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No Confidence


Consumer confidence plummeted in February according to the latest survey by the Conference Board. Along with the headline number, almost every component of the index fell to nine year lows. Economists took some comfort that the plans to buy component did not fall as sharply. However, the percent of consumers that plan to buy either a home, auto, or appliance fell to 36.7% from 38.6% last month. Plans to purchase appliances suffered the largest decline. Only 26.4% of respondents anticipate purchasing a major appliance, down from 28.2% last month. February purchasing plans continued the streak of which less than 40% of consumers anticipate making a major purchase. Plans to buy homes actually rose, while plans to buy a car fell to the lowest level since October 1996.

Home buying continues to remain resilient. Existing home sales set a record in January, breaking the six million unit rate for the first time. Auto sales on the other hand have started skidding. Representatives from Ford and GM gave presentations at Prudential's Planes, Trains, and Automobiles conference and predicted February sales could come in below 16 million vehicles, lower than the 16.6 million in January. Ford expects full year 2003 vehicle sales to be between 16 million and 16.5 million units. To help combat lackluster sales, GM announced it is sweetening it zero-percent financing on SUVs by extending the length of finance time to five years from two years. But hurry, the offer ends this week.

Along with consumer confidence, investor confidence plunged in February. The UBS Index of Investor Optimism fell 29 points to 9 in February eclipsing the previous record low by 20 points. Additionally, investors now expect to earn 6.7% on their investments, also a record low. Maybe this helps explain the resiliency in consumption. Since they expect to earn only 6.7%, might as well spend it.

The tally for the fourth quarter is almost complete. According to First Call, earnings appear to be 10.4% higher than last year. While the fourth quarter was the best quarter since the third quarter of 2000, it was against very easy comparison. Additionally, earnings were forecasted to grow almost twice, 19.9%, the final results when the quarter started. It is also worth noting that revenue posted the strongest growth since the second quarter of 2001. While this was also against easy comparison, this might be further indication that inflationary pressures are surfacing in more measurable areas of the economy.

Companies have not been optimistic regarding the first quarter. First quarter negative pre-announcements for the S&P 500 companies are running higher than any quarter in 2002 and our number positive pre-announcements by over 3 to 1. Currently, S&P 500 companies are expected to increase earnings by 7.3% during the first quarter, down from 11.7% at the beginning of the quarter. But investors should not be fooled by this statistic as almost half or 3.4% of the growth is expected to come from just three companies - ExxonMobil, ConocoPhillips, and ChevronTexaco. Watch for earning to be revised upward for these since analysts currently expect the average oil price to be $26.59 for the first quarter. Today, the April contract closed at $37.70 and $30.56 is the lowest closing price so far this year.

Looking further out, second quarter earnings are expected to increase by about 5%, with the "second half recovery" contributing to most of the growth this year. Although, Chuck Hill, director of research for First Call, acknowledges that, "Our guestimates for earnings growth in 3Q03 and 4Q03 of 9% and 12% may be hardly worth the paper they are printed on."

Looking at revenue growth for the different S&P 500 industry groups it is notable which industries have strong revenue growth:

Industry 4Q02 Revenue Growth
Technology 2%
Health Care 9%
Consumer Cyclical 6%
Industrials 3%
Consumer Staples 5%
Energy 21%
Communication Services -1%
Materials 13%
Utilities 8%
Transports 7%
Total S&P 500 6.5%

The four strongest industries, Energy, Materials, Health Care, and Utilities, are input costs for most of the economy. There has been numerous anecdotal evidence that health care costs are affecting businesses of all sizes, and price increases are starting to be passed on to employees. Materials will likely continue to experience stronger relative revenue growth. AK Steel announced last week that it was increasing its price for flat-rolled steel by $30 per ton. Steel is already up about 10% from the beginning of last year.

There is definitely an inflationary bias surfacing in the economy and it is amazing that deflation is a more popular subject. I understand the deflation argument, but just don't see any indication that we will experience deflation, especially after listening to comments made by several Federal Reserve members over the past couple months. If there is going to be debt deflation, it will likely come after attempts to inflate our way out of the current debt problem fails.

We have long believed that the Consumer Price Index is not a proper measure of inflation. While goods and services price increases are one manifestation of inflation, so are increasing trade deficits and asset inflation. I know I have done the inflation song and dance before, so I'll spare you this time. But, it does appear that inflation is starting to affect what has become the measurement of inflation. It could still be a while until it sneaks into the CPI, but it is moving in that direction. For one, the CRB index has increased 30.8% over the past year.

Hewlett-Packard reported earnings on Tuesday. The number two computer maker reported stronger than expected earnings, but fell short on revenues. The weakness in revenue was attributed to a 7% decline in the Americas, "as weak commercial spending continued." Carly Fiorina, CEO of HP, also said, "The recovery will be slower than some of you are expecting. We will never return to the growth rate of the 1990s."

There seems to be a split in companies and how much the Iraq situation is affecting business. HP believes that some of the weakness is due to heightened risk aversion by companies. Tom Engibous, CEO of Texas Instruments, shares this view. At an investor conference he said, "It's very clear that corporate America is holding down spending…. Consumers aren't being affected by it as much as corporate America." The other camp says it's, "just an excuse," according to Michael Marks, CEO of Flextronics, which ironically has HP as its biggest customer. Marks said, "I don't think we've seen any change in order patterns from out customers based on Iraq." After the Iraq situation is resolved, Michael Dell does not, "think there will be a dramatic increase in spending."

The uncertainty with Iraq, might have actually boosted business activity over the past couple months. Companies might have decided to hold more inventory in preparation for possible supply chain disruptions. This could also explain the recent surge in the manufacturing sector. The Financial Times reported that the European operations of GM and Toyota are asking their Asian component suppliers hold 10 day's extra supply. The precaution is based on concerns that travel through the Suez Canal is disrupted.

Some readers could not get past the phonics of the hedge funds whose shareholder's letter I included with my commentary. For those that think it was a hoax, it must have been a very good one. There have been several articles discussing it, including the Wall Street Journal and the Financial Times. We included a link to the Journal story when the story broke on our homepage. It was also reported that Soros was an investor, he does probably wish it was a hoax. Since the story is included in the subscription section of the above papers, here is a link to Elliot Wave International that contains some quotes from the Wall Street Journal article.


Selected emails will be addressed in Bear's Chat

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