2002: Bipolar Forecasts
Wall Street strategists are systematically forecasting a strengthening economy for 2003. The party line calls for business spending to pick up while the consumer takes a back seat after propping up the economy since 2000. President Bush also included an increase in the amount small businesses can expense for equipment purchases. At least that is what is trying to be sold to the markets. Corporate bond spreads have narrowed considerably since the first part of October when spreads widened to historic levels. Ford's 10-year spread has narrowed by 220 basis points and GM's by 193 basis points. Overall, investment grade spread have improved by 48 basis points after blowing out to almost 280 basis points over Treasuries during October. Investment grade bonds have retraced over half the widening that occurred during the third quarter last year. Speculative grade bonds have also recovered about half of the widening as well. Default swaps have come in considerably as well. Ford's 5-year default swap has declined by over 40%, Sprint's has fallen by more than more than 75% from the peak in late July. Verzion down 74%, AT&T down 70%, SBC Communication down 75%, AOL down 72%, and Disney down 60%. A few of these are back to the levels from the beginning of last year. It looks like investors have put 2002 behind them and are focusing on positive news. Taking advantage of the improved market conditions, Tyco issued $3.75 billion in convertible bonds. Watching corporate debt issuance will be a key factor in gauging if and to what degree there is a recovery in business spending.
Unfortunately for the economy, it really doesn't matter what businesses do. Consumers power about two-thirds of the economy. Businesses will have to spend like crazy if they are going to make much of a difference. And with consumers slowing down, it is unlikely that business will go crazy. Even if companies are able to raise funds, there are several overhanging issues that will make it difficult for businesses to undertake a prolonged meaningful spending recovery. The continued focus on companies to generate cash flow combined with the considerable amount of overcapacity that still exists will keep companies from embarking on a spending spree.
More important for the economy is what consumers do this year. The U.S. consumer was reliquidified by two refinancing waves during the past two years. It is unlikely that a third refinance wave will happen this year. Refinancings will still remain popular as long as interest rates hover at these levels, but the likelihood that interest rates will drop enough to spur another wave is remote. Even if rates do drop, housing prices are leveling off and will not provide amble amount of equity to extract. We are starting to see the repercussions of a slowing consumer. Aggressive retailers have expanded the store base to the point where single digit total sales growth causes same store sales to shrink. This holiday shopping season is littered with examples of this.
While the International Council of Shopping Centers showed that home furnishings and furniture performed the best, a 7.4% gain, CSFB this week cut its rating on Ethan Allen and La-Z-Boy to Neutral from Outperform. CSFB cited, "retail furniture sales slowed in December following relatively stable results over the past few months."
Circuit City reported December same store sales fell 6%. Last month, Best Buy announced its December same store sales fell by 5%. Last month, Tweeter said it expected December same store sales to fall 12% to 15%. This week, Tweeter announced total sales fell 1% and comparable store sales fell 10.4%. This is the type of situation that will be played out throughout the retail sector. Total sales start slipping due to consumers pulling back causing large declines in individual stores due to the massive expansion of retailers. Tweeter also announced it is in negotiations with lender for a waiver on a loan requiring the company to maintain an EBITDA level above $40 million over a trailing twelve-month period. RadioShack announced that lower mobile handset sales were slow during the holiday season and will not meet its previous earnings forecast.
Tiffany & Co. also reported lackluster holiday sales. US same store sales increased only 1%, while stores in Japan showed a decline of 10%.
Home Depot announced same store sales fell 10% during the fourth quarter, twice the previous estimate. Robert Nardelli, CEO of Home Depot, further warned that revenue growth would be flat in 2003.
SEC is telling companies that use assumed rates of returns greater than 9%, they have some explaining to do. Last year, there were almost 400 companies of the almost 9000 companies listed on one to the three major exchanges with an assumed rate of return greater than 9%. While this is not a large percent of companies, the list is comprised of several largest companies, including the current big kahuna - GE at 9.5%. Other companies include: Abbott Labs (9.5%), American Express (9.5%), Anheuser-Busch (9.5%), Bank of America (10.0%), Bristol Myers (10.0%), Fannie Mae (9.5%), JP Morgan Chase (9.25%), Eli Lilly (10.5%), Merck (10%), Pepsi (9.8%) SBC Communication (9.5%), and Verzion (9.25%).
Today, the Wall Street Journal reported a unique twist to Bush's tax plan. In order not to discriminate against companies that do not pay dividends and do not wish to, retained earnings will be treated as reinvested dividends. This will allow investors to exclude the company's increase in retained earnings when calculating their capital gains tax. It will be interesting to watch detail unfold. What happens if the company loses money? Do investors have to pay taxes if the stock does not decline an equal amount? How will short sales be treated? Plus, this is only applicable on earnings that have been taxed. Could the dividend tax issue be the part of the economic plan Bush is willing to concede to get the rest of the package passed? Then if the economy and stock market continue to languish, he would have somewhere to point a finger during the re-election campaign.