The Survey Says...
The Institute for Supply Management (ISM) released the results its March surveys this week. On Monday, the manufacturing survey had the second consecutive reading over 50 since July 2000 coming in at 55.6. The reading was also about a point above estimates. Additionally, almost every component of the index showed improvement. The lone holdout remains the employment picture. This will likely to continue even if the recovery continues. Corporate profits were damaged much more than the overall economy. With managers concentrating on shoring up profits, companies will be slow to add costs, which include adding workers. There is considerable evidence that the majority of the recent manufacturing activity has been to replenish dwindled inventories. Norbert J. Ore, chairman of the ISM, stated, "we have reached the end of the inventory liquidation."
Wednesday, ISM released the non-manufacturing survey, which also showed an improving sentiment among business managers. Interestingly, the non-manufacturing survey shows that employment remains the biggest drag on the index. In fact, employment was the only component that is "decreasing faster" from the previous month. The non-manufacturing survey indicates that the inventory replenishment has ended as well, with the inventory component increasing for the first time in over a year. Additionally, there is an increased feeling that inventories are too high. However, with new orders increasing there is either a contradictory signal or managers are counting on a significant increase in end-demand.
Factory orders in February declined 0.1%, but non-defense orders excluding aircraft rose 0.9%. Economists were pointing to this as signs of a recovery in business investment. With all the focus looking for the turn in various economic data, it is helpful to take a step back every once in a while to remember what the actual dollar amount is, and how it compares to the past. Non-defense, non-transportation orders, which rose 0.9% in March remains well below levels all the way back to 1998, and below most of 1997. In fact, almost every single component that makes up the Commerce Department's factory orders is below levels of 1998. Consumer goods and transportation, surprise surprise, are the components that have not declined to 1997-1998 levels.
Automakers continue to entice consumers with incentives, which will continue at least through the end of April. GM continues to use aggressive marketing to move vehicles. Tuesday, GM announced that it will continue its current incentive program until April 30. Interestingly, GM is the most aggressive in using incentives and is posting better results that the other two US automakers, but it still lags behind most of the foreign makers. GM sales were down almost 2% in March while 13 foreign automakers increased sales, and only six experienced declining sales. (I'm including Mercedes, Jaguar, etc. as foreign makers even thought they have a US parent or operations). Some of the foreign automakers set records for the month of March. Mercedes-Benz (sales up 5.6%), Toyota (sales up 4.1%), Lexus (sales up 8.4%), Mitsubishi (sales up 23%), Audi (sales up 2.4%), and BMW (sales up 19%) all posted record March sales.
One analyst was quoted in a Bloomberg article that the sales incentives are not driving the month-to-month sales. Then why does GM along with several others keep extending them? Does he think GM and Ford like losing money?
The past year has been a very unique. Technology and manufacturing pushed the economy into recession per the NBER. However, consumers never slowed down spending, nor did residential housing take a breather. In fact, a record number of new houses were. As employment fell, consumer debt increased. Since the economy is primarily a consumer driven market, it is difficult to see how the current period can be classified as a recession. True, manufacturing and technology has been severally hit, but there have been minimal repercussions to the overall economy. Or at least yet.
With housing holding up, and housing accounting for the majority of the assets of most households, it is no wonder why there was no "negative wealth effect" - wealth didn't depreciate. As long as the consumer has faith in the economy, everything keeps chugging along. There are several million-dollar questions. Will consumers maintain their spending spree? Will housing continue to hold up? Will business start undertaking capital projects? How much will corporate profits rebound?
Regardless of what happens in the overall economy, corporations will have difficulty restoring profits to peak levels. We have seen a sea change in corporate America, led by a similar sea change in investors. Investors also used to be enamored with top-line growth, and would not only dismiss discussions of aggressive accounting, but seemed to support it (anyone remember a Tyco report in 1999?). Because investors scrutinizing companies much more than just a year go, corporate managers now have to appreciate the various risks that were previously disregarded. More importantly, investors are looking for earnings, not just top-line growth. This in turn forces managers to be much more cost conscious. William Esrey, chairman of Sprint and head of the Business Council, recently stated, "almost all the business people I talk to remain extremely cautious." A recent poll by the Business Council showed that 56% of companies plan to either cut their workforce or hold it steady, and 53% planned on reducing capital expenditures. The Challenger, Gray & Christmas layoff report revealed that employers anticipate cutting 102,315 workers. While the trend in announced layoffs is getting better, the 102,315 job-cuts is still "133 percent higher than the monthly average job-cut figure of 43,870 in 1991 and 1992 - during the last recession," according to John Challenger, CEO of the outplacement firm. Throw in a couple economic challenges like global overcapacity and rising healthcare costs, and current multiples of 30 times earnings will be difficult to justify.
While the 25% drop in the S&P 500 is similar to the 31% drop in operating earnings, everyone should know that a decent portion of those operating earnings contained a lot of smoke and mirrors. In order for earnings to get back to peak levels, business conditions will have to be better than in 2000 for the simple reason that earnings will not be able to be manufactured, but from actual manufacturing.