Skittish Market Doesnt Show The Real Picture

June 7, 2002
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What’s troubling the stock market is a crisis of confidence.

The stock market isn’t trading off fundamentals today, it’s trading off emotion.

You could call it Enronitis, said Mitchell Stapley, chief fixed income officer of Fifth Third Investment Advisors.

“We discount what management is telling us; we think they’re lying. We don’t trust what the auditors are telling us; we think they’re lying to us,” Stapley said in a presentation at Frederik Meijer Gardens Tuesday.

That distrust is going to take a while to change, he added.

There are three things at play right now that are making the market skittish: loss of investor confidence in financial institutions; tremendous political tension worldwide; and concerns about the weakening dollar and the possible flight of capital out of the United States.

The current period the market is in is just like a kidney stone; it’s going to be painful, but it’s going to pass at some point, Stapley said.

“But looking at the fundamentals and the valuations created out there, maybe long term investors have something to hope for.”

Consumers have carried the day in contributing to growth during the recession.

When President Bush encouraged Americans last September to do whatever they could to keep the economy going, people listened and the numbers prove that, Stapley said.

October 2001 was the best month ever for car sales, up 86 percent thanks to zero percent financing. Durable goods purchases were up 60 percent as people took advantage of low interest rates and spent money.

More impressive, he said, was the 5.6 percent spike in real GDP growth in the first quarter of this year.

Consumer spending in total for the fourth quarter last year was up 6.1 percent, compared to a long-term trend of 3 percent, and it slowed to 3.2 percent in the first quarter of this year.

Business made the sharpest correction ever in its inventory cycle. In last year’s fourth quarter, businesses met consumer demand with inventory on hand rather than purchasing new goods. As a result, the level of liquidation nearly doubled.

Inventory liquidation slowed in the first quarter, adding 3.8 percent to GDP growth, and companies started to purchase new goods again.

Business capital spending, down sharply in 2001’s fourth quarter, has come up in the first quarter, Stapley said.

Housing outlays, down 4.6 percent at the end of last year, were up 14.6 percent in the first quarter. And government spending was fairly strong in both the fourth and first quarters of 2001 and 2002, respectively.

“We should see the economy stabilizing here,” he predicted.

In the first quarter the economy grew about 2 percent and in the second quarter about 3 percent to 4 percent — and Stapley hopes that will hold true for the third and fourth quarters.

But if the economy continues to struggle, weak earnings can be expected and the stock market will continue to struggle as well.

Overall returns to the market have been “painful.” Even corporate America’s bedrocks of the stock market — Caterpillar, Disney, DuPont and IBM, for instance — experienced negative first quarter results.

The market simply won’t do better or feel better until companies grow their earnings, he said.

Though earnings are up about 9 percent quarter over quarter, they’re still not up year over year. But Stapley expects earnings are going to start looking a lot better in the third and fourth quarters.

However, there has been a tremendous surge in U.S. productivity trends, Stapley pointed out.

From the first quarter of 1995 to the fourth quarter of 2000, productivity increased at a 2.7 percent rate vs. the long-term average rate of 1.41 percent.

In the first quarter of this year, productivity surged at an 8.6 percent annualized rate.

“That is absolutely key to the future of the stock market because it’s basically the wealth of this nation,” Stapley said.

“As long as we can grow the economy at a 4 percent rate, as opposed to a 2 percent rate, that’s a much more positive environment for companies to work than it would be at a lower level of productivity.”

The productivity surge of the past six months has reduced unit labor costs by 4 percent on an annualized rate, the fastest six-month decline since 1961, he noted. Subsequently, profit margins were up by more than 25 percent.

“This incredible gain in productivity is going to allow corporations much economies to pick back up,” Stapley added.

The surge in productivity is a secular rather than a cyclical phenomenon, he said. Normally, an expansion is followed by a recession, and then productivity declines because companies don’t invest in technology and machinery and they lay off workers.

The period of expansion that occurred from 1991 to 2001 broke all the rules.

Australia is the only other country sharing in the productivity surge. Other countries in Europe and Asia are seeing declining productivity levels as a result of the economic slowdown, because they don’t have the structure and efficiency to reallocate human capital the way the United States can, Stapley observed.

In the past nine months 1.1 million people have lost their jobs, and as painful and sad as that is, he said, it allows the United States to quickly reallocate capital to its fastest and most efficient use.

Through a period like that, unemployment might stay high longer because productivity gains are being accomplished by replacing human capital with machinery, he explained. And lower labor costs are great for a company’s earnings — and for the stock market.

The fact that inflation is the lowest it has been in five years provides a tremendously positive backdrop for recovery, Stapley said.

“Things are better than the stock market is showing.”           

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