UNEDITED

This week marks the first week big of peak earnings season. Almost 25% of the S&P 500 has reported earnings. Of the 123 companies that have reported, 69% have beat estimates, only 9% have failed to meet forecasts. Analysts estimated that fourth quarter earnings would climb 21.9% during the fourth quarter. Using the actual earnings for the 25% that have reported, earnings growth is 22.7%. This is likely to climb as it is likely that more companies will report better than expected earnings.

Investors have greeted earnings enthusiastically. The S&P 500 is up 3.2% already this year, with NASDAQ has advanced 6.9%. Small capitalization stocks continue to lead the market. The Russell 2000 is up 7.3% since the end of 2003. While most stocks have advanced after announcing earnings, a few have dropped. Intel remains lower a week after indicating first quarter results might be lower than anticipated. Apple and Yahoo are also trading lower. Even after beating analysts' EPS estimates for the fourth quarter, 3M dropped almost 6% after it announced fourth quarter US sales volumes were flat with last year.

Harley Davidson's results were better than analysts' expected, but its future outlook caused investors to pause. During the conference call the company said, "Our U.S. dealer network experienced some modest decline in retail sales during the fourth quarter." The company also said pricing fell by 1%. Both were explained by the elimination of the 100^th Anniversary bike. The company also acknowledged that, "The stock market bubble and the associated wealth effect during the mid and late 1990s continued to fuel a heated-up unit growth rate, averaging 17.1 percent per year." Now that this has dissipated, Harley forecasts that unit sales growth will revert to its core unit growth rate of 7% to 9% for the foreseeable future. The company, however, insists that it can leverage high-single digit unit growth into mid-teen EPS growth.

Similar to previous quarters, General Motors Corp. has turned into General Mortgage Corp. On a GAAP basis, GM lost $2 million during the first quarter. The automotive operations lost $678 million on form continuing operations and the financing and insurance operations earned $676 million. After a few "adjustments", GM earned $838 million during the fourth quarter. Most of this adjustment is related to an agreement made with the UAW to provide lump-sum payment and vehicle discount vouchers to retired workers. Under GAPP was expensed, but GM believes that since it was one-time in nature, earnings should be adjusted to provide better a better comparison. While we agree it allows for better comparisons, it is still a real expense of $725 million and it is glossed over by this treatment. It will be interesting if that expense is added back next year when the company has to use it as a comparison.

GM's inventory has increased substantially over the past year, especially its trucks. Truck inventories grew to 86 days supply in the fourth quarter from 62 days last year. This is also something that Delphi Automotive acknowledged in its earnings report. When it commented on the outlook for the first quarter the company said, "we're seeing weaker production schedules than anticipated among some North American customers, reflecting year-end inventory positions."

While the automakers might have to slow production, the rest of the manufacturing sector is poised for growth. Fastenal, one of the leading industrial distributors, reported fourth quarter earnings this week that were 18% better than last year on sales growth of 15%. The company included a table showing its average daily sales growth by month. This table is reproduced in part and shows the acceleration in sales during the fourth quarter.

Commenting on its fluid power segment, Eaton's CEO and chairman, Alexander M. Cutler, said, "The traditional mobile and industrial markets began to recover in the fourth quarter, reflecting the pickup in capital goods expenditures. We anticipate that this recovery will gather steam during 2004, resulting in the first year of growth in these markets since 2000."

While manufacturing continues to show signs of expansion, employment continues to be the biggest economic issue. An increase in temporary workers is usually a precursor to employment growth. Fourth quarter results from Kelly Services bodes well for employment outlook. Revenue increased 11.1% from the fourth quarter last year, and 6.2% sequentially. Year-over-year sales growth for the US commercial staffing segment increased 4.0%, compared to a 2.6% decline in third quarter.

Earlier this month, Ryland Group announced that fourth quarter orders were down 9%. This announcement caused the stock to drop about 10%. It seems that was yesterday's news. On Wednesday, the company reported "highest fourth-quarter consolidated net earnings, revenues, closings, backlog and earnings per share in its history." Record results have become the norm in the homebuilding sector. Centex, the nation's largest homebuilder, reported the highest quarterly earnings in its history. Centex earned $3.04 per share in the fourth quarter, which was $0.22 better than analysts' estimates and 22% ahead of last year's results. Closings increased 15% and sales increased 9% compared to last year. The dollar value of its backlog increased 35% to $3.8 billion, this is about two quarters of revenue.

On Wednesday, the Department of Commerce released December new housing starts. Housing starts topped 2 million units on an annualized basis for the second straight month. Starts increased 1.6% from November and are 15% higher than last December. Permits also increased in December, but still trail starts by 164,000. The Mortgage Bankers Association index of mortgage applications jumped 30% for the week ending January 16. The purchase index soared 12.5% to an all time while the index measuring refinance activity jumped over 50% to 33.27.3. This was the highest since the first week of August 2003.

Fourth quarter results are confirming what everyone should already have known, the economy expanded at a very healthy pace during the fourth quarter. By most accounts it has continued into 2004 and will likely continue until credit conditions deteriorate or interest rates increase. The few companies that are disappointing investors are blaming company specific issues. Valuations remain extended, but investors have not focused on valuations for several years and don't appear overly concerned. In fact, according to the results from E-Trade, the retail trader is back. Trading increased 46% in the fourth quarter 2003 from 2002 and has increase another 35 to 40 percent in the first three weeks of January. Margin debt soared 33% from the third quarter to $1.64 billion and up 80% from a year ago. While companies have boosted earnings, it appears stock prices have decoupled from the underlying fundamentals. Everyone knows by now that this condition can last much longer than thought possible. Unfortunately, it always comes to an end.