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Stocks Weak, Consumers Strong

All the bulls that were asking how much lower can stocks go are starting to get answers this week. The Internet software companies proved how fast the technology sector is imploding. All the talk was on Ariba drastically missing all estimate Wall Street forecasts. Not only did Arbia state that it would lose 0.20 a share instead of making a nickel, but it will also have revenues of only $90 million. Wall Street had estimates in the $171 million range. Wall Street, caught totally flat-footed, immediately reduced estimates for the rest of the year. Inktomi also surprised analysts by announcing it would lose $0.23 - $0.25 per share on revenue of $36 to $38 million. Analysts expected Inktomi to earn $0.04 on $63 million in revenue.

While today's rumor of Lucent's eminent bankruptcy was refuted by the company, Lucent is thought to be drawing down a $3.8 billion credit line. Since Lucent only received a fraction of its initial projection for Agere, Lucent is on shaky ground. Most analysts expect Lucent to have enough cash on hand to get through the year and finish its restructuring. However, the restructuring needs to work for Lucent to remain viable.

Mark Cuban's guest host appearance on CNBC last Friday proved to be a pleasant surprise. With his usual candor, Mr. Cuban took technology analysts to task saying "They're idiots" and "They have no clue."

Now there are signs that the technology cancer is spreading. The USA Today ran a story yesterday discussing rental rates for the metropolitan areas with large technology exposure. New York rates have declined almost 10% to $57 per square foot, while vacancies have almost doubled to 8%. And this is only since the beginning of the year. New York is the market that has held up the best of all the areas reviewed. Phoenix has experienced a 15% drop in rates with vacancies up to 9% from 6%. Austin has been hit hardest, with rates dropping 27% and vacancies have soared to 13% from just 3% at the beginning of the year. Rates in Seattle have not declined significantly yet, but vacancies are at 10% compared to last year's all-time low of 1%. With Boeing moving its headquarters out of Seattle the vacancy rate will increase almost another 1.5%. While rates have not dropped significantly, real estate experts in Seattle look to San Francisco as a leading indicator. Rents of the converted warehouses that Internet companies flocked to have dropped 24% this year with vacancies doubling to 11%. The on-going energy crisis in California and the Pacific Northwest does not bode well for a recovery anytime soon.

The focus now turns to the residential real estate market. This has been one of the last standing pillars of the economy. First signs of weakness should appear in resort-type locations as second homes start coming to market.

The U.S. consumer still mystifies economists. Auto sales for March came in at 17.1 million run rate, better than anyone forecasted. While down from last year's blistering record pace, a run rate above 16 million is considered a good year. The Asian automakers continue to gain market share from domestic companies. Asian automakers gained more than 3% market share to 29% of the market. Toyota posted its best month ever. Economists that are expecting a consumer slowdown are quick to point out the huge incentives that automakers were awarding to move cars off the lot. However, that misses the point that consumers are still willing to saddle themselves with increased indebtedness and higher monthly expenses. Maybe the Dallas Fed President has more pull with the consumer than I thought and everyone took him up on the suggestion to "go buy an SUV."

Retailers are also seeing continued spending by consumers. Yesterday, Best Buy reported sales for the quarter ending March 3rd. Same store sales increased 1.8% with total sales increasing 26%. Best Buy noted strength in its digital products, namely DVD and high-definition television. Anecdotally, the last couple of times I went to Best Buy I had to drive around the parking lot for five minutes to find a parking spot and a lot of shoppers were hovering around the TVs. Market News International's Reality Check column highlighted the sentiment among shopping mall operators. All the operators were positive. Karan MacDonald, a spokesperson for Taubman's Centers, a national mall chain, summed up the overall mood "It sounds to me like March was good - most of my mall managers expect to stay even with last year or post low-single digit increases." Given how strong the economy was during the first quarter of last year, this is quite a testament.

The energy crisis has hit the Atlantic coast. Massachusetts Electric was approved to increase utility rates up to 69%. The rate hike will only apply to about 300,000 customers that opened accounts within the past 3 years. The largest increase of 69% will be for industrial customers, residential customer will fare a little better with rates increasing 23%. Mass. Electric indicated that rate increases will be sought for another 900,000 customers after July 1. Mass. Electric is currently paying almost 6.4 cents per kWh for electricity it can only sell for 5.4 cents. Earlier this week Mayor Giuliani said New York City could experience power outages this summer.

Japan has finally come up with a plan to bailout its distressed banking system. The plan centers on a $87 billion government sponsored fund to buy shares from the banks as they unwind their cross-holdings. There were some squabbles today on some of the details, but most expect the plan to be finalized soon so the fund can start working in the next few months - in time for the half-year results reported in September. Starting in September Japanese companies have to value investments at market value instead of cost. This new accounting rule is expected to shed more light on how dire the situation is. One indication of just how bad the banking situation is from Goldman Sachs. David Atkinson from Goldman's Japan office determined that it would take up to 150 years for Japanese companies to repay their loans at current earnings levels. The Japanese plan is calling for companies to deal with their debt in the next ten years. Mr Atkinson does not see that as viable and "there is not a single sector that could repay within 20 years, let alone 10."

Eisuke Sakakibara, Japan's ex-deputy minister of finance, remains pessimistic on the Japanese economy. While optimistic longer term, Mr. Sakakibara sees "a possibility the economy will get a double-dip recession."

The gutting of American manufacturing took a couple more hits this week as Republic Technologies International joined the long list of steel producers to file Chapter 11 and Mattel announced it would close its last US plant and move it to Mexico citing cost cutting measures.

What does all this mean? With companies missing revenue forecast by such a large margin, Wall Street does not recognize the severity of the fallout from the tech bubble. It is highly likely that growth will fall faster than estimates, and turn negative, as Wall Street keeps looking for the silver lining. Lucent shows how fast an established company can slip once it leverages itself and experiences unfavorable market conditions. At one point today, Lucent slipped below its 1996 IPO price. While consumers are continuing to empty their wallet at a record pace, the day will come when they realize they need to start saving again. Remember that household wealth declined last year for the first time since the government started following it in the 1940s. As consumers retrench to get their financial house in order the economy, being dependent on consumption, will slip in to a recession. Not a pretty picture, but there is no way to get out of a bubble except for not creating one in the first place.

Selected emailed questions or comments will be addressed on Bears' Chat.

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