Mid-Week Analysis

By: PrudentBear.com | Wed, Jan 31, 2001
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GDP Growth
New Single Family Home Sales
Monthly Inventory of Unsold Homes

The stock market rally continues generally, with the blue-chips taking their turn to outperforming this week. So far this week, the Dow has added 2%, while the S&P500 has increased 1%. The economically sensitive issues are rallying strongly, with the Transports jumping 5% and the Morgan Stanley Cyclical index adding 4%. The Morgan Stanley Consumer index has increased 2%. The broad market is rallying as well, with the small cap Russell 2000 and the S&P400 Mid-cap indices both adding 2%. Bucking the trend, with today's declines, the Utilities and the NASDAQ 100 are down 1% for the week. The Morgan Stanley High Tech index in unchanged, while the Semiconductors have gained 6%. The Semiconductors gained 27% during January. The Street.com Internet index has declined 1%, reducing its year-to-date gain to 28%. The NASDAQ Telecommunications index has added 2%, increasing January gains to 20%. The Biotech index has declined 2% this week. The financial stocks have gained marginally, with the S&P Bank and the AMEX Securities Broker/Dealer indices adding 1%.

The credit market has rallied strongly, with two-year Treasury yields dropping 16 basis points to 4.64%. Five year Treasury yields have declined 13 basis points and the 10-year 14 basis points. Long-bond yields have declined 12 basis points to 5.52%. Mortgage yields have dropped sharply, with the benchmark Fannie Mae security seeing its yield drop 18 basis points to 6.63%. Agency yields have generally declined 16 basis points. Spreads continue to narrow across the board, with the 10-year dollar swap spread narrowing 6 to 80. The dollar rally appears to have stalled, with the dollar index declining about 1% so far this week.

The Federal Reserve, of course, reduced short-term interest rates 50 basis points today to 5.50. It was a rather interesting release from the Fed, excerpted here in part:

"Consumer and business confidence has eroded further, exacerbated by rising energy costs that continue to drain consumer purchasing power and press on business profit margins. Partly as a consequence, retail sales and business spending on capital equipment have weakened appreciably. In response, manufacturing production has been cut back sharply, with new technologies appearing to have accelerated the response of production and demand to potential excesses in the stock of inventories and capital equipment.

Taken together, and with inflation contained, these circumstances have called for a rapid and forceful response of monetary policy. The longer-term advances in technology and accompanying gains in productivity, however, exhibit few signs of abating and these gains, along with the lower interest rates, should support growth of the economy over time."

The Fed had plenty of data in which to draw evidence of what is widely known, the economy slowed markedly during the fourth quarter. Today, the government reported that GDP expanded at a rate of 1.4% during the fourth quarter, a decline from the third-quarter's 2.2%, and the slowest pace since 1995. While durable good spending dropped 3.4%, consumption increased by 2.9%. Interestingly, nonresidential construction spending increased 9.4%. Growth, however, was pressured by a 24% decline in automobile production that, according to Bloomberg, was the largest since a 33.7% decline in early 1996. The economy's current weak spot is clearly the manufacturing sector, with more confirmation coming with today's decline in the Chicago National Association of Purchasing Managers index to 40.2 from 45.2. And while the new orders and employment components declined, it is certainly worth noting that the important prices paid component actually increased more than one point to a strong 62.9.

And while the Federal Reserve completes its extraordinary 100 basis point cut for the month of January (and Wall Street analysts clamor for more, more, more!) there are certainly signs that even easier credit availability is about the last thing needed in the real estate markets. Today, the Commerce Department announced that December new home sales surged 13% from November, the largest increase since early 1993. It was one of the highest levels ever recorded, with an outright record for sales in the West. New home sales came in at a rate of 975,000 units, blowing away the consensus estimate of 890,000. Year over year, sales were up 6% overall and 31% in the West. The inventory of new homes dropped to a very low 3.9 months, the lowest since April 1999. Notably, the inventory of homes available in the West is 15% below this time last year. The average selling price increased to $205,100. Bloomberg included a cogent quote by Ian Shepherdson, chief U.S. economist at High Frequency Economics: "Given the severe weather in December, this number is nothing short of amazing. The numbers neatly capture the chasm between the state of the industrial sector and the rest of the economy." For all of 2000, new home sales were only slightly below the record level from 1999.

This morning's release of the Mortgage Bankers Association's weekly mortgage application index showed an 8% decline from the previous week. Yet despite the moderate decline, the number of purchase applications remains above the levels from this time last year, while the number of applications for mortgage refinancings is about four times last year's. With mortgage rates again dropping sharply this week and with adjustable mortgage rates declining with the Fed rate cuts, signs continue to point to a very strong housing market.

There are also signs that the labor market is not as weak as some believe. An interesting article came today from MarketNews International. In its "Reality Check" column - US Recruiters Report January Jobs Rebounded - an executive (Eric Lindberg) from an employment agency stated "we're seeing a little slowdown in the construction area, but all the other areas we deal with - healthcare, information technology and banking - are all very strong…We're still finding it difficult to find people - we have plenty of openings. The critical part is still finding the right person."

From MarketNews International: "Wage pressures, while 'slowing a bit,' continue to be expressed through counter offers, reserved for employees that threaten to jump ship for higher pay. 'We commonly see increases of 10%, 15%, or 20% for them to stay,' Lindberg said. Lindberg's concern is that 'negativity about the economy has been overemphasized by the press' and could spur 'a downward spiral' of the economy should companies become too conservative in their outlooks. For instance, on the 26,000 Chrysler layoffs over three years, he noted the headlines never pointed out that most would be through attrition and retirement, a relatively benign way to go about downsizing."

MarketNews International also questioned Tim Loncharich, an executive from a Dallas-based employment company, about the slowing job market: "I see none. Zero. Despite the layoffs we've been reading about in the last three weeks, we see no corresponding increase in the unemployment rate." Although the holidays and bad weather were behind a sluggish December, "two weeks into January our sales have bounced right back up." Further from Loncharich: "the stock option dreams have gone away, but these people are still in demand. And they've gotten smarter. They're asking for more in compensation. These people are in extraordinary strong demand - we still can't find enough web designers."

And from Charles Sigrist, executive from a Chicago based agency, "based on his branches around the nation, the West Coast and California" continue to have "strong job growth." Also from MarketNews International: "An official for another national staffing firm observed a good news/bad news scenario for the current job market. The bad news is that January was a little flat with companies in a layoff or restructuring mode…the good news is that we're finally going to find people to fill the openings we have."

And while much attention was paid to yesterday's sharp drop in consumer confidence, it does not appear that this is translating into less spending. Yesterday, the Bank of Tokyo-Mitsubishi weekly retail sales report showed an increase of sales from the previous week, with same stores sales 3.9% above very strong sales from this time last year.

There is certainly not, however, much encouraging fundamental news in the technology sector. Yesterday, Applied Materials (AMAT) lowered revenue and earnings guidance for the quarter ending today. Revenues were guided down about 10% to $2.6 to $2.7 billion. Yet, even using the low of the range, revenues are still expected to increase 44% above year ago levels. All the same, it does appear that there is increasing weakness looking forward. AMAT reported that orders are expected to be below $2.6 billion. Earlier, Chartered Semiconductor (out of Singapore) announced plans to scale back its aggressive expansion, revising capital spending to $1.2 billion from $1.5 billion. Chartered also indicated that its utilization rate would trend toward 70% in the first quarter of 2001.

The Semiconductor industry should be watched very carefully over the coming months. Semiconductor companies increased capital spending at record rates the past couple years anticipating the forecasted strong demand of electronics from computers to cell phones. We have in the past written that massive overcapacity was being created, and it is becoming apparent that the unfolding slowdown is the beginning of the inevitable severe industry retrenchment. Over the past couple weeks there have been some interesting developments in the wireless world. Just about every handset maker has guided down expectations for at least the first-half of the year. According to Nokia, the industry is looking for 500 to 550 million units sold in 2001, down from earlier expectations of 550 million. There also continues to be storm clouds hovering over the development upgraded technologies, particularly that of "3G technology."

With the marketplace already suffering from telecom debt worries, two of Europe's largest mobile phone companies have additional water to throw on the fire. Vodafone and Telecom Italia Mobile (TIM) said that 2.5G mobile phones would not be sold in significant volumes until next year. With one TIM executive forecasting: "It will probable be summer 2002 before most of the handsets we have on sale are GPRS. I also think there is some over-hyping about the timing of third-generation phones. My guess is 2004 rather than 2002."

Additionally, because France only had two bidders for its four 3G licenses, it decided to hold another round of its contest. Bouygues Telecom was the latest bidder to pull out, citing it did not want to assume "unreasonable financial risk." Telefonica pulled its bid earlier citing the high prices France was charging for the licenses.

It is an interesting and complex world, in the markets and throughout the global economy. There are certainly many fundamental issues that should weigh on stocks, particularly in the technology area. For how long Federal Reserve rate cuts provide the courage for investors to continue to "look over the valley," only time will tell. We are also forced to wait and see how the highly unstable and distorted US financial system and economy responds to these very aggressive moves from the Federal Reserve.


 

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Mid-Week Analysis
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