(UNEDITED)
The war in Iraq appears to be starting to wrap up. While there is obviously more work for our soldiers, the "liberation" of Baghdad on Wednesday removed a substantial amount of uncertainty hanging over the market. This should allow investors to turn their focus back on the economy and not a moment to soon as first quarter earnings are starting to be released and will hit full stride next week. Companies have already started using the war as an excuse for weak sales growth. In its earnings release, Best Buy said, "Because of the 'CNN effect,'…our comparable store sales in March have declined approximately 3 percent." Investors have been giving some of these companies the benefit of the doubt as well. Using Best Buy again, its stock dropped over a dollar after indicating first quarter sales would be lower than analysts predict. By the end of the day, Best Buy was trading almost forty cents higher. It always makes investors reassess what is moving markets with stock prices diverge from fundamental developments.
March retailing data, which will be released this Friday, will be difficult to gauge for numerous reasons. Easter falls on April 20 this year compared to March 31 last year, the inclement weather in February likely pushed some sales into March. Lastly, the war probably caused a shift in timing of purchases. I doubt the war caused enough uncertainty on its own to make consumers cancel purchases. We also know that consumers are flush with credit. Record refinancing h as put billions of dollars into homeowners pockets and it has not be used to lower other debts in aggregate as total consumer non-housing related debt has grown by over $13 billion during the first two months of the year.
The MBA refinance index fell 5% this week to 6162.80. While this is down 34% from the peak last month, the level of refinance activity remains at a historic level. There have been only nine weeks that the refinance index has been higher, with five of those happening in the previous five weeks and all within the past 27 weeks. The purchase application index soared 10%, to the fourth highest level ever. The continued strength of the housing market could keep the economy propped up longer. Nevertheless, the frenzy in the housing market brings it own set of concerns, especially as the housing market is starting to resemble a bubble.
As war worries subside, consumers could unleash with a buying spree. I have not subscribed to the theory that the war has caused a meaningful reduction in personal spending, so any increase in spending will likely be short lived. However, it has been very dangerous to bet against the consumer and they remain flush with credit. Plus, there are indications that consumer confidence is increasing. Wednesday's ABC/Money Magazine consumer confidence index rose four points to -22. Additionally, Investor's Business Daily reported that its Economic Optimism survey jumped over 7 points to 56.4, which is a 10-month high. I wonder how much of the increase in confidence revolves around positive developments in Iraq versus gains on Wall Street. If the market pulls a rabbit out of the hat and home sales continue on a torrid pace, there is a good chance that consumers will shoulder the economy a bit longer.
March auto sales were better than expectations, coming in at a 16.2 million unit rate. This also continues the trend over the past year of one weak month (under 16 million units) followed by a rebound. There has yet to be two consecutive months with auto sales below the 16 million unit rate since the summer of 1998. Also continuing a recent trend, General Motors announced it increased its incentives. It will now offer zero percent financing for five-years on almost every model it produces, including models such as the Corvette, which has previously not qualified.
Commercial office vacancies continued to rise in the first quarter. The first quarter marked the eighth consecutive quarter of declining occupancy and rental rates according to Reis Inc., a real-estate research firm. Adding to the trepidation was a resumption of a negative net absorption rate. During the fourth quarter 2002, there was a slight positive net absorption of office space, which the industry was hoping would mark a turning point in demand. During the first quarter, there was over 3 million square feet of office space that was vacated, adding to the 139 million square feet vacated during 2001 and 2002.
The manufacturing sector downshifted again in March. All major surveys regarding the health of manufacturing reported weaker results than February. The ISM survey dropped over four points to 46.2, the lowest level since November 2001 and below the important 50 level, signaling contraction in manufacturing activity. In fact, six of the 10 components that make up the index showed contraction and all but 2 dropped from February levels. The strongest component of the survey was prices, up 4.5 to 70. Employment remains one of the weakest. While it is too early to call for stagflation, it will be worth paying attention if stagflation starts getting mentioned in the inflation/deflation debate.
More surprising was the drop in the non-manufacturing survey. The eleven point drop, to 47.9, was the steepest decline since August 1998. This was also the lowest the index has been since October 2001, right after the terrorist attacks. Similar to the manufacturing survey, most components fell, excluding prices that rose to 62, the highest level since the end of 2000.
The labor market continues to be one of the biggest drags on the economy. Not only is the weakness evident in the surveys, but employers reduced their payrolls by 108,000 in March according to Friday's report from the Bureau of Labor. Plus, companies continue to announce more layoffs. Just this week, New York City announced it will cut 3,400 jobs, Stanley Works announced 1,000 jobs will be cut, Applied Micro Circuits is eliminating 286 workers, about one-third of its workforce. AT&T Wireless might cut as many as 1,800 IT jobs, which is almost half its IT workforce, Tecumseh is firing 550 employees. The labor market will have to improve before the economy does. The announcement from AT&T Wireless indicating it might cut half its IT jobs, should temper those anticipating a tech rebound.
Another theme that we have been discussing is how companies will start shifting away from the aggressive growth business models of the 90s. This week, McDonald's announced it slash spending on new restaurants and remodeling by 40% and will only open 360 new restaurants this year, down dramatically from over 1,000 opened last year.
First quarter earnings announcements have started and analysts are calling for S&P 500 earnings to increase 8.6% over last year, but energy accounts for the overwhelming majority of earnings growth. Not counting the energy sector, earnings growth will be closer to 2%. Analysts expect each quarter to get better. Second quarter S&P 500 earnings are forecasted to grow by 6.9%. The third and fourth quarter earnings are expected to increase by double-digits, 13.1% and 22.0% respectively. I'll be very surprised if fourth quarter earnings growth even comes close to 22%. So far the second half recovery forecasts are zero for two. Will the third time be a charm? I doubt it.
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