Mixed Data = Recovery?
Economists are all singing the same tune about the economy. The data has gone from bad to mixed, which obviously signals an imminent recovery. Why cannot the mixed data show exactly that, the economy is still in limbo? The National Bureau of Economic Research (NBER) seems to be the only organization which agrees. Last week the NBER issued a memo saying, "With continuing declines in employment and other indicators, there is no suggestion in the data as yet of a trough in economic activity." Robert Hall, Stanford economics professor and committee chairman, with added more detail in an interview with the FT, "We're not about to declare a trough, because one hasn't occurred, and we typically wait a long time until after the fact." Victor Zarnowitz, committee member and fellow at the Conference Board, is "somewhat encouraged by recent, mixed signs of a turnaround, but just mildly. I'm not strongly encouraged because the details are not strongly encouraging."
Today's release of industrial production indicates the manufacturing sector remains in the doldrums. Capacity utilization fell to 74.4, the lowest level since 1983. It would seem obvious that this is an indication that the economy is still experiencing weakness. However, here is how Bloomberg started its story, "U.S. industrial production declined less in December than at any time in five months." This was followed up with a quote from Cynthia Latta, an economist at DRI-WEFA Global Insight, "This says the economy is probably getting ready to turn around." Just because certain statistics are near previous lows, does not mean it cannot go lower. I think economist have been too busy day-trading stocks and are looking at previous lows as some sort of technical resistance.
Even throughout the much publicized restructuring and plant closings, total capacity still grew by 1.5% last year. It will be very difficult for the economy to turn around without major reductions in capacity. I don't wish bad times for anyone, but the economy will continue to suffer while there are a host of marginal companies competing against each other and holding prices down, and utilization rates low. It will take a long time to correct the distortions, but the U.S. economy experienced the longest bout of prosperity ever, which culminated into one of the biggest bubbles in history. To think a minor recession is all that is needed to correct the imbalances is balderdash (I hear Jim Rogers has return from his journey).
The optical industry is a prime example of an industry that needs to shut down capacity. The industry is currently holding an industry conference. One Wall Street analyst in attendance confides that the industry is still fixated on believing their own hype. The industry seems to think that video on demand will be the "killer app" to get broadband to the "last mile." Others are trying to spin the capacity issue saying there is not too much bandwidth, but too few customers. At the same time the industry is confused by regulatory issues, lack of standards, lack of mature technology, and financing uncertainty. It will be very difficult for the industry to spend capital on new equipment, while all the uncertainty hangs over the industry. The bandwidth problem will continue to plague the industry as one Wall Street firm calculated that each year a dollar buys 60% more capacity. This means bandwidth demand must grow by 60% each year just to have flat revenues. There was buzz also that Intel already has built an "optical" fab and is entering the optical component space. I doubt that would be welcome news to those trying to turn a profit in a market that is experiencing severe overcapacity.
Yesterday, Intel released fourth quarter earnings, but more importantly Intel revealed its capital expenditures will drop 25%. Intel anticipates spending $5.5 billion verses last year's $7.3 billion. Revenue for 2001 was $26.5 billion, down 21%, and up just slightly over 1998 results. In 1998, Intel employed about 65,000 workers. Today, even after laying off 5,000 employees, Intel employs 29% more people. In order to align employees to revenue, Intel would have to layoff almost 19,000 employees. The increased number of employees combined with SG&A expense as a percent of sales declined for the second consecutive quarter, after a long trend of increasing since 1998. Without significant cost cutting it will be difficult for Intel to grow into its valuation of 180 times earnings.
Layoffs continue in tech-land. Mitsubishi is cutting 2,000 jobs. 3Com announced it would cut an additional 9% of its workers in a move to help restore profitability. Marconi, the European telecommunications equipment company, announced another 4,000 job losses, on top of the 9,000 already cut. Additionally, Marconi warned investors, "The outlook is still very difficult. We don't expect to see any improvement in the market for the whole of 2002."
Merrill Lynch's chief U.S. strategist, Richard Bernstein, dropped his equity weighting to 50% from 60%. "We have commented that there is a thin line between a liquidity-driven market that anticipates improving fundamentals and a bubble. The equity market may have stepped over that line," Bernstein wrote in a report.
Due to infrequent transactions, it is difficult to get timely data on the real estate market, and even harder for the commercial side. Looking at anecdotal evidence provides the best way to measure its health. So far it appears that commercial real estate has yet to pick up. The LA Times reported that the office space vacancy rate in Burbank has soared to 15.2% and is likely on its way to 20%. Subleases are making the situation worse for landlords. The same article reported that sublease space is being offered at 35% discounts in the airport area of LA. While it is obvious that higher vacancy rates and lower rents put pressure on real estate values, it is difficult to measure the degree. The Dallas Morning News today reported that the Ericsson Tower in the Telecom Corridor area of Richardson, which recently has been called the Telecom Crater, sold for $16 million. The buyer commented that "A year ago we made an offer to buy that property for $33 million, and we didn't get the deal."
With earnings season underway, investors will finally be able to get a sense on how the economy is running at a micro level. There has been enough time since September 11 for companies to get a sense for what sustained demand is likely to be going forward. However, company forecasts should always be taken with a block of salt.