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Will History Rhyme?


Earnings announcements for the first quarter are mostly complete. As of last Friday, 97% of S&P 500 companies had reported first quarter earnings. Seventy-four percent of S&P 500 companies beat estimates with only 14% missing Wall Street's projections. Earnings for the S&P 500 rose 27.5% from last year and revenues were up 11.8%. The outlook for second quarter earnings is looking better. There are 161 S&P 500 companies that have already provided guidance for the second quarter with 45% indicating that second quarter results will be better than anticipated and only 35% guiding lower. This compares favorably v. the 33% that issued positive guidance last quarter and 47% guiding earnings lower. Estimates for second quarter earnings growth have jumped over the past three week from 16.8% to 18.1% for the S&P 500. At the beginning of the year, earnings growth estimates stood at 13.6% for the second quarter. Most of this increase is attributable to the energy sector. With the price of oil trading above $40 per barrel, analysts have increased second quarter earnings growth estimates from 8% to 19% this month.

With earnings out of the way, economic data will be one of the central drivers for the stock market, especially since investors are will be handicapping the rising interest rate cycle. Practically everyone is expecting the Federal Reserve to raise rates by 25 basis points at the June 30 meeting. Recent strength in banking stocks have convinced some investors that stocks have priced in this initial tightening of 25 basis points. There is little chance that the Federal Reserve will raise rates by half a point, but if the economic data points to a weaker economy, especially the employment reports, than this 25 basis point increase could be delayed until August.

There was a couple economic data items released on Wednesday that at first blush appeared to signal that the economy was slowing. The month-over-month change in durable goods orders fell 2.9% and excluding transportation, orders fell 2.1%. This was well below expectations of declines of -.9% and 1.0% respectively. The decline is due to the strong orders received in March. In fact the March data was revised significantly higher. March durable goods orders were revised to an increase of 5.7% from an original increase of 3.4% and excluding transportation orders were revised to up 6.3% from up 3.3%. The increase in March orders excluding transportation was the largest increase since April 1991. So it should not shock anyone that order declined from these elevated levels and it does show that the economy is falling off a cliff. Besides March data being revised significantly higher, the year-over-year increase in durable goods orders was 13.0%. This was the third consecutive month of double digit year-over-year growth in orders and shipments. Inventories are starting to bottom. On a month-over-month basis, inventories have increased in each of the past five months, but are still down from a year ago. The year-over-year decline is down to only 0.5% which is much better than the 2% to 3% declines that were happening as recent at February. Economists have been waiting for the inventory build that will not come. The steady increase in unfilled orders might fuel companies to start carrying more inventories if suppliers become unable to ship products in a timely manner. Unfilled orders increased 7.3% from last April.

New home sales dropped 11.8% in April from the previous month to the lowest level since November last year. While the news caused homebuilding stocks to lose just over 1% as measured by the S&P 500 Homebuilding Index, the report does not signal that the housing market has dramatically slowed. The decline is from the all-time record rate of home sales set in March. In fact, there have only been nine months that new home sales were higher than in April and all those have been in the last 10 months. Additionally, the median home price increased to $221,200, well ahead of the previous record of $212,500 set in February this year and 16.7% higher than last April.

Existing home sales rose 2.5% to a 6.64 million annual rate in April. This was the second-highest level on record, and only below the record set in September 2003 by 40,000 homes.

The decline in new home starts is not evidenced by results from Toll Brothers. This week, the largest luxury homebuilder reported that earnings per share jumped 24% during the quarter ending April 30, 2004 from the year ago period. Even more impressive was the 35% increase in revenues, and the 73% increase in contracts signed. This led backlog to soar 69$ to $3.7 billion, which is $1 billion more than its revenues were last year and "contains most of our projected revenues through second quarter 2005." Escalating housing prices benefited Toll Brothers during the quarter. The average price of a home that closed during the quarter increased 2.8% from last year, but the average price of a house which a contract was signed jumped 10.4%. The table below chronicles the increase in home prices for Toll Brothers.

Period Average Price Year-over-Year growth
2Q04 $616,000 10.4%
1Q04 $596,000 8.4%
4Q03 $580,000 6.4%
3Q03 $570,000 3.1%
2Q03 $558,000 5.4%
1Q03 $550,000  
4Q02 $545,000  
3Q02 $553,000  
2Q02 $529,000  

It is easy to see that housing prices have not only increased, but has accelerated. With mortgage bankers getting more creative than a four-year old caught in a lie, it is doubtful that the initial jump in interest rates will slow the housing market. In fact, the UK has boosted interest rates three times since November, which has taken rates from 3.5% to 4.25%. This move has done little if anything to slow housing inflation. The Council of Mortgage Lenders recently increased its forecasts for housing inflation from 8% to 14% for this year. This comes after housing prices jumped 15% last year and 25% in 2002.

Most indications show that the housing market remains strong. It is interesting that new home sales declined the most since January 1994. After the decline in 1994, it took two-and-a-half years to get back the previous peak. Also similarly, the Fed started rising rates early in 1994, something that is currently expected to start next month. As Mark Twain once said, "History doesn't repeat itself, but it does rhyme."

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