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Un-Productivity Abounds

Mortgage Refinancing Index

The latest consumer credit data suggest that the American consumer might be starting to retrench and curb the reckless spending spree of the past several years. That is certainly how many are viewing the data, with the notion that the weak job market is causing consumers to be more frugal. Consumer borrowing rose only $6.2 billion, or a 4.7% annual rate. This was the slowest growth since October 1999. I certainly hope consumers are starting to retrench. But the Mortgage Bankers Association released its weekly data on refinancing. While the index fell 10% from the previous week, the index is still five times higher than a year ago. The sustained boom in refinancing makes it tough to call the consumer dead, even with consumer credit growth easing. Consumers are just borrowing more from Peter and less from Paul. Notice the consumer is not paying off Paul, just simply borrowing less. But, consumers might be paying off Mary. Non-revolving credit actually fell. This seems reasonable given that auto sales have eased off a record pace. Consumers, however, are still more than willing to finance dinner as revolving credit increased at an annual rate of 11.7%.

Since the second week of the year, after the first surprise rate cut, the refinance index has only posted three readings under 2000 with the lowest reading still being a lofty 1955. For a little historical prospective, 1998 was the first time the index crossed 2000 since it was developed in 1990. Given the sustained refinancing activity, I'm amazed that consumer credit has grown so much, especially revolving credit. During the 1998 - refinancing boom, it appears consumers used some of the money to pay off their credit card balances. Since 1991 there have only been two months when revolving credit declined, July 1998 and November 1998, which roughly coincides with the 1998 boom. Perhaps, the refinancing activity helped pay a hefty income tax bill. It will be very interesting to see how much longer consumer credit and refinancings are able sustain such lofty levels. Remember, in all these discussions regarding consumer credit and refinancings, home equity loans are not in the equation. Finding hard, timely data is next to impossible. It is interesting that the refinancing boom has lasted for five months now, and there does not appear to be the melt-up of consumption and equity prices that followed the 1998 boom.

Refinancings are not the only thing being less productive. The big economic story for the week was the decline in worker productivity for the first quarter. This marked the first decline since the first quarter of 1995. The 0.2% decline was much lower than the 1% increase economists forecasted. The Labor Department also surprised economists with a much higher increase in unit labor cost. In the first quarter labor cost increased at a 5.2% annual rate, which was the largest increase since the fourth quarter of 1997. This large increase is on the heels of fourth quarter's 4.5% rise. The last time unit labor cost increased more than 3.5% in consecutive quarters was in 1990 when unit cost increased 6.1% in the second quarter, then posted 5.8% and 6.8% increases in the third and fourth quarters respectively. The string would have been two quarters longer except the first quarter of 1990 increased only 3% after the 4.4% increase in the fourth quarter of 1989. It is worth mentioning that the economy slipped into recession in third quarter of 1990. Other similarities to 1990 include the first back-to-back declines in business investment since the fourth quarter of 1990 and the first quarter of 1991. Of course most of the economist interviewed by the news media see an easy solution to the productivity decline - a 50 basis point cut in Fed funds.

With the constant increasing debt burden of the consumer, the latest report detailing 401(k)s adds to the financial stress the typical American is facing. Assets in 401(k)'s dropped for the first time in 2000, according to a recent report from Cerulli Associates. This should not be a shocker to many people. However the report also said that 77% of the growth in 401(k) assets over the past five years is due to market appreciation. This means only 23% of the growth came from contributions. I thought one of the big bull arguments was the fact that there was all this 401(k) money that needed to be invested every month. The report also projects that new flows into 401(k) will remain flat at $40 billion for the next five years, and growth in new plans has slowed to 8% from 15% just five years ago.

It is easy to hypothesize about the death of fundamental analysis when looking at the valuations placed on companies. The Houston Chronicle published a story filled with investors' comments regarding annual reports. A Michigan investor, "I get all my stock information on my Palm Pilot. I need very, very, quick information. I want to be able to read it in a matter of seconds." "They're too complex, I don't understand them and don't have the time," revealed an investor from Cincinnati. However, I hope comment made by John Markese, president of the American Association of Individual Investors, was taken out of context: "You have to ask yourself other than the glossy pictures, what are you missing? The answer is probably very little." I hope this is not the advice of the AAII. Investors would be much better off reading an annual report of the companies they invested in instead of getting real-time quotes fed to their Palm Pilot. I would advise skipping the glossy pictures and focus on the financial statements and footnotes. I'm sure a lot of Lucent investors wish they would have questioned the rising account receivables last year.

At least the unrealistic expectations of individual investors are coming down. In its monthly survey, UBS PaineWebber reported that investors now expect to get an average return of 8.7% this year. Just in January 2000, that number was 16.7%. Commenting on the survey Tracy Eichler, investment strategist for UBS PaineWebber, said "Where we are today is exactly where we should be," and historically returns are "in the 7-to-10 percent range." However, later Eichler says, "This gives me and our economist a lot more optimism that the Fed is going to continue easing." I thought this is exactly "where we should be." Why should a change in expectations from what was wildly unrealistic to somewhat realistic be any reason for a rate cut? The article included a quote from John Bogle, that does not bode well for the industry he helped forge: "We have now departed a two-decade-long golden era for equity investors in which we literally never had it so good, and are entering an era in which the party is over."

For those still hoping for a second half recovery, the Chicago Tribune conducted a study of 57 executives around the Chicago area. Eighty-four percent of the executives believe the economy will be worse this year compared to last year. Forty-seven percent predict a recession. Just a year ago, only 7% thought economic conditions would worsen. Larger companies have a much gloomier outlook then the smaller companies. Of the Top 50 public companies, 93% thought the economy was weakening, while only 75% of the smaller public companies shared the same view. Adding to the bleak outlook, John Chambers, CEO and chairman of Cisco, said, "the valleys will be much lower," when discussing Cisco's third-quarter earnings. Instead of discussing Cisco here, I'll defer to the Kathleen Pender of the SF Gate (Pro forma earnings deceptive). While not including any hardcore analysis of Cisco's performance, she does an excellent job of explaining the reality of the situation. Then read her other article regarding accounting conventions, Write-offs remove excess inventory from books -- not shelves.

Apple Computer revealed just how flat the learning curve is in the technology sector as it announced it would open up retail stores. This comes on the heels of Gateway announcing it is closing down a substantial number of its Gateway Country stores. Maybe Gateway will offer to sublease its stores to Apple. Also in the tech world, Telecommunications Reports International published a report indicating the number of U.S. households with Internet access declined for the first time. Amy Fickling, managing editor of the report, said that "growth in every category slowed" and "the market is close to its maturity level." However, analysts are quick to point out that number of hours spent on line is still increasing, 10.3 hours per month up from 8.7 at the end of the year.

In keeping with the informal inflation watch here, prices continue to increase throughout the economy. Energy sure is getting more then its fair share of coverage this week. The average price of gasoline reached an all-time high early this week of $1.703, which eclipsed the previous high set last year of $1.68. The record high price set-off a flurry of forecasts on how high the price could move this summer, $3.00 seemed to be the target du jour. California got hit with some unseasonably warm weather, which when combined with several power plants idled for maintenance, forced rolling blackouts once again.

Spending on prescription drugs soared last year. Total spending increased 18.8% to $131.9 billion according to a study by the National Institute for Health Care Management Foundation. The growth was mainly due to increases in scripts written (42%), but a shift into more expensive drugs (36%) and price increases (22%) contributed a significant amount to the increase in amount spent on prescription drugs.

On the humorous side of the news, Wade Cook Financial Corp. disclosed that it lost 89% trading its own money last year. Deb Bortner, director of the Washington Sate Securities Division and president of the North American Securities Administrators Assn., sums it up, "Either Wade is unable to follow his own system, which he claims is simple to follow, or the system doesn't work."

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