 1) squeezed out a quarterly profit for the second time ever. The company earned 4Q02 net income of $2.7 million, or a penny a share. However, the results fell 48% short of the firm's 4Q01, which marked the firm's first quarterly profit. In that quarter, Amazon achieved net income of $5 million. Revenue, however, beat last year by 28% and rose to $1.43 billion. Excluding restructuring charges and other one-time items, the firm earned 19 cents a share, beating Wall Street's expectation for a 14-cent profit. A free shipping promotion helped boost sales during the holiday shopping season. For 2003, Amazon raised its outlook from 10% sales growth to 15%. However, many analysts are concerned about the stock's high valuation. As are we!
1. SECTOR-RELATED NEWS
UNITEDHEALTH GROUP (UNH, $85, up 1) saw its profits soar in the latest quarter. The healthcare firm reported 4Q02 net income of $380 million, or $1.20 a share, up a huge 53% over last-year's 76-cent profit. The results easily topped Wall Street expectations for $1.16 in earnings. Revenue jumped 11% to $6.68 billion in the quarter. For the year, earnings rose 48% to $4.25 a share.
TODD'S TAKE: As the U.S. population gets older, UnitedHealth continues to grow profits at a breakneck pace. The latest earnings surprise marks the 17th straight quarter of double-digit profit growth. 17 STRAIGHT quarters of DOUBLE-DIGIT profit growth. That's not an easy feat by any standard.
These record results are occurring even while medical costs continue to rise. UnitedHealth's medical costs rose 10% to $2.8 billion in 2002, a hefty increase by any measurement. Costs are expected to rise another 11-12% throughout the industry this year.
But UnitedHealth, the nation's #1 health insurer with over 17 million members, is more than covering these higher costs by raising health plan premiums as well. Last year the firm raised premiums by enough to earn $2.2 billion from operations, a 32% increase over 2001's numbers. In 2003 the company expects to raise premiums by 13%, once again outpacing the expected 11-12% medical cost increases.
In addition, the company vastly improved its cash flows for the year. 4Q02 cash flows from operations surged a huge 111% to $760 million. Cash flows jumped 31% to $2.4 billion for all of 2002. With more cash coming in, UnitedHealth was able to repurchase 4 million of its own shares in the fourth quarter and 22.3 million shares throughout the year. Good news for shareholders, as it increases the value of the remaining shares, all else being equal.
2003 should be another solid year. The company's CEO said, "We are realizing the ongoing benefits of increasing operational advantages in services, systems, connectivity, and health informatics that are driving market share gains and margin improvements. These will support a continuation of strong overall performance in 2003." The healthcare firm projects 22% profit growth this year, which would mean $5.18 a share in earnings. So it looks like the double-digit earnings expansion streak will continue.
Over the next few years, the baby boomer population will continue to age. That will boost business in the Healthcare industry for years to come. And while medical costs keep rising, firms like UnitedHealth will be able to raise premiums to cover the costs increases. We recommend UnitedHealth as a solid investment in the Healthcare industry.
FINANCIAL
CITIGROUP BEATS ESTIMATES
The world's largest financial firm came out with earnings before the bell Tuesday. CITIGROUP (C, $36, down 1) reported net income of $2.43 billion, or 47 cents a share, in the fourth quarter of 2002. Earnings beat analysts' estimates by a penny but fell 37% from 2001's 4Q profit of 74 cents a share. Revenue rose slightly, from $18.9 billion in 4Q01 to $18.93 billion in the most recent period. 4Q results included $1.55 billion in charges related to the stock research scandal and the Enron bankruptcy. Still, Citigroup earned a record $15.3 billion, or $2.94 a share, in 2002 and grew full-year earnings by 8%. For the current year, the firm plans on achieving double-digit profit growth.
TODD'S TAKE: This marks the end of a tough year for both Citigroup and the entire Financial sector. With the stock market downturn continuing for another year, corporate banking business remaining at low levels, and regulators fining investment banks for stock research miscues, financial firms were expected to struggle in the fourth quarter.
Since Citigroup is the largest financial firm in the world, the bank felt the effects from all of these negative factors. The company's corporate and investment bank division reported a $345 million loss for the quarter, down from the year-ago period's $905 million profit.
The poor performance was due to the charges that Citigroup took to 4Q earnings. The company wrote off $1.3 billion in the investment bank division, in relation to the stock research settlement agreed upon in December. In addition, Citigroup infused $255 million to its loan loss reserves in anticipation of future liabilities from a weak corporate economy.
However, as was the case with other commercial banks like WACHOVIA (WB, $36, down 2) and BANK ONE (ONE, $37, down 2), a strong-performing consumer business eased some of the pressure. The firm's consumer group, which includes retail banking and credit card services, jumped 25% year-over-year to $2.4 billion in the fourth quarter.
Despite all of the downward pressures to earnings, Citigroup was able to grow earnings by 8% in the overall year. According to CEO Sandy Weill, the firm faced "significant challenges: Continued weakness in global markets, record bankruptcies in the developed world.and intense scrutiny of its business practices." But the banking giant steered through the obstacles and posted record results, which is "a testament to the strength of Citigroup."
Business should improve for Citigroup in 2003. The firm expects to generate double-digit profit growth, as the stock market has a good chance of posting a positive return this year and corporations return to more normal spending trends. But even if the economy doesn't improve, we are confident that Citigroup will once again deliver record earnings. After all, it IS the largest financial firm in the world. You can't get to that level without weathering the tough times effectively.
FINANCIAL
THE BULL PULLS AHEAD WITH HIGHER EARNINGS
MERRILL LYNCH (MER, $36, down 5) posted 4Q02 earnings of $615 million, or 64 cents a share, beating estimates by a penny. Profits rose 25% from 4Q01 earnings of 51 cents. Including charges related to the stock research settlement, Merrill earned 63 cents -- still meeting expectations and vastly improving from 4Q01's charges-included loss of $1.51 a share. Revenue, however, declined 12% to $4.2 billion for the quarter and fell 15% to $18.6 billion for the full year.
TODD'S TAKE: The latest quarterly results tell a two-part story at Merrill. Basically, the numbers show us how an investment bank can make money in a weak stock market and banking environment.
Revenues were down across the board at Merrill. Stock and bond trading revenue dropped 40% and brokerage commissions fell 10%, as the third straight down year drove more investors away from the market. The investment banking side of the business didn't fare much better, as both underwriting revenue and advisory revenue dropped 22%, to $420 million and $165 million respectively. In addition, the weak market made it difficult for Merrill to make money on investments, and asset management revenue posted a 14% decline to $1.1 billion.
However, Merrill still posted a 25% profit increase. This performance was a strong testament to the effectiveness of the bank's drastic cost-cutting efforts. Over the last two years, Merrill has laid off over 21,000 employees, with 2,300 job cuts occurring in 4Q02. As a result, compensation costs fell 14% year-over-year. Additionally, the firm cut its non-compensation costs by 25% in the quarter. Despite falling revenues, the bank's profitability is at its highest mark in years.
The stock research settlement hampering all of the major investment banks dragged down Merrill's profits too. The bank paid $210 million for its part in the settlement. Earlier in the year, the firm paid $100 million to settle earlier charges in the stock research investigation.
Looking ahead, Merrill's future is cloudy. The company warned that another weak year in the stock market would cause further erosion in its trading and investment banking revenues. If that happens, the company said, "It will be difficult to maintain 2002 revenue levels in the current year."
That's the problem with Merrill. Unlike rival CITIGROUP (C, $36, down 1), the firm has no commercial banking business to fall back upon. Commercial banking was much stronger than investment banking this year, and the trend could continue this year. That's why we like Citigroup more than Merrill -- Citi doesn't have to worry as much about the falling stock market.
FAST FOOD
NOT-SO-HAPPY MEALS AT MCDONALD'S
MCDONALD'S (MCD, $14.90, down 0.55) posted the first quarterly loss in the history of the company Thursday. The company posted a 4Q02 net loss of $344 million, or 27 cents a share, compared with a profit of $272 million, or 21 cents a share, for the same quarter last year. Earlier guidance missed the mark, having called for a net loss of only 5-6 cents.
TODD'S TAKE: Shares dropped on the news, trading at under $15, the lowest level in eight years. Share price has been declining since summer highs saw prices in excess of $30. The company did not provide specific EPS guidance for the upcoming quarters.
The loss was partially attributable to an $810 million charge that covered the cost of exiting Latin American markets, abandoning a large technology implementation, and closing 719 stores, mostly in the US and Japan. The closings were much higher than expected; in December management had anticipated closure of only 175 stores.
The quick service restaurant industry as a whole saw declining growth in the second half of the year, reflecting a weak economy and declining consumer confidence. For McDonald's, sales increased a mere 1% for the year and 2% for the fourth quarter, and US sales declined 1.5% for the year and 1.4% for the quarter. Negative comparable sales, higher labor costs, and higher financial support to franchisees all put pressure on the bottom line.
McDonald's' new CEO said that the previously targeted 10-15% growth ratio was "unrealistic" at least in the short term, and that over the next 12 to 18 months, the focus for the burger giant will be on the foundation of the business -- and attempting to reverse the sales trends and margin declines.
Competition has been heating up in the fast food marketplace, as McDonald's, Burger King, and other competitors fight to maintain market share and adjust to changing consumer tastes. The hotly-debated "dollar menu" will continue, although the new CEO is open to change. Although customers like the price and variety of the dollar menu, the results haven't been spectacular for McDonald's or any of its competitors. The idea was that the dollar menu would drive incremental purchases - but in fact, incremental purchases have been more than offset by a shift in product mix to the dollar offerings, and the use of the dollar menu for single items rather than meal purchases.
In addition to the closures, the company is abandoning plans to develop a billion-dollar global technology system, which had been strongly supported by former CEO Jack Greenberg. The company is also planning to change its kitchen operations, and make improvements to food taste and service. The massive restaurant remodeling plan implemented by Greenberg is still in place, but Cantalupo has placed it on the table for potential cuts.
We look for a leaner McDonald's in the coming year-if not in terms of its burgers, at least in terms of its operations. Hopefully, that will result in an improvement in the stock price. But we're keeping a close eye on the burger behemoth. This stock is NOT for the faint of heart.
MARKET UPDATE
For the past several months we have been very negative about the market's medium-term prospects for extremely good and specific reasons. Two weeks ago we saw some hopeful signs of a firming economy. Those hopes may be getting dashed in the face of continued weak demand for technology, state and federal budget deficits, poor earnings forecasts, and looming global threats. With more weak numbers issued last week, such as December's fall in industrial output and a staggering November trade deficit, the strength of the economic recovery is in doubt.
After two positive weeks, last week's 2-5% sell-off for the indices we watch in this column should not be a serious concern. But, the major indices have tried and failed to assault the top of the near-term trading range. The S&P 500 reached 935 on January 13th -- only 15 points from the December 2nd high of 950 -- and has pulled back to Friday's close of 902. With little good news in sight, the market is probably heading back to the December lows. If so, the S&P would reach 870. The Dow would shed 240 points and hit 8340, and the Nasdaq would hit 1330 -- just 50 points from Friday's close. Support should hold at those levels. But, a war or other major event could send the markets to the next level of resistance, which would mean a drop of another 15% for the major indices.
Only 56 of the 240 Sectors in our database ended up last week compared to 166 the previous week. Hospitals, Computer Based Systems, Music & Video Stores, Shipping, and Farm Products were the leaders. Techs headed the losers, which included Printed Circuit Boards, Semiconductor Equipment & Materials, Semiconductor Memory Chips, Semiconductors, Specialized, Application Software, and Semiconductor Broadline.
Commodity prices including gold and oil are rising in the face of anticipated supply disruptions, as a peaceful solution to the Iraqi crises appears remote. The UN inspectors' next report to the Security Council is due on January 27th. Expect a lot of volatility this week leading up to it. In fact, expect volatility until global tensions ease.
This is no time to take big chances on new LONG positions; and tightening stops -- as we advise below for several open Trading Account positions -- is prudent. We have had a profitable year to date in the Trading Account, and we want that to continue.
COMMENTARY:
MARKET OVERVIEW
MARKET EARNS ITS PAIN
Though this trading week was a day shorter than normal, investors felt the most pain of the year this week. The market tanked on three of the four trading days, with the Dow sinking by triple digits in all three losing sessions. A mix of cloudy earnings reports and geopolitical tensions formed a tight grasp from which the market couldn't escape.
Though many of the high profile financial results met or beat earnings estimates, the market feel sharply this week. That's because a bunch of companies reported better-than-expected earnings but failed to provide bright outlooks on future profits.
That's what this week's market told investors: Companies that aren't positive on the future will be punished. A number of Dow companies fell into that category this week. For instance, JOHNSON & JOHNSON (JNJ, $54, down 1) on Tuesday beat earnings estimates but offered cautious comments on the future. CATERPILLAR (CAT, $44, down 3) did the same thing two days later. Both stocks subsequently traded lower on the news.
Other Dow stocks both missed estimates and offered cautious outlooks. EASTMAN KODAK (EK, $32, down 7) recovered from a year-ago loss to turn a profit, but the photography film company missed estimates by 3 cents and announced a new round of layoffs and lower 1Q estimates. J.P. MORGAN CHASE (JPM, $24, down 2) missed estimates and offered a cautious outlook as well.
Earnings coming out of the Tech sector were a bit more positive. A number of firms continued to post losses, but many of them issued positive projections for 2003. For example, LUCENT TECHNOLOGIES (LU, $1.98, up 0.34) posted its 11th straight quarterly loss but reaffirmed its higher revenue estimates for the upcoming quarter. Additionally, EMC (EMC, $7.14, up 0.24) reported a narrower loss in 4Q02 but predicted higher-than expected earnings in the first quarter. Add to that solid earnings reports from QUALCOMM (QCOM, $37, unch.) and AMAZON (AMZN, $22, up 1), and the Tech-heavy Nasdaq sold off by less than the other two indices.
War concerns took over on Friday, and the market tanked. The all-important United Nations Iraqi arms inspection report will be released on Monday. A day later, President Bush will deliver his State of the Union speech. The U.N. is expected to speak positively on Iraq's disarmament efforts. But it looks like the market thinks that war is inevitable. On Friday, gold and oil surged while the dollar sold off. The jitters led to a 200+ point drop in the Dow.
Not only did the market post losses this week. All of the gains that the market earned in 2003 were wiped out after Friday's gloomy session. Expect investors to keep their attention on geopolitical developments, at least early next week. But with a number of companies left to report earnings, the market will shift its focus back onto Corporate America soon after.
For the week, the Dow Jones plunged 456 points, a huge 5.3%, to end at 8131.
The S&P 500 sank 40 points, a big 4.4%, to close at 861.
And the Nasdaq held its ground a little better, falling 34 points, or 2.5%, to finish the week at 1342.
ECONOMY WATCH
1. HOUSING STARTS REACH A 16-YEAR HIGH
New housing starts soared to a 16-year high, according to a Commerce Department report. New starts rose 5% in December to an annual rate of 1.84 million new homes. Building permits jumped 8% to 1.88 million, the highest rate in 24 years. Economists were expecting housing starts to remain at an annual rate of 1.69 million. This is another piece of evidence that the housing market will continue to sizzle in 2003.
2. TRADE GAP WIDENS
The U.S. trade deficit expanded to $40 billion in November, the Commerce Department announced on Friday last week. Exports clocked in at $83 billion, while imports rose from $117 billion to $123 billion. The gap increase was fueled by a surge in imports, as American consumers bought more foreign-made computers, clothes, toys, and furniture. However, a large chunk of the rise was due to the port lockout on the West Coast, which delayed imports from making it to shore until November. That boosted import numbers for the month.
3. JOBLESS CLAIMS MIXED
Initial jobless claims rose slightly in the latest week, according to the Labor Department. Claims increased by 18,000 to 381,000. However, the four-week average, seen as a more stable measure of the job market, slipped 2,000 to 386,000 claims. Both numbers remained below the key 400,000 mark. But there are a number of seasonal factors that lessen the importance of these figures. A more accurate jobless claims report may be a few weeks away.
4. LEADING INDICATORS POINT TO SLOW ECONOMIC GROWTH
The Conference Board released its latest index of leading economic indicators. The index moved up 0.1% in December, the third straight monthly rise in the numbers. Eight of the index's 10 indicators rose last month, including building permits and consumer expectations. Jobless claims and stock prices were the two falling indicators. Since December, however, both of those have improved. Persistent increases in the index can signal an economic turning point.
IN THE NEWS
I. 3M LOWERS COSTS TO RAISE EARNINGS
Manufacturer and Dow component 3M (MMM, $126, unch.) announced a year-over-year rise in 4Q earnings Tuesday. The company, which produces a variety of products ranging from Scotch tape to asthma inhalers, earned $510 million, or $1.29 a share, in the fourth quarter, rising 34% from 4Q01's 96-cent profit and beating the consensus estimate by a penny. Revenue rose 7% to $4.14 billion, driven by a 12% increase in international sales. Sales in Asia surged 22%. The company expects to earn $1.40 a share in 1Q03, a slightly higher range than the $1.37 that analysts are projecting. Overall, a strong, if not impressive, quarter for 3M.
II. J&J EARNINGS RISE
JOHNSON & JOHNSON (JNJ, $54, down 1) announced a profit rise of 30%. Johnson & Johnson posted net income of $1.4 billion, or 48 cents per share, improving upon a profit of 36 cents in the year-ago quarter. Analysts were expecting the firm to earn 47 cents. Sales jumped almost 15% to $9.4 billion. The solid 4Q results were driven by strong sales of medical devices and arthritis treatments. Sales of the company's arthritis drug Remicade surged 80% to $380 million, while revenue from medical devices jumped 16% to $3.3 billion. Looking ahead, Johnson & Johnson expects to boost sales by 11-12% in 2003. However, the firm doesn't see the 17% earnings growth in 2002 as a long-term trend.
III. J.P. MORGAN POSTS A WIDER LOSS
Dow component J.P. MORGAN CHASE (JPM, $24, down 2) reported a net loss of $385 million, or 20 cents a share, in the fourth quarter of 2002, wider than its 4Q01 loss of 18 cents. Last year, the company took big charges on loan losses in the troubled country of Argentina. This year, the bank took a $1.3 billion charge to cover Enron-related costs and legal costs, as well as $390 million related to its J.P. Morgan-Chase Manhattan merger. Excluding costs, the firm earned 36 cents a share. Profits dropped 2% for the full year, the second straight time this has happened. A rise in commercial credit costs hurt results as well, as loan charge-offs rose from $445 million in 2001 to $645 million. The company expects these costs to remain high in 2003.
IV. EASTMAN KODAK TAKES A BAD EARNINGS PICTURE
Fellow Dow company EASTMAN KODAK (EK, $32, down 7) posted lukewarm results as well. The photography film giant posted net income of $130 million, or 39 cents a share, turning around a 4Q01 loss of 71 cents. However, excluding a cost-cutting charge, the company earned 65 cents and missed Wall Street expectations by 3 cents. And excluding all one-time items, the company earned just 13 cents a share in the fourth quarter. Additionally, Kodak announced another 2,900 layoffs to occur this year, slicing its work force by 3%. Because of the job cuts, the company will take $75-100 million in charges and miss 1Q estimates. These two earnings reports helped drag the Dow lower in Wednesday's session.
V. AMR POSTS LARGEST-EVER LOSS FOR AN AIRLINE
AMR (AMR, $3.26, down 2.39), the parent company of American Airlines, announced a 4Q02 loss of $530 million, or $3.39 a share, beating expectations for a $3.73 loss and improving upon the year-ago loss of $5.17. But "improving" is a subjective word in this case, as the new loss remained steep. And the firm reported the largest yearly loss in the history of the Aviation industry -- $3.5 billion. That's $9.6 million EVERY DAY. As the company's CEO put it, these results are "unsustainable."
VI. NO DIAL TONE: AT&T GIVES DISAPPOINTING OUTLOOK
Shares of AT&T (T, $20, down 6) plunged Thursday, as the company released its latest financial results. The country's largest long-distance telephone company turned last year's loss into a profit, reporting 4Q02 net income of $515 million, or 66 cents a share, compared to a 4Q01 loss of $1.39 billion, or $1.97 a share. The results, however, included gains from the sale of its cable TV business to COMCAST (CMCSA, $26, down 1). The company reported a loss of 79 cents a share from continuing operations (which factors out the one-time gains), more than doubling last year's corresponding loss.
In addition, the firm announced that it would stop offering quarterly and annual earnings guidance, instead focusing on providing more detailed financial statements. But the company did say that it expects Telecom spending to decline again this year. That's enough information for us to stay away from the stock. With the proliferation of the Internet and email communication, as well as wireless phones, long distance is a dying business.
VII. EMC LOSES LESS THAN LAST YEAR
EMC (EMC, $7.14, up 0.24) announced a smaller loss in the fourth quarter of last year. The data storage company reported a net loss of $64 million, or 3 cents a share, down from a $70 million loss in the year-ago period. The results were in line with estimates. Excluding a layoff-related charge and other one-time items, the company turned a profit of 2 cents a share. Revenue declined from $1.51 billion to $1.49 billion in 4Q02 but clocked in above previous estimates for $1.28 billion in sales. Additionally, the company offered guidance on the first quarter, projecting earnings of a penny per share on revenue of $1.35-1.4 billion. Currently, analysts expect the firm to break even on the low end of the revenue range.
VIII. TEXAS INSTRUMENTS LOSES BUT EXPECTS GAINS
Chipmaker TEXAS INSTRUMENTS (TXN, $15.86, down 1.31) on Wednesday posted a loss in the fourth quarter of last year on higher revenue. The firm reported a net loss of $590 million, or 34 cents a share, compared to a 7-cent loss in the same quarter a year ago. However, the results included a big $640 million charge related to the company's holding in MICRON TECHNOLOGY (MU, $8.23, down 0.93). Excluding items, the firm actually posted a profit of $100 million, or 6 cents a share, improving upon a loss of 6 cents a year ago. Revenue jumped 20% to $2.15 billion. Both numbers surprised analysts, who were looking for a profit of 3 cents on $2.08 billion in revenue. Texas Instruments expects similar results in the first quarter, with revenue remaining flat sequentially over the fourth quarter and earnings coming in at 6 cents.
IX. STARBUCKS TAKES ITS EARNINGS BLACK
Coffee brewer STARBUCKS (SBUX, $23, up 3) reported a 17% jump in earnings Thursday after the bell. The company earned fiscal 1Q (ended December 29) net income of $80 million, or 20 cents per share, up from a 17-cent profit in the year-ago quarter. Analysts expected the firm to earn 18 cents a share. Sales surged 25% to $1 billion, while same-store sales jumped 9% for the quarter. The company expects the strong sales to continue in January, boosting same-store sales above its expected 3-7% monthly growth range. Due to the unexpected sales jump, Starbucks raised its 2003 earnings projections by 2 cents to 67-68 cents a share.
X. AMAZON POSTS ANOTHER PROFIT
E-tailer AMAZON (AMZN, $22, up 1) squeezed out a quarterly profit for the second time ever. The company earned 4Q02 net income of $2.7 million, or a penny a share. However, the results fell 48% short of the firm's 4Q01, which marked the firm's first quarterly profit. In that quarter, Amazon achieved net income of $5 million. Revenue, however, beat last year by 28% and rose to $1.43 billion. Excluding restructuring charges and other one-time items, the firm earned 19 cents a share, beating Wall Street's expectation for a 14-cent profit. A free shipping promotion helped boost sales during the holiday shopping season. For 2003, Amazon raised its outlook from 10% sales growth to 15%. However, many analysts are concerned about the stock's high valuation. As are we!
1. SECTOR-RELATED NEWS
UNITEDHEALTH GROUP (UNH, $85, up 1) saw its profits soar in the latest quarter. The healthcare firm reported 4Q02 net income of $380 million, or $1.20 a share, up a huge 53% over last-year's 76-cent profit. The results easily topped Wall Street expectations for $1.16 in earnings. Revenue jumped 11% to $6.68 billion in the quarter. For the year, earnings rose 48% to $4.25 a share.
TODD'S TAKE: As the U.S. population gets older, UnitedHealth continues to grow profits at a breakneck pace. The latest earnings surprise marks the 17th straight quarter of double-digit profit growth. 17 STRAIGHT quarters of DOUBLE-DIGIT profit growth. That's not an easy feat by any standard.
These record results are occurring even while medical costs continue to rise. UnitedHealth's medical costs rose 10% to $2.8 billion in 2002, a hefty increase by any measurement. Costs are expected to rise another 11-12% throughout the industry this year.
But UnitedHealth, the nation's #1 health insurer with over 17 million members, is more than covering these higher costs by raising health plan premiums as well. Last year the firm raised premiums by enough to earn $2.2 billion from operations, a 32% increase over 2001's numbers. In 2003 the company expects to raise premiums by 13%, once again outpacing the expected 11-12% medical cost increases.
In addition, the company vastly improved its cash flows for the year. 4Q02 cash flows from operations surged a huge 111% to $760 million. Cash flows jumped 31% to $2.4 billion for all of 2002. With more cash coming in, UnitedHealth was able to repurchase 4 million of its own shares in the fourth quarter and 22.3 million shares throughout the year. Good news for shareholders, as it increases the value of the remaining shares, all else being equal.
2003 should be another solid year. The company's CEO said, "We are realizing the ongoing benefits of increasing operational advantages in services, systems, connectivity, and health informatics that are driving market share gains and margin improvements. These will support a continuation of strong overall performance in 2003." The healthcare firm projects 22% profit growth this year, which would mean $5.18 a share in earnings. So it looks like the double-digit earnings expansion streak will continue.
Over the next few years, the baby boomer population will continue to age. That will boost business in the Healthcare industry for years to come. And while medical costs keep rising, firms like UnitedHealth will be able to raise premiums to cover the costs increases. We recommend UnitedHealth as a solid investment in the Healthcare industry.
FINANCIAL
CITIGROUP BEATS ESTIMATES
The world's largest financial firm came out with earnings before the bell Tuesday. CITIGROUP (C, $36, down 1) reported net income of $2.43 billion, or 47 cents a share, in the fourth quarter of 2002. Earnings beat analysts' estimates by a penny but fell 37% from 2001's 4Q profit of 74 cents a share. Revenue rose slightly, from $18.9 billion in 4Q01 to $18.93 billion in the most recent period. 4Q results included $1.55 billion in charges related to the stock research scandal and the Enron bankruptcy. Still, Citigroup earned a record $15.3 billion, or $2.94 a share, in 2002 and grew full-year earnings by 8%. For the current year, the firm plans on achieving double-digit profit growth.
TODD'S TAKE: This marks the end of a tough year for both Citigroup and the entire Financial sector. With the stock market downturn continuing for another year, corporate banking business remaining at low levels, and regulators fining investment banks for stock research miscues, financial firms were expected to struggle in the fourth quarter.
Since Citigroup is the largest financial firm in the world, the bank felt the effects from all of these negative factors. The company's corporate and investment bank division reported a $345 million loss for the quarter, down from the year-ago period's $905 million profit.
The poor performance was due to the charges that Citigroup took to 4Q earnings. The company wrote off $1.3 billion in the investment bank division, in relation to the stock research settlement agreed upon in December. In addition, Citigroup infused $255 million to its loan loss reserves in anticipation of future liabilities from a weak corporate economy.
However, as was the case with other commercial banks like WACHOVIA (WB, $36, down 2) and BANK ONE (ONE, $37, down 2), a strong-performing consumer business eased some of the pressure. The firm's consumer group, which includes retail banking and credit card services, jumped 25% year-over-year to $2.4 billion in the fourth quarter.
Despite all of the downward pressures to earnings, Citigroup was able to grow earnings by 8% in the overall year. According to CEO Sandy Weill, the firm faced "significant challenges: Continued weakness in global markets, record bankruptcies in the developed world.and intense scrutiny of its business practices." But the banking giant steered through the obstacles and posted record results, which is "a testament to the strength of Citigroup."
Business should improve for Citigroup in 2003. The firm expects to generate double-digit profit growth, as the stock market has a good chance of posting a positive return this year and corporations return to more normal spending trends. But even if the economy doesn't improve, we are confident that Citigroup will once again deliver record earnings. After all, it IS the largest financial firm in the world. You can't get to that level without weathering the tough times effectively.
FINANCIAL
THE BULL PULLS AHEAD WITH HIGHER EARNINGS
MERRILL LYNCH (MER, $36, down 5) posted 4Q02 earnings of $615 million, or 64 cents a share, beating estimates by a penny. Profits rose 25% from 4Q01 earnings of 51 cents. Including charges related to the stock research settlement, Merrill earned 63 cents -- still meeting expectations and vastly improving from 4Q01's charges-included loss of $1.51 a share. Revenue, however, declined 12% to $4.2 billion for the quarter and fell 15% to $18.6 billion for the full year.
TODD'S TAKE: The latest quarterly results tell a two-part story at Merrill. Basically, the numbers show us how an investment bank can make money in a weak stock market and banking environment.
Revenues were down across the board at Merrill. Stock and bond trading revenue dropped 40% and brokerage commissions fell 10%, as the third straight down year drove more investors away from the market. The investment banking side of the business didn't fare much better, as both underwriting revenue and advisory revenue dropped 22%, to $420 million and $165 million respectively. In addition, the weak market made it difficult for Merrill to make money on investments, and asset management revenue posted a 14% decline to $1.1 billion.
However, Merrill still posted a 25% profit increase. This performance was a strong testament to the effectiveness of the bank's drastic cost-cutting efforts. Over the last two years, Merrill has laid off over 21,000 employees, with 2,300 job cuts occurring in 4Q02. As a result, compensation costs fell 14% year-over-year. Additionally, the firm cut its non-compensation costs by 25% in the quarter. Despite falling revenues, the bank's profitability is at its highest mark in years.
The stock research settlement hampering all of the major investment banks dragged down Merrill's profits too. The bank paid $210 million for its part in the settlement. Earlier in the year, the firm paid $100 million to settle earlier charges in the stock research investigation.
Looking ahead, Merrill's future is cloudy. The company warned that another weak year in the stock market would cause further erosion in its trading and investment banking revenues. If that happens, the company said, "It will be difficult to maintain 2002 revenue levels in the current year."
That's the problem with Merrill. Unlike rival CITIGROUP (C, $36, down 1), the firm has no commercial banking business to fall back upon. Commercial banking was much stronger than investment banking this year, and the trend could continue this year. That's why we like Citigroup more than Merrill -- Citi doesn't have to worry as much about the falling stock market.
FAST FOOD
NOT-SO-HAPPY MEALS AT MCDONALD'S
MCDONALD'S (MCD, $14.90, down 0.55) posted the first quarterly loss in the history of the company Thursday. The company posted a 4Q02 net loss of $344 million, or 27 cents a share, compared with a profit of $272 million, or 21 cents a share, for the same quarter last year. Earlier guidance missed the mark, having called for a net loss of only 5-6 cents.
TODD'S TAKE: Shares dropped on the news, trading at under $15, the lowest level in eight years. Share price has been declining since summer highs saw prices in excess of $30. The company did not provide specific EPS guidance for the upcoming quarters.
The loss was partially attributable to an $810 million charge that covered the cost of exiting Latin American markets, abandoning a large technology implementation, and closing 719 stores, mostly in the US and Japan. The closings were much higher than expected; in December management had anticipated closure of only 175 stores.
The quick service restaurant industry as a whole saw declining growth in the second half of the year, reflecting a weak economy and declining consumer confidence. For McDonald's, sales increased a mere 1% for the year and 2% for the fourth quarter, and US sales declined 1.5% for the year and 1.4% for the quarter. Negative comparable sales, higher labor costs, and higher financial support to franchisees all put pressure on the bottom line.
McDonald's' new CEO said that the previously targeted 10-15% growth ratio was "unrealistic" at least in the short term, and that over the next 12 to 18 months, the focus for the burger giant will be on the foundation of the business -- and attempting to reverse the sales trends and margin declines.
Competition has been heating up in the fast food marketplace, as McDonald's, Burger King, and other competitors fight to maintain market share and adjust to changing consumer tastes. The hotly-debated "dollar menu" will continue, although the new CEO is open to change. Although customers like the price and variety of the dollar menu, the results haven't been spectacular for McDonald's or any of its competitors. The idea was that the dollar menu would drive incremental purchases - but in fact, incremental purchases have been more than offset by a shift in product mix to the dollar offerings, and the use of the dollar menu for single items rather than meal purchases.
In addition to the closures, the company is abandoning plans to develop a billion-dollar global technology system, which had been strongly supported by former CEO Jack Greenberg. The company is also planning to change its kitchen operations, and make improvements to food taste and service. The massive restaurant remodeling plan implemented by Greenberg is still in place, but Cantalupo has placed it on the table for potential cuts.
We look for a leaner McDonald's in the coming year-if not in terms of its burgers, at least in terms of its operations. Hopefully, that will result in an improvement in the stock price. But we're keeping a close eye on the burger behemoth. This stock is NOT for the faint of heart.
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