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Capx Spending Gets Pushed Out

This week kicks off earnings season for the second quarter, but really heats up next week. So far there have been few earnings surprises. However, there have been a couple pre-announcements that have provided insight to how the technology sector is shaping up. Needless to say, capital spending has yet to pick up. Two companies that sell software to the retail sector, JDA Software and Retek, warned that they will miss revenue and earnings expectations for the second quarter and lowered guidance for the next quarter. Investors have taken 55% and 60% off the value of their stock's price respectively. Retek withdrew its guidance from 2003 until it can better "determine the future trend and volume of deal closings." Technology companies have been using historical closing rates in their models to forecast future results. This has led to overoptimistic sales forecasts and companies are starting to realize that past performance is not indicative of future results. If this is indicative of the retail sector and retailers are starting to retrench, we wonder if retailers see storm clouds on the horizon.

Announcements from several other technology companies indicate that the idea of a capital spending led recovery is fading quickly. While not the story stock it once was, Silicon Graphics warned that its revenue would below previous guidance for the quarter just ended. Revenue will be about 10% lower than the $310 to $330 million range previously announced. Commenting on the shortfall, the company's CFO, Jeff Zellmer said, "There is a continued reluctance in the IT sector to commit to significant capital spending, leading to less predictable sales cycles."

Citrix Systems also announced its revenue would come in around $117 million, far below the $130 million to $140 million range given at the beginning of the quarter. Citrix is not looking for a pick-up anytime soon. For the next two quarters, Citrix forecasts flat revenues centering around $115 million for the last two quarters of the year.

While technology companies continue to languish, cyclical companies indicate that the manufacturing rebound has been sustained. Oregon Steel Mills reported second quarter shipments increased 14% from last year and 9% sequentially. Additionally, its average selling price during the second quarter was 6% higher than the first quarter.

One positive trend is starting to develop. Companies are starting to initiate more conservative accounting practices. Ruby Tuesday announced it is refinancing its "synthetic lease facilities with traditional bank debt through its existing credit group." AMB Property, which owns and operates industrial real estate, "began expensing the fair value of options granted." Also worth noting, AMB Property noted that "leasing activity across the portfolio was not as strong as we expected it to be in the second quarter." They also expect same store growth of 1% - 2% for the year, below their previous forecast of 2.5% growth.

Last week, the Financial Times published an article, Top fund manager sees stock markets halving, about European hedge fund manager Hugh Hendry. Hendry has skirted the bear market by choosing stocks based on his "golden 5 percent" rule - 5 percent of stocks will rise even during a bear market. Hendry would chose which investment met the golden 5 percent rule by monitoring the flow of liquidity from central banks. Historically central bank liquidity has flowed into the stock market, but Hendry noticed that the latest liquidifcation got funneled into property and commodities. This led him to buy the homebuilders, property companies and food and tobacco companies. Recently, even these stocks have tuned down. Hendry quickly started selling his stocks and is less than 100% invested for the first time in 3 years. "One has to give serious consideration to that now the bear market has encroached into my golden 5 per cent [of stocks]. And no equity strategy succeeds with that outcome: value, growth, good management, strong balance sheets, nothing works." He thinks that investors who believe they can hide in safer stocks that have a better balance sheet, "must be smoking some seriously powerful narcotics."

The Dallas Morning News reran a story first published in The Independent, Noted economist saw this coming , featuring economist John Kenneth Galbraith. According to Galbraith the current problem in corporate governance boils down to two problems. The large, modern corporations are manipulated by the "financial craftsmen" and have grown too complex and difficult to monitor. Also, companies "have grown out of effective control by the owners, the stockholders, into nearly absolute control by the management and the individuals recruited by management." Then management has "set its own compensation, either in the form of salaries which can get to fantastic levels or of stock options." Galbraith quipped that "Recessions catch what auditors miss."

Wall Street got excited today because RevPAR numbers for the lodging industry were better than expected last week. Upper Upscale was the only segment which RevPAR declined. RevPAR growth has failed to increase as Wall Street expected and Starwood Hotels & Resorts' stock price has suffered, falling over 25% since it topped out in April. Because the stock has fallen so dramatically the past couple weeks, UBS Warburg upgraded the stock to Buy from Hold, even though they reduced EPS estimates and the price target. For the trailing 12-months prior to September 11, HOT earned $1.99 per share. At that time it was trading just north of 35, or about 18 times trailing earnings. Looking ahead to next year, UBS Warburg lowered its estimate for 2003 earning to $1.55. Putting its old 18 times multiple on $1.55 yields a price of $28.00, which is lower than the $29.25 it closed at today. Warburg also uses EBITDA as a valuation metric, but those days are over, at least for a while.

The stock market continues to slide. While it is difficult to determine the mind of the market when everything sells off. There is one ominous thread developing which centers on the derivatives market and credit market. Utilities have been hit for 14% this week. Over the past several years, utility companies become big players in the derivative market. Trading in some key financial stocks such as Capital One (COF), MBIA (MBI), and Radian Group (RDN) is particularly ominous. The weakness in some of the securitizing retailers over the past couple weeks hints at potential problems in the asset backed market. The weakness in these stocks hints at stress building in the collateralized debt obligation (CDO) market. Unfortunately, history tells us that when credit markets come under stress, all markets come under pressure. Stephen Roach, economist for Morgan Stanley, today noted in his commentary, "the debate still stands a good chance of shifting toward the possibility of a Fed easing -- especially in the event of a financial accident." Today, Fed fund futures fell below 1.75% indicating that traders are pricing in an easing.

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