The End of an Era
The Enron collapse will resonate throughout the economy for a long time. As exemplified by Enron, aggressive managers and executives that were rewarded over the past several years. As Enron falls, hopefully prudence and cautiousness will regain popularity. Additionally, the Enron stock plunge put the wheels in motion for some sort of pension reform as signaled by President Bush in Tuesday's State of the Union speech.
The booming economy and bull market fed on itself as the most aggressive individuals were promoted and caution and prudence were scoffed at. Whether it was an aggressive buyer that ordered a lot of product that was sold, an aggressive CEO that went on an acquisition spree, aggressiveness was rewarded and caution was not. So it is natural that those in the top spots in companies have an aggressive mindset, that is who they are. Look at who are deemed the best CEOs around: Welch, Gerstner, Kozlowski, Gates. It will require time to purge the economy.
Sparked by Enron, this week accounting issues moved front and center. The reversal today gives the appearance that the market has moved on. Maybe it has, but it is very likely that these issues will regain popularity once companies start releasing their annual reports in late March.
I'm not a big fan of labor unions, but it looks like their expressed concern over defined contribution was valid. I thought the biggest problem with defined contribution plans was the shift from professional managers to individuals, and companies did very little to educate their employees. But in light of the Enron debacle, it seems a lot of companies push their own stock for employees to buy and used company stock as their payment for matching contributions. This increases operating earnings and dilutes shareholders. For the companies in the Dow, pension plans contributed $5 billion to earnings in 2000. Also the losses in 2000 are only now showing up on companies' books when they report 2001 earnings.
There is also a very real possibility that the shift from defined benefit retirement plans (traditional pension plans) to defined contribution plans (401(k)s) will reverse. In recent years companies enjoyed above average returns. For those with traditional pension plans, the huge gains over the past five years allowed companies to skip payments into the pension plans. Additionally, it was common for aggressive companies to raise their assumed rate of return. Now that the market has posted back-to-back declines with this year shaping up to be equally challenging, companies will have to start funding their pension plans once again. GM already announced it will take pay in $2 billion to fund its pension plan after it experienced a 5% decline instead of its assumed 10% gain. GM said they are funding it to avoid higher insurance premiums.
Employees of companies with defined contribution plans might not realize that not only was the investment risk passed on to them, but they also gave up an insured retirement.
Today, Greenspan signaled that the economy must be bottoming. Greenspan ended an era (sure feels that long) by not cutting interest rates. Combined with today's report that fourth quarter GDP rose 0.2% in the fourth quarter, everything sure points to a bottom. However, what is the quality of the "bottom"?
Looking a little deeper into the data, it confirms what we already know. The American consumer is not rolling over. Last week I wrote:
"One factor that will weigh on the first quarter is the amount of sales that were pulled forward due to heavy promotional activity. Another much less discussed factor is the amount of economic activity from the third quarter that was delayed into the fourth quarter relating to September 11. Gartner estimates that 8% of PC sales in the fourth quarter were pushed into the quarter from the third."
If Gartner is right about 8% of fourth quarter computer sales were pushed into the fourth quarter from the third due to September 11, which would be all the growth in computers. Furthermore, adding those sales, which equal $23 billion, to the third quarter and subtracting it from the fourth quarter results in GDP decreasing by -0.5%. (All GDP calculations assume taking the numbers at face value and not trying to figure out hedonic or seasonal adjustments).
Most of the growth again came from personal expenditures, which were up 1.3%, or $84.5 billion. Of that gain, almost $80 billion was due to increased purchases of durable goods. There is no doubt that attractive financing deals spurred spending. Sales of autos and auto parts increased $57.7 billion, or more than 16% from the third quarter and up 22% last year's fourth quarter. So far it does not appear that the run on autos has abated. Incentives of $2,500 from Ford and up to $3,000 on some GM models are surely having the desire effect. It will be interesting to see how long the automakers can continue to sell cars at such low margins. While sales are continuing to run at very health rates, there is little doubt that the pace will prove unsustainable.
The question remains "how sustainable is the growth in consumption?" And only time will tell.
Global Crossing, the once high-flying telecom company, filed for bankruptcy this week, and will be purchased for $750 million, which is less then 20% its trailing 12-months of revenue. Two years ago Global Crossing was a $40 billion company trading at 27 times trailing revenue.
Toys "R" Us is another retailer scaling back operations. It has decided to close 64 stores and layoff 1,900 employees as it tries to retrench and regain market share from Wal-Mart by focusing on redesigning its stores and becoming a better place to shop. As a father of two little girls, I can vouch that the newer design is a huge improvement. Now I just have to learn where everything is again.
Friday will be another event filled morning, with the focus mainly on the employment situation report. Anecdotally there sure has not been a plethora of good news on the labor front. Expectations are for; you guessed it, a lower decline. Estimates call for non-farm payrolls to decline by 80,000 vs. the 124,000 decline in December. The unemployment rate is expected to raise 0.1% to 5.9%.