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100 Basis Points Left

The Federal Reserve lowered the target rate for federal funds by 25 basis points to 1.0%. Furthermore, the Federal Reserve said, "the probability, though minor, of an unwelcome substantial fall in inflation exceeds that of a pickup in inflation from its already low level. On balance, the Committee believes that the latter concern is likely to predominate for the foreseeable future." This clearly leaves the door open for additional easing at the next meeting in August. At the same time the Federal Reserve is indicating that the economy has bottomed out and is stabilizing, "Recent signs point to a firming in spending, markedly improved financial conditions, and labor and product markets that are stabilizing." But the statement turns right around to say the economy "has yet to exhibit sustainable growth."

Durable goods orders dropped in May by 0.3%, well below the 1.0% gain economists were expecting. New orders for durable goods were $168 billion, which was the lowest level since June 2002. The largest drop occurred in electrical equipment (-2.2%) with fabricated metals showing the most strength (+2.5%). Orders for non-defense capital goods ex-aircraft dropped 0.5%, extending the 2.6% slide in April. This component is usually viewed as an indication of future business capital spending. Even with the wave of corporate debt issuance, companies appear reluctant to increase capital spending. With capacity utilization running at 74.3% in May, which is a level not seen since the early 1980s recession, there is little reason for manufacturers to add capacity. This seems to confirm the idea that companies are using the proceeds from these issuances to shore up balance sheets rather than embarking on capital improvements or expansion. Additionally, computer orders fell 1.1% after an impressive 18.8% gain in April. While the manufacturing sector of the economy clearly lost some momentum, the overall economy is not heavily dependent on manufacturing. It does cast more doubt on businesses starting to shoulder some of the responsibility in getting the economy back on track.

In stark contrast to the manufacturing sector, residential real estate is on fire. New home sales jumped 12.5% to a 1.157 million annual rate, surpassing the record set last September by 9.5%. This was 11% stronger than economists had forecasted. While existing home sales did not reach a new record, sales of existing homes increased more than economists expected coming in at a 5.92 million annual rate. One statistic I mentioned a few months ago was the increase in the number of mortgage bankers reported by the Department of Labor. The growth of mortgage bankers underscores how much the industry has boomed. The most recent data available is from April of this year and at that time there were 102,700 mortgage bankers. This compares with only 78,600 in April of 2002 and 61,900 in April of 2001. This 66% growth over the past two years is only surpassed by the insane growth of the internet companies during the internet bubble. Just for reference the number of employees at Internet service providers leaped 126% in the two years prior to peaking in July 2000.

Consumer Confidence as measured by the Conference Board dropped 0.1 points to 83.5 in June, but was 1.5 points better then economists' expectations. The present situation component fell 2.4 points to 64.9, but the expectations for the next six months increased 1.4 points. The plans to buy responses were the most interesting. Only 3.0% of respondents planed to purchase a home in the next six months. This was a drop from 3.8% in May and was the second lowest data point since March 1997. Additionally, only 5.9% anticipate purchasing a new vehicle within six months. This was lowest response since October 1996. The number of people planning to purchase an appliance ruined the trifecta. The number of respondents planning on purchasing an appliance dropped 3.4 percentage points, but is equal to the 28.2% in March and higher than the 27.5% in February. The number of people planning to take a vacation in the next three months fell to 41.2%, the lowest level since December 1978.

News from companies on the eve of earnings is looking more and more pessimistic. On Monday, oft-troubled Tenet Healthcare said that second quarter earnings will be "significantly below" expectations and took the opportunity to revise full year guidance down sharply. The hospital operator has been hit with pricing strategy issues that have caused lower than anticipated revenue accompanied by higher expenses. For the year ending June 30, 2004, Wall Street had been forecasting EPS of $1.40. Tenet's new guidance is for a range of $0.80 - $1.00 per share.

Avery Dennison, the leading label maker, cut its second quarter profit forecast by 15% due largely to poor North American sales. CFO Daniel Bryant noted that, "We've seen virtually every division in almost every geography feeling some slowness in the quarter….Office supply shipments have not improved measurably since the first quarter."

Consumer products giant Unilever lowered full year sales estimates yet maintained earnings guidance. "We have clearly given up more of the headroom in our plan than we are comfortable with at this stage and are therefore adjusting the growth outlook ... for the year," the company said in a statement.

Chemical maker Rohm & Haas said it expects a second quarter loss and sees no growth in second quarter sales volume. "The overall global economy is relatively stagnant, which is impacting demand across many of our businesses," noted Raj L. Gupta, chairman and chief executive officer of Rohm & Haas. Not only is business "stagnant," but seems to be headed down, "Early in the quarter we saw indications that things might be improving, however demand in late May and early June has not shown the same momentum, due in part to general weakness in the economy, as well as the prolonged wet weather in the US."

Goodyear announced that shipments for new car tires fell by over 8% in May. The reduced production levels from the Big Three are starting to work through the system.

Lousy weather continues to be a good excuse for missing earnings estimates. Fast Food drive-in operator Sonic forecasted earnings for the current quarter would be below analysts' estimates. There was little mentioned that Sonic experienced higher costs associated with rolling out breakfast. This not only increases the store hours but offers a cheaper menu to customers throughout the day.

Where would we be if there was not another company citing SARS as its reason for missing estimates? Chip-maker Advanced Micro Devices said that, "The anticipated global sales improvement in the month of June did not materialize as we had anticipated." One of the leading reasons for AMD missing its second quarter sales forecast by 14% was the "decline in personal computer and handset sell-through in China and other Asian markets, largely related to the SARS epidemic".

Federal Express announced quarterly earnings that beat Wall Street estimates by two cents, yet expressed caution about the current state of the economy. The Memphis-based delivery firm noted that June volume at its Ground and Freight divisions has been below expectations.

The world's largest cruise ship company, Carnival, announced disappointing second quarter profit that fell 34% from a year ago. Carnival has been forced to cut prices by as much as 30% due to the sluggish economy and safety concerns following the war. "Given the concerns leading up to the war with Iraq and its eventual outbreak, along with the uncertain worldwide economy, we are satisfied with the performance of our brands in this extremely difficult environment for leisure travel," said Micky Arison, Carnival Corporation & plc Chairman and CEO.

Continuing the pessimistic outlook we saw from truckers last week, CNF Inc was the latest trucker to lower its second quarter forecast, citing a weak US economy. Second quarter earnings will be at least 30% lower than analysts had predicted.

Of course the negative news cannot seep into the housing sector. Last Friday, builder KB Home reported quarterly earnings of $1.94 a share, 18% better that consensus expectations of $1.64. Housing revenue rose 22% and total orders increased 17% for the quarter. KB Home stated that backlog units are up 17% and support forecasts for the remainder of the year. "For the remainder of 2003, we expect to continue to benefit from favorable housing market conditions, including the combination of healthy demand and constrained land supply, and will continue to leverage our size to generate further operating efficiencies in the future," said Bruce Karatz, chief executive, in a statement.

Negative earnings pre-announcements continue to run ahead of last year's pace, but below the first quarter's. As of Wednesday morning, 52% of all pre-announcement have been negative according to First Call. I'm a little surprised by the apparent weakness companies are experiencing late in the quarter considering the credit spigot is wide open. I previously anticipated that the momentum from early in the quarter would continue and companies would be reluctant to lower guidance for the third quarter when announcing second quarter earnings. Consumers continue to be the single bright spot in the economy, but there are signs that consumers are getting tired. Perhaps the most telling anecdotal evidence was written by David Leonhardt in the New York Times. In an article discussing what the Federal Reserve will do, he included a comment regarding what Wal-Mart managers are experiencing:

Wal-Mart managers have recently seen some customers carrying calculators through their stores, apparently adding up their bills before they go to the register, a company spokeswoman, Mona Williams, said. More merchandise is being scattered around the stores, suggesting that people are changing their minds about what they can afford in the middle of a shopping trip. And packs containing more than one shirt have not been selling well.

"The country at large might be more optimistic about the economy,' Ms. Williams said, 'but the people we see in our stores are still very cautious about how they spend their money."

As everyone knows, as Wal-Mart goes so goes the economy. Earnings season might be setting up for a nice fireworks display.

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