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Stock Market Takes a Back Seat


A lot has happened in a week. The bombing of Iraq started just as I was finishing up last week's article. During the rest of the week the markets rallied strongly as a victory appeared imminent. What a difference a couple days make. Now it appears the war in Iraq will last much longer than anticipated last week. While the analysis of retired generals appears more pertinent than the analysis from Wall Street, not that that is a high hurdle, the underlying health of the economy will be in the spotlight after the military campaign ends. Also, since my military knowledge only extends to knowing the difference between a tank and aircraft carrier, I better stick to what I know.

There is mixed data on whether the war is causing the economy to slow down. Merrill Lynch found that 17% of IT managers are slowing their spending because of the war. With a large portion of revenues being booked in the last weeks of each quarter, the timing of the war could push sales out of the first quarter.

This week's release of durable goods orders supports the survey's findings. Not only did February orders fall 1.2%, computers and electronics orders fell 2.9%, with computers orders alone dropping 12.3%. Additionally, January orders were revised down from an increase of 2.9% to an increase of 1.9%. Non-defense capital goods ex-aircraft, which is used as a proxy for business spending, fell 2.8%, reversing the majority of last month's 4.3% surge. The decline in durable goods does not bode well for the beleaguered manufacturing sector or the hopes that a capital investment recovery is just around the corner.

While we will have to wait and see if economic activity picks up after the military campaign ends, I doubt the war has tempered any meaningful purchasing plans. It does not appear that the start even created much of a "CNN effect." It would have been expected that the start of the war would have slowed economic activity as consumers tuned into news channels to monitor the news regarding the war. But early indications appear the impact was "minimal," at least according to Wal-Mart. Target actually said its sales were "above plan" last week. According to the Bank of Tokyo-Mitsubishi, retail sales increased for the week ending March 22 by 0.1%. Mike Niemira, senior economist for BTM, commented that, "the weather lift was offset to a degree by a mild 'CNN effect'."

The ABC/Money Consumer Comfort survey registered a two-point decline to the lowest level since 1993. This weekly survey is conducted from Wednesday through Sunday each week, so it would have picked up the sentiment since the start of the war. It also would have picked up the stock market rally that added to its gains from the rally starting two weeks ago. Consumer confidence as measured by the Conference Board aligns with the ABC survey. Its index of confidence dropped 2.3 points in March to levels not seen since October 1993. The ABC survey offered no positive signs, and the Conference Board offered very little. The number of respondents planning to purchase a major appliance increased by 0.7 points. Any other silver lining was countered by an increase in the reciprocal index. There was a 0.2 point increase in the index indicating business conditions were good, but a similar 0.2 increase in the index indicating business conditions are bad.

Investor optimism is not faring any better. The latest survey from UBS measuring investor optimism fell four points to 5, the lowest level since the index was created six-years ago. Almost half of the respondents said that the war was the most important threat to U.S. financial markets. We have seen how consumer confidence follows the stock market. This survey was conducted during the first twelve days of March. During that period the S&P 500 fell over 4%. Since then the S&P 500 has risen over 8%.

Over the near term the economy could follow the war developments. Assuming the stock market will correlate with how well the war is going, consumer confidence will likely follow the stock market. With the refinancing wave still on afterburners, consumers remain flush with cash. Consumers have yet to act fiscally responsible. It is amazing that in the midst of "economic uncertainty", the MBA purchase index jumped over 10% this week to the highest level this year.

While the war might not be causing businesses to curtail spending, companies will be using it as an excuse when earnings are reported next month. The travel sector is most at risk due to fears of terrorist attacks during the war. This week, Carnival, the world's largest cruise operator, and Starwood Hotels & Resorts indicated the war was causing booking to decline. Starwood said it "could not have anticipated the significant deterioration in business" the war would cause. Time will tell, but Starwood's underlying problem revolves around its end market. Starwood operates high-end properties that cater to business travelers. It's no secret that businesses have severely reduced travel spending, and according to several surveys travel budgets have been permanently cut.

Investors have lost faith with the stock market. More and more are looking at real estate as an investment alternative. More and more second home buyers are buying for investment reasons. A recent survey conducted by the National Association of Realtors and EscapeHomes.com found that 37% of purchasers in 2002 cited investment as their primary reason for purchasing, compared to just 20% in 1999. An earlier survey found that 16% of buyers since 2000 used the sale of stocks and/or bonds as their source of funds, much higher than the 7% that used the sale of stocks and bonds to finance their purchase prior to 2000. There is also little doubt that the surge in home prices has not helped the increase in vacation homes. There have been several articles written mentioning homeowners extracting equity out of their primary home to purchase their second home.

Lately, there have been several articles mentioning the lack of earnings pre-announcements. Historically, companies that will not meet analysts' forecasts will announce their shortfall a few weeks ahead of when they are scheduled to report earnings. Obviously, this bout of negative news typically results with the market selling off. Conversely, investors are usually encouraged if there is a limited number of companies warning they will not meet analysts' estimates. However, according the First Call pre-announcements are running much higher than during the previous five quarters. In fact, there are almost three S&P 500 companies that have issued a negative announcement than have issued a positive announcement. One explanation to accound for this difference is the number of companies this issued warnings when announcing fourth quarter results. In fact, half of the negative pre-announcements for the first quarter were issued in January. It appears there has been a shift in when companies are issuing guidance. More and more companies are cutting back on communications with investors and only providing information during quarterly conference calls. There are also a growing number of companies that have stopped issuing quarterly guidance. How this ends up affecting the market is yet to be seen. The new SEC chairman, William Donaldson, discussed his concerns of companies playing "game of earnings projections."

Here is a portion of Donaldson's Remarks at the 2003 Washington Economic Policy Conference:

Corporate America developed a short-term focus, fueled by an obsession with quarter-to-quarter earnings and the pervasive temptation inherent in stock options. The game of earnings projections, and analysts who focused on achieving self-forecasted results (or a firm's failure to achieve those results) created an atmosphere in which "hitting the numbers" became the objective, rather than sound, long-term strength and performance. The perception that uninterrupted earnings growth was the hallmark of sound corporate progress made it irresistible for far too many managers to make little adjustments in financial reports to meet targeted results. Many times, such bad or questionable business decisions were rewarded with the afore-mentioned compensation packages that often bore no relationship to what I would call "real management performance."

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