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Is The Bull Market On Its Last Legs?

Is The Bull Market On Its Last Legs?

This aging bull market may…

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During the quarter there were…

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Reading through the first batch of earnings releases confirms that the economy is running on two separate tracks. Consumer related companies are experiencing business levels comparable to or surpassing year ago levels, while companies dependant on business spending are seeing a much more difficult environment.

Companies agree that the economy has bottomed, but their forecasts vary on the degree of recovery. Texas Instruments included in their earnings release the whole roadmap for the recovery:

"We have turned the corner toward growth. TI's shipments, affected by liquidation of excess inventory in 2001, are accelerating as they catch up to the rate of our customers' shipments," said Tom Engibous, TI chairman, president and CEO. "Beyond that, growth will be driven by improvements in our customers' end-equipment markets. The key driver for improvement will be a stronger economy, which will lead to more normal levels of global corporate spending. Increased spending will allow corporations to start closing the gap between current productivity levels and the higher efficiency that new technology enables. This combination of higher corporate spending and improved productivity will have a self-reinforcing effect throughout the economy."

This line of reasoning is held by just about everyone. While possible, I cannot see how businesses can afford to maintain the level of capital investment as they have in the recent past. It seems that while everyone agrees that there was a bubble in telecom and technology, they fail to recognize that there was a capital spending bubble that permeated throughout the economy. Looking at the GDP data, gross private investment as a percent of GDP has been confined to a gradually increasing trend, with 15% generally being the peak during booms and 12% - 13% proving to be the trough during recessions. After the recession of the early 90's, gross private investment surged to 19.2% of GDP in 2000. This was the longest period that gross private investment increased as a percent of GDP. More on the historical perspective at a later date, I'll concentrate on earnings now. Suffice it to say, we are not anywhere close to 13%, or even 15% for that matter.

Back to TI's earnings. TI's forecast does match its economic assessment, sort of. During the first quarter, TI spent $120 million for capital expenditures. This was down by almost 50% sequentially, and down over 85% from year ago levels. TI forecasts total capital expenditures of $800 million for the full year, which is quite a bit higher than the $480 million annual rate from the first quarter. But, TI spent almost $1 billion more last year, and almost $2 billion more in 1999. In fact, the $800 million capx goal is less than any year going back to 1993, when it was $730 million. 1993 also marks the last time capx was less than 10% of revenues. Assuming Merrill's analyst is correct with $8.2 billion in revenue, capx will be 9.7% of sales, down significantly from 23% and 22% of sales in 2000 and 2001 respectively.

Novellus was the other technology company that reported earnings ahead of estimates that led to Tuesday's rally. Investors were excited about the $174 million net new orders in the first quarter, 60% higher sequentially, and Novellus' forecast of $250 million in net orders for the second quarter. While, Novellus predicts the current slow down has ended. Investors, have been betting on a rapid recovery since October. Since October, shares in Novellus have more than doubled and now trade at more than 6 times 2003 forecasted revenues, and more than 8 times trailing revenue. Clearly, investors have discounted a recovery resembling the boom times of the previous couple years. Also noteworthy, Novellus stated in its conference call that it experienced sequential improvement in every region except the U.S.

Maytag's earnings contained a microcosm of what is happening in the economy. Home appliance revenue increased 22.5% from year ago levels while commercial appliance revenues fell 10%. Maytag realizes that the first quarter was unsustainable growth. In its press released it offered the following guidance:

"Looking ahead, the major appliance industry year-over-year sales growth may be more subdued in subsequent quarters. Even though we do not believe the major appliance industry will continue at the record pace experienced in the first quarter, we anticipate earnings per share performance for the second quarter to be approximately the same level as achieved in the first quarter."

Residential sales were much better for American Standard (ASD) as well, as commercial sales declined.

Boise Cascade also proved to mimic the overall economy. Its office solutions segment saw sales drop 8% from year ago levels, while its building materials distribution sales increased 10%.

Manpower announced, "For the first time in several months we have seen an increase in demand for our services." Investors however have bid up the stock by over 70% since the from its September low. Revenues are still 15% below year ago levels, but the stock is 30% above year ago levels. Manpower believes the second quarter will be "a pivotal quarter" and "it will determine the strength and pace of the recovery."

It should be no surprise that General Motors had a strong quarter. A couple items caught my eye while going through GM's earnings release. While its headcount declined by 17,000, its payroll increased by $31 million dollars. GMAC experienced a "significant increase from mortgage operations."- GMAC owns Ditech funding.

Johnson Controls (JCI) is yet another company that anticipates cutting capital expenditures. Last year, JCI spent $621 million. This year JCI is forecasting a range of $575 to $600 million in capital expenditures, and this company is experiencing higher revenues and income from year ago levels. The strong auto market is paving the way for auto supply companies. JCI increased its forecasts for full year sales (fiscal year ending September 2002). It now sees revenue growth of 6% verses the 5% increase forecasted six months ago. The change was based on an increase in industry light vehicle production to 15.7 million, an increase of 600,000 vehicles. Either JCI is low-balling the number or GM is extremely optimistic. GM is forecasting 16.5 million units.

Harley Davidson keeps rolling. I wonder if it is just a coincidence that the average home refinance cash out amount is about the same as the cost of a Harley? Harley posted another record quarter and upped production volumes again. Revenues increased 22% and motorcycle shipments increased 19.4%. As Harley keeps reporting record sales, its financials receive a lot of unwanted scrutiny. Short sellers point to the growing receivables, and other "quality of earnings" issues, along with rising dealer inventories. Buyers of Harleys have gone from a waiting list to having a choice of colors. Harley says it is part of their plan since it realized it was losing sales as customers would not wait. So far investors have given management the benefit of the doubt. Even if Harley didn't have any issues, it would be an expensive stock. HDI trades at 5 times revenue and 36 times earnings.

I think Manpower might have said it best when it said the second quarter will be pivotal. Just like last year, companies are guiding for a rebound in business and investors are jumping on. Last year, reality set in during May. At some point companies and investors will have to recognize that capital spending will not return to the glory days and consumer spending will likely wind down as the home ATM runs out of money.

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