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  • Due nuove obbligazioni Societe Generale, in Euro e in Dollaro USA

    Societe Generale porta sul segmento Bond-X (EuroTLX) di Borsa Italiana due obbligazioni, una in EUR e una in USD, a tasso fisso decrescente con durata massima di 15 anni e possibilità di rimborso anticipato annuale a discrezione dell’Emittente.

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APRIL 14 - 18, 2003


We have been saying for some time that the key issue to focus on during this reporting season is what the analysts do with their estimates for 2H03, particularly 3Q03. Would the analysts slash the upcoming estimates as they did a year ago and again last fall, each time pushing back by six months the expected step up in earnings growth? We have been fessing up for some time that we didn't know what to expect.

Unfortunately (we're getting tired of using that word and look forward to when we can replace it with fortunately), the pre-announcement and estimate revision patterns of the last two weeks now have us leaning toward expecting another round of estimate slashing that pushes the step up in earnings growth back another six months.

The drop since 1 April in the expected S&P500 earnings growth has been from 7.0% to 6.5% for 2Q03, and from 13.2% to 12.5% for 3Q03. Most of the cuts have come in three sectors. The tiny transports sector expectations went from 8% to 1% for 2Q03 and from 28% to 25% for 3Q03. But that is driven by the airline problems.

Among the three sectors most sensitive to capital spending the declines have not been so pronounced. Although the industrial sector earnings for 2Q03 and 3Q03 were slashed during the first three months of 2003, they are unchanged at -9% and 7%, respectively, since 1 April. The slashing in materials continued, going from 3% to 0% for 2Q03 and from 26% to 24% for 3Q03.

The tech sector where estimates had been holding up so well from the beginning of the year until lately, saw signs of estimate cutting resuming. The 2Q03 estimates held up well from 1 January through 1 April, falling only two percentage points over those three months. However, that drop from 25% to 23% took place from the last two weeks of March. Since 1 April, the expected growth fell from 23% to 21% although the 3Q03 growth expectations only fell from a very ambitions 54% to 53%.

Another thing that makes us suspicious that the tech estimates may be beginning to crack is the rise in the ratio of negative to positive pre-announcements over the last two weeks. The ratio jumped from 2.0 to 2.5. Two weeks ago there were 25 negative to only 1 positive. It wasn't that bad last week, but the 18 negative to 6 positive was still more negative than usual.

We are beginning to believe the cuts in the three capital spending sensitive sectors, as well as in some other economic sensitive sectors, will accelerate as the 1Q03 reports come out with their accompanying comments and guidance about the upcoming months. By early May the pattern should have emerged, and the die will likely be cast for 2H03.

We suspect that 3Q03 may be too early in the recovery to expect the big pickup in earnings in the three capital spending sensitive sectors that analysts are expecting. The capital spending binge induced recession left too many industries with too much capacity, and it is unlikely reach utilizations high enough to trigger opening the capital spending spigot in enough industries this soon in the recovery.

Last Monday, McDonald's announced a cutback in capital spending for 2003. Plans were reduced from earlier plans of $1.9B to $1.2B, down from $2.0B in 2002. Net new restaurants added in 2003 are expected to be 360, compared to over 1000 in 2002. We view this as an implicit recognition that there are too many burger joints on too many corners. We believe it is representative of what needs to be done by others in the restaurant industry, and by others in many other industries facing overcapacity and stiff competition.

There may be more announcements of this nature in the coming months, indicating that the reopening of the capital spending spigot may be a ways off for many industries. Meantime, we still need the consumer to continue to be the driver until that spigot opens. The economic news last week relating to the consumer was not as encouraging as the summary numbers may have indicated.

After the dismal employment related reports week before last, the weekly new unemployment claims reported last week for the week before last remained over 400k. At 405k, the good news was that 405k was less than the 445K the week before, and was below expectations of 425k. The drop last week was only from a transitory spike. The four week average for new employment claims has been oscillating around 400k for the past two years, with no signs of falling back to more typical post recession averages of about 350k.

The March retail sales number looked terrific on the surface. It was up 2.1% from February versus an estimated 0.7%, and following a 1.6% decline in February from January. Ex autos the gain was a still robust 1.1% versus an estimate of 0.4%, and following a 1.0% decline in February. But much of the surge was driven by a 7.9% gain in building materials which took a hit in February because of the bad weather in much of the country. Auto industry sales were up 5.6%. None of the other categories showed growth above 1.5%.

The University of Michigan preliminary consumer sentiment for April came in at 83.2, well above the 78.3 expected or the 77.6 for March. But how much of that was due to the end of the war is hard to tell and how much of that war euphoria will hold remains to be seen.


Now that Tommy Franks declared the war over last Friday, the market focus on geopolitical issues shifts to news about running Iraq and restoring US relations with non-coalition countries. That means the two types of news items that will have the most impact on the market will be those that indicate Saddam and sons have been verifiably killed, making running Iraq easier, and those that indicate weapons of mass destruction have been verifiably found, making it easier to restore good relations with Russia, France, Germany, and others. Geopolitical news will still be important, but the market focus will shift more toward economic and earnings issues.

Market emotion always overreacts and its emotional reaction to the winning of the war has been no different. Every time the market has a big run on good news from the war front, it eventually triggers second thoughts about what the economy may be like after the dust settles on the Iraqi war. Unfortunately, it is hard to sort out how much impact the war and the resultant higher oil prices have had on the economy. Even if we could, there remains the issue that this recession was very different from any in our lifetime. Even without the war and the other geopolitical concerns there would still be a lot of uncertainty on how the economic and earnings recovery would unfold.

Therefore, the uncertainties are extremely high on what will happen to 3Q03 earnings. The market doesn't really care much at this point about 2Q03 earnings. The market tends to look ahead about two quarters, so the real issue is whether the pickup in earnings growth anticipated by the industry analysts will materialize.

But as we have been stressing, the crystal ball has been fuzzier than many of us have ever seen in our lifetimes. Part is due the unusual nature of this recession and part due to the geopolitical uncertainties, particularly in recent weeks the outbreak of hostilities in Iraq. With all these uncertainties, compounded by the fact that 1Q03 earnings were substantially distorted by the higher energy prices, investors are recognizing that they have to dig even deeper into what is going on at the investment candidates of interest.

That means back to the fundamentals, especially in the form of closer scrutiny of the candidates balance sheet and income statements and the accounting behind them. It also means a harder look at a companies strategy and how it fits into its industry. It means wringing out the emotion and being more objective, both in analyzing the fundamentals and in determining realistic valuations.

One thing that does give us hope is that the talk about the tech sector may have swung to the negative extremes typical of a market bottom. The pendulum always swings too far at the bottom. It usually takes the form of pessimism that the industry is mature and that the base is now so big that new technology driven markets will not be able to have as much impact as in the past.

The WSJ article on Larry Ellison, head of Oracle, last Tuesday was a great example. Larry's ramblings merited front page of the Marketplace section, complete with a full color caricature. It may be sort of the reverse of the Sports Illustrated or Business Week cover syndrome where one's appearance on the cover for positive reasons is often the sign of that downfall is just around the corner. Larry felt the industry might not be immune to aging. He felt that the current turmoil signifies "the end of Silicon Valley as we know it". He felt tech "is as big as it's going to be". Strong words.

The next day the NY Times ran an article on the front page of the business section complete with color photo of Gordon Moore. This one stated that experts were warning "that Moore's law may soon reach theoretical limits, with dire consequences for the technology industry's economic engine". Moore's law is that the number of transistors on a chip would double annually. This argument has been made countless times over at least the last twenty years. But there always seems to be some unforeseen breakthroughs that keep the technology on track with Moore's law. And there is enough on the drawing board now that will likely keep it on track for at least another decade. At some point it will run into theoretical limits, but not in the near future.

The driver is intact, but as in the past, it shows up in end products in waves. We just happen to be in one of those dead spots at the moment, which reinforces the pessimism generated by the economic doldrums.

We love seeing articles like these because they seem to be a necessary prerequisite before the next surge in technology itself, and in tech stock valuations. If we are not yet at the bottom, articles like these probably are an indication it may not be too far off. While we may have been one of those that pooh-poohed the new era or new paradigm talk in the late 1990's, because we felt that tech was still cyclical, we also said that it was high cyclicality superimposed on a high growth trendline. We believe that is still true.
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1Q03 Earnings Results

Even though there may have been some temporary factors, such as high energy prices and war-induced uncertainties, that distorted 1Q03 earnings, the results were so positive that they have to have positive implications for the earnings outlook for this year.

With two-thirds of the S&P500 having reported, and using the results from those and the consensus estimates for the remaining one-third, the earnings expectations for year-over-year earnings growth for 1Q03 is now at 11.7%. Since the remaining one-third will undoubtedly beat their current estimates, the final numbers should be even higher. For those that have reported so far, the total earnings reported are 6.8% above the total final estimates of those companies. If that rate were to hold for the remaining one-third, the results for 1Q03 earnings growth when all the reports are in would be 14.0%. Therefore, it would seem safe to say that the final results will at least be over 13%.

Some are saying that this good performance is only because the estimates had been lowered so much. That is not case. The expectations for 1Q03 earnings growth back on 1 October was 17.4%. True, that did get slashed in October and November the way the 3Q02 estimates were slashed six months earlier, in this case to 11.7% by 1 January. And it is true that that estimate was cut to 7.1% by late February. But then it rose to 8.3% by the start of the 1Q03 reporting season on 14 April.

The rough rule of thumb in normal times is that the final results end up at about where the expectations were at the start of the quarter. The estimates get taken down about three percent and then the results beat the final estimates by about the same amount. But if the final results are 13% to 14% growth, that would be above the 11.7% at the start of the 1Q03 and not much further below the 1 October 17.4% estimate than final results would be in more normal times. The only real difference from normal was how much the estimates went down in the interim.

The sectors that so far are showing the greatest surprises relative to their normal surprise patterns are consumer cyclicals, materials, financials, and technology. The only sectors with meaningful year-over-year earnings growth in 1Q03 were energy, consumer cyclicals, technology, and financials. Those with earnings down from last year are utilities, transports, and industrials. Those with sub-par growth are consumer staples, materials, communications services, and healthcare.

One reason the results are so good relative to expectations is that there have not been any real bombs this quarter - no big companies who missed final expectations by a wide margin. Also helping was the impact of the weak dollar may have been underestimated. The strong euro meant European earnings were translated at a 22% higher rate than in the year ago quarter. That benefit will not be as great going forward, but if the current translation rate holds for the rest of this year, 2Q03 European earnings would translate at 20% above year ago, while it would be 11% for 3Q03 and 7% for 4Q03. Of course, if the dollar weakens further, those translation gains would be greater yet.

3Q03 Estimate Revision Patterns

As we said above, the key to the future of the recovery is whether the 3Q03 estimates hold up, particularly the very ambitious expectations for the capital spending sensitive sectors of technology, industrials, and materials. That applies to 2Q03 estimates, but only insofar as revisions on those numbers are an indication of what may be to come for revisions to 3Q03 estimates. The market already is discounting weak earnings in 2Q03.

The good, no, great news is that the analysts are not slashing their estimates for 3Q03, or even for 2Q03, they way they did for the corresponding quarters a year ago and six months ago. More importantly, that is especially true for the three capital spending dependent sectors for 3Q03, although not for 2Q03.

Since 1 April, 2Q03 expected growth has been cut from 23% to 20% for tech, from an 8% decline to a 10% decline for the industrials, and from a 3% gain to a 2% decline for materials. But for the overall S&P500, the change has only been from a 7.0% gain to a 6.2% gain.

More important is the modest cuts for 3Q03. Tech only dropped from a mighty 54% to a still mighty 53%. Industrials were unchanged at a 7% gain, although materials did drop from 26% to 22% growth.

If the 3Q03 earnings for the three capital spending sectors come in anywhere close to the current estimates, it would mean that many businesses would have opened their capital spending spigots and the recovery would have some real legs.

Reasons for Skepticism

The job of the financial analyst is analyze with a skeptical bias. Despite the very encouraging patterns in 1Q03 earnings surprises and in 3Q03 earnings estimate revisions, it is still easy to be skeptical.

As we have continued to stress, this recent recession was unique in our lifetime. It was the only one to have been brought on by a capital spending binge rather than the usual overheated consumer spending.

Logic implies that the recovery from this recession should be more gradual than the recoveries from other recessions that we have experienced. It will take time for capacity utilization in many industries to rise far enough to entice business to think about adding capacity via new facilities or even improving efficiencies to boost capacity of existing facilities.

What is needed to soak up unused capacity is more spending by consumers. The consumer has to continue to increase spending, hopefully at a faster pace than in recent quarters. Recent recessions were caused by overheated consumer spending and not enough capacity to meet that demand. Prices rose, causing the Fed to raise rates. That temporarily cooled demand so capacity could catch up. The Fed than lowered rates, stimulating consumers to unlock the pent up demand that had built up while the high rates were causing consumers to hold back spending.

This time, since the Fed never raised rates to cool consumer spending, their spending has held up much better. But that means there may not be the pent up demand to cause the surge seen in recent recoveries. It may have been subdued to some degree in recent quarters by the geopolitical uncertainties, but those uncertainties may continue for some time. Therefore, it seem that increases in consumer spending over the next few quarters may be not much more than the modest increases in consumer spending over the past year.

While it may seem clear that this recovery should be much more gradual, at least in the early years, than recent ones, what is definitely not clear is how fast or slow that recovery should be, and how long it will take for business to open the capital spending spigots.

The outlook for consumer spending will likely be an enigma for a while. How much it has to grow to entice businesses in enough industries to open the capital spending spigot will continue to be an enigma. There will be no fireworks going off when an industry reaches capacity utilization levels that get that industry's players to spend to add capacity, let alone any indicators that let us know that point may be near at hand.

Probably more so in this recovery than in recent ones, we won't know when revenue and earnings are going to show the high growth rates typical of a recovery until we are in the midst of it. Visibility remains very clouded.

Looking at pattern changes in earnings surprises and earnings estimate revisions is only one piece of the puzzle. For those patterns to have much validity, they need to mesh with the economic outlook. At the moment there are so many warning flags on the economic front that one has to be skeptical that the long awaited acceleration in revenue and earnings growth to more traditional recovery rates is near at hand.

Over the past year the earnings estimates were not holding up well enough to believe that recovery was at hand. Now they are. But will the economy support those expectations?

Economic Data Worries

At a speech two weeks ago at the Boston Security Analyst Society noted portfolio manager Peter Lynch said no one can realistically forecast the economy so don't bother.

Unfortunately, in the real world of analysts, if they are going to make reasonable earnings estimates to help portfolio managers make stock selections, the analysts must do so within the framework of an economic scenario. But the problem is the economic, and therefore, the earnings crystal balls continue to be very clouded. A month ago the Fed's announcement that they would not change interest rates was accompanied by a statement that there would be no accompanying bias statement because they did not did not know where the economy was headed. Two weeks ago Philadelphia Fed President Santomero reaffirmed that position in a speech saying there were no signs indicating where the economy was headed. We are in that camp.

The latest body blow from economic reports was the advanced 1Q03 GDP report last Friday. The 1.6% growth was well below expectations. While the war may have been a factor, along with bad weather and all the other excuses, the bottom line is there have now been two quarters in a row of sub-par GDP growth.

Even worse, was that the all important business spending component was even weaker than in 4Q02. Spending on plant & equipment shrank 4.2%, compared to a 2.3% gain in 4Q02. Consumer spending was only up 1.4%, the slowest pace since 2Q01 in the middle of the recession.

The Fed's Beige book released last Wednesday indicated that 2Q03 is off to an even slower start than was 1Q03.

One of the most worrisome sets of economic data in recent months has been the employment data. New unemployment claims have been over 400k for ten weeks, with three of the last four weeks well over 400k. But the pattern in the three years since the beginning of 2000 is so far not that different from the pattern in the three years from the beginning of 1989. While the recent data is worrisome, it is not alarming. Nevertheless, a drop to the 350k level needs to happen soon. Last week, the number was 455k, well above the 422k estimate, and above the upward revised 447 the week before. Another report this week well over 400k would not be helpful.

The very volatile non-farm payrolls were in a nice upward trend for most of 2002, but toward the end of the year it appeared to be rolling over. That was confirmed with the early 2003 data, so another weak report this Friday for April would be worrisome.

Also coming out this Friday is April layoffs from Challenger Gray. After five months of a modest upward bulge in layoffs, there was a noticeable slowing in March. The April data may indicate whether March was the start of a new trend or an anomaly.

Since this was a recession brought on by a capital spending binge that left too many industries with too much capacity, a recovery in business capital spending depends on getting capacity utilization up to high enough levels to open the capital spending in enough industries get the economic recovery moving at a better pace. One key measure of that is the monthly industrial production and capacity utilization report. Two weeks ago, the report for March fell short of expectations for both measures.

March capacity utilization came in at 74.8%, compared to expectations of 75.3% in February. Since 1968, the only times capacity utilization was this low or lower was during and following the recessions of 1974 and 1982. The 1974 recession brought capacity utilization down to current levels, but only for a brief three month period. This time it has been stuck at that level for fifteen months. The 1982 recession drove capacity briefly down almost to 70%, but its total time at 75% or less was about fifteen months. If capacity utilization continues much longer at about 75% or less, it would be the worst since at least 1968.

Company Data Worries

While the homebuilding industry continues to refuse to die, we are wondering what many of those new homeowners are putting in their homes. All the major home appliance makers, Whirlpool, Maytag, and Electrolux, warned on upcoming earnings, as did a number of furniture makers.

Although the auto makers continue to surprise on the upside, both General Motors and Ford warned on 2Q03 earnings. It remains to be seen if the tremendous incentives will work in the future. The April sales will be reported this Thursday.

The 1Q03 GDP breakdown results last week showed that consumer spending for durable goods such as autos and appliances fell 1.1%, following a decline in 4Q02.

The weekly sales reported by a handful of retailers, and the monthly sales reported by many more, continue to be worrisome. The comparisons for April to last year's April benefit from Easter coming much later this year. But even with that advantage, the April results have been disappointing. Most of the retailers will report their April sales on Thursday of next week.

The most important events of the 1Q03 reporting season were the two that did not happen.

1. There have still not been any 1Q03 bombs, meaning no big companies came up short of expectations by a wide margin. Hence, the final results are exceeding expectations by far more than normal.

2. The analysts so far have shown no signs of slashing 2Q03 or 3Q03 or 4Q03 estimates. They are virtually unchanged since the start of the reporting season on 14 April.

The second point is the most important since, unlike a year ago and six months ago, the analysts have not reacted to the past quarter reports in a way that negated the high expectations for the upcoming quarter. As we said last week, this is no guarantee that the 3Q03 expectations will be met but it certainly means it is more likely than at any other point since the onset of the recession.


Not only do 1Q03 earnings continue to beat the estimates by far more than normal (6.6% vs the 2.7% average of the last nine years), but the final results (likely to be closer to 14% than 13%) will be well above the 11.7% expected at the beginning of the quarter.

Following the earnings recession in 1998 brought on by the overseas economic problems, there were six quarters in a row when, starting with 1Q99, the final results exceeded the estimates at the beginning of the quarter. That was followed by six quarters of coming in below the beginning of the quarter estimates as the economy started to deteriorate and fell into recession.

In 1Q02, the final results exceeded the beginning of the quarter estimates, as one with expect soon after the end of the recession. But it was not sustainable as it normally would be in a recovery. The final results fell short of the beginning of the quarter estimates in the remaining three quarters of 2002. Whether the breakout this quarter will be the start of a sustained pattern remains to be seen. With the soft expectations for 2Q03, it will be an ominous sign if the final results to not expect the beginning of the quarter estimate of 7.0%.


Employment continues to be the primary worry. The 48k job loss in April was somewhat less than what most were expecting. But don't celebrate. It was the third month in a row of losses rather than additions. The last time that happened was in the fall of 2001, when the US was in recession. Even worse, the upward trend in job creation, which had been in effect from October 2001, now appears to have peaked in August 2002 and the apparent downward trend since then is being further confirmed.

The unemployment claims data continues to supporting this pattern. New claims are in their third bubble in the past two years. Most of the time during the past two years the four week average for new claims have been running at close to 400k. The first upward bubble was in 4Q01, with a peak at about 500k. That was at the tail end of the recession. There was a mini-bubble in 2Q02 that peaked at about 450k. New claims have built at least a bubble as big as that of 2Q02 and is still in an upward trend.

Given the improvement in consumer sentiment reported before last week by the University of Michigan, it was not really a surprise that consumer confidence, as reported last week for April by the Conference Board, not only showed improvement, but was better than expectations.

However, the scary thing was the jump in consumer confidence was almost identical to the jump that followed the end of the Gulf War. Not only was the data almost identical, but the economy then was in a jobless recovery similar to our current problems. Unfortunately, the Gulf War euphoria was only temporary. Consumer confidence soon fell back to levels below the bottom hit during the war.

Many of the retailers will be reporting same store sales on Thursday, with a few coming out on Tuesday and Wednesday. The consensus same store estimate from the retailer analysts for the 68 retailers reporting April monthly sales is 4.3%, or without including 5.6% for Wal-Mart, it is only 3.4%. The sounds pretty good in the current environment, but don't be mislead. It is not good when adjusted for when Easter fell. Easter came in March last year, but in late April this year.

Based on the weekly comments from Wal-Mart, Target, and the other five that report weekly, April was another soft month when one adjusts for the Easter falling in March last year but in April this year. The excuse this time is cooler weather. In the words of that famous economist Rosanna Rosannadana, "It's always something". Last week, the reports from the seven weekly reporters ranged from below plan up only to in-line with plan.

The news from the auto industry was not very encouraging either. Light vehicle sales for April came in at 16.5m SAAR. That was modestly below the 16.9 consensus. On the surface that looks okay, but given that the auto companies pulled out all the stops on incentives, the April sales were disappointing. Not even a $5/day lease on a Ford Mustang could stem the tide. Also, ominous was that inventories for the Big 3 were at 85 days, 24% above normal.

On a year-over-year basis, April sales were up about 2% from the year ago 16.2%, but that is misleading. The 16.5m this April gives no indication that the 2%/yr decline trend in auto sales that has been in place for the past 27 months is about to change, increased incentives not withstanding.

Although they reported earlier in the 1Q03 reporting period, the 2Q03 earnings warnings from most of the auto, home appliance, and home furnishings makers continue to be caution flags on the consumer spending track. Last week added a few more with the consumer electronics retailers Tweeter Home Entertainment and Ultimate Electronics warning on 2Q03.

One bright spot was the same store sales report for April from Starbucks which indicated the Yuppies are spending.


Another sector very sensitive to the economy is materials. The pattern of beating 1Q03 final estimates but warning on 2Q03 earnings continued. Last week it was chemicals leader DuPont warning, and major copper producer Phelps Dodge making comments that caused analysts to drop estimates.

The materials sector is one of the few where 2Q03 and 3Q03 estimates are being slashed.


There was some interesting comments from several tech canaries.

Ingram Micro, the world's leading wholesale distributor of tech products and services, beat 1Q03 expectations, but warned that 2Q03 earnings would be significantly lower than the already downward revised estimates.

On the other side, there was encouraging news from the two Taiwanese semiconductor foundries. Both Taiwan Semiconductor and United Microelectronics projected 2Q03 revenues would be up 20% from 1Q03 revenues. Also, Wishay, a major passive component (capacitors, resistors) supplier, said they are seeing some improvement in business.


Visibility continues to be about as bad as it gets. About the only facts we know at this point about 3Q03 earnings are:

Earnings for 1Q03 were very good, both relative to expectations and relative to year-over-year growth.

The industry analysts are expecting year-over-year earnings growth in 2Q03 will be less than half that of 1Q03.

While the final outcome for 2Q03 earnings remains more difficult to predict than normal at this stage of the quarter, it is clear that 2Q03 earnings growth will not be as strong as in 1Q03, possibly even below that of 4Q02.

The industry analysts are predicting a rebound in earnings growth in 3Q03 that continues on upward in 4Q03.
The big unknown at the moment is whether the anomaly in 2003 quarterly earnings is going to be the surprisingly strong 1Q03 or the weaker 2Q03 that breaks the five quarter upward trend.

While we have talked about the dreaded D word in earlier reports, including last week, we are not yet ready to jump on the deflation bandwagon despite the sharp drops in the PPI and CPI reported last week for April. As we have emphasized in the past in regard to other data sets, one data point does not make a trend. There are no red flags waving on deflation, at least not yet, even though the drop in the PPI was the largest on record.

However, the yellow caution flags are up, as they were last week following the Fed's statement the week before on "a substantial decline in the rate of inflation". It is obvious that the war, and especially the resultant higher energy price and their subsequent decline, are causing some temporary distortions in the PPI and CPI data. The April data does mean that the PPI and CPI results over the coming months deserve our full attention. Maybe more ominous than the aggregate results for the PPI, was that commodity prices excluding energy have fallen for eight straight months.

The Fed did finally dare to use the actual D word when Fed vice-chairman Roger Ferguson used it in a speech last Friday. He did, however, say the chances of it happening remain quite remote.


Capacity utilization, the one set of data that best summarizes the economic recovery problem, dropped again in April. The 74.4% was about in line with the 74.5% consensus, but down from the 74.8% in March. That continues the downward trend from the 76.4% mini-peak in July 02. After steadily declining from 83.6% in May 00 to 76.7% in August 01, capacity utilization has been relatively flat. It fell to 74.6% by December 01, then gradually rose to the July 02 mini-peak of 76.4%, and has since fallen to a new low for this cycle of 74.4%.

Previous cyclical lows since 1968 that were deeper than the current 74.4% were 74.0% in May 1975 and 70.8% in December 1982. The lows associated with other recessions were 78.3% in August 1971, 77.7% in July 1980, and only 78.6% in March 1991.

The 1975 downturn was a classic V. Capacity was below 77% for only 10 months. The 1982/83 downturn was also a classic V, but deeper and longer. Capacity was below 77% for 21 months.

The 21 months below 77% now matches the 21 months below 77% in the 1982/83 downturn. The 2002/03 downturn has so far not gone as deep as in the 1982/83 downturn, because it has been stuck in a very narrow range between 74.4% and 76.4% for 20 months. What is different with this recovery is that capacity utilization looks like an L rather than the pronounced V associated with other recessions.

The related industrial production data released at the same time was unchanged from March at a 0.5% decline, and about in line with the consensus 0.4% decline. Industrial production data has been very volatile since last November, with no clear trend established, but the weak reports for the last three months may be signaling a breakout on the downside.


The manufacturing surveys conducted by the Philadelphia and New York Feds, while somewhat limited, nevertheless are often of value because they are the first look at how the current month is doing. The results for the April surveys were mixed.

The Philadelphia Fed's manufacturing index rose from a negative 8.8 in April to a negative 4.8 in May, slightly worse than the expected -4.8. This was the third consecutive month in negative territory. After two months in negative territory, the New York Fed's index soared from -20.3 to a positive 10.6, well above the expected -10.0.


The most important developments last week was that both Intel and Dell continued to indicate that they see no signs yet of a substantive upturn. IBM was a bit more bullish at its analyst meeting last week.

The April book to bill was reported last week for semiconductor capital equipment. It came in at 0.86, well below the consensus expectation of 1.00. In addition, the March results were revised downward to 0.91 from the originally reported 0.99. The April 03 bookings came in 12% below consensus and 23% below those of April 02. April billings were only up 5% from April 02 and were down 48% from April 01.


The retail same store sales for the week ending 10 May from the six retailers that report weekly were in line with their plans for May. Unfortunately, the plans for May for all six are for not much better than flat. Wal-Mart, with expectations of a year-over-year gain of 1% to 3%, and JC Penney, at a 2% to 3% gain, are the most optimistic. Target is looking for only flat, plus or minus 1%, while May Dept Stores expects a 1% to 3% decline. Federated, which as of this month is no longer reporting weekly, has the same expectations as May Dept Stores. These lackluster expectations, along with the actual results for the first week, verify that the stronger growth in April was due only to the difference of Easter being in March in 2002 and in late April in 2003.

Since most of the retailers are on an April ending quarter, the 1Q03 earnings picture is coming in to focus. With 72 of the 138 retailers on the First Call list having reported, and using the actuals for those 53% and the estimates for the other 47%, earnings are expected to be up 0.9% over the 1Q02 retail earnings. Excluding Wal-Mart, it would be a 1.4% decline. Since many had pre-announced earnings or reported April same store sales, the actual results are only 0.9% (sic) above the final expectations.

As the reports come in the cuts on 2Q03 estimates continues. On 1 April the retail analysts were expecting the earnings for the First Call list to be up 9.7%. that has been cut to 6.1%. The hopes for a 2H03 revival continue. The 15.8% earnings growth expected on 1 April for 3Q03 has only dropped to 15.1%.


The preliminary Univ of Michigan consumer sentiment for May continued the reversal in April from the March cyclical low. The Michigan consumer sentiment number bottomed at 81.8 in September 2001, gradually recovered to a mini-peak if 96.9 in the May 2003, and gradually decayed to 77.6 in April, and then sharply recovered in April and May, first to 86.0 in April and then to 93.2 in May. In both months the expectations part of the index outpaced the current part.

If consumer sentiment can stay in the 90's that would be very favorable, but after the rapid two month rise, it will take a few months of staying in or bettering that range to be convincing. The peak in the last cycle was 111.3 in Feb 00 but we now know that was a period of irrational exuberance and that readings in the 90's are healthier.

New unemployment claims dropped 13k for the week ending 10 May. The consensus estimate was a gain of 5k. It was the third straight week that new employment claims fell. But at 417k, new unemployment claims are still above the 400k level that many economists say marks a weak job market. More importantly, new unemployment claims are still in the upward channel that began at the beginning of this year. In addition, continuing unemployment claims were up 120k to 3.77m, their highest level since November 2001.


As the string plays out on 1Q03 earnings reports, the results continue to be good, with one exception. One reason the 1Q03 results did so well relative to expectations was that there were no bombs, i.e. no big companies that fell short of expectations. Last week Hartford Financial announced a $1.7B charge for asbestos litigation reserves, an item considered part of operating earnings for insurance companies. That one charge alone shaved 1.6 percentage points off the 1Q03 S&P500 earnings growth.

That means instead of coming in between 13% and 14% as had been expected in recent weeks, the final results will probably be just under 12%. With 94% of the S&P500 having reported and using actuals for them and estimates for the remaining 6%, 1Q03 earnings growth stands at 11.6%. Barring any bombs in the Home Depot or Hewlett-Packard reports this week, the final results should be a tad above the 11.6%.

After three quarters of small cap earnings growth (as measured by the S&P600) outpacing that of the large caps (as measured by the S&P500), small cap earnings growth in 1Q03 will be slightly less than that of large caps. S&P500 earnings growth, with 86% having reported, is expected to come in at 10.7%, while S&P500 earnings growth is pegged at 11.6%. Both will probably be a few tenths higher, but small caps will very likely show the slower growth.

Normally, small cap earnings fall faster than those of large caps in a recession, but come back faster in the recovery. Until 1Q03, the earnings growth for the two indexes were following their normal patterns. The apparent 1Q03 aberration may be more than an aberration. The current industry analyst estimates for 2Q03 are 5.9% for the S&P500 and 6.8% for the S&P600. Given that small cap estimates tend to be trimmed more than those of large caps, the odds are that small cap earnings growth will not surpass large cap earnings growth in 2Q03. This is another deviation from normal patterns that waves a caution flag on the recovery.


The stimulus program has made enough progress in Congress that has move back on to the radar screen. We continue to be disappointed with the direction the stimulus program is headed in Congress. Given that the main problem facing the recovery is excess capacity, the real need is to stimulate increased consumer spending to sop up enough of the excess capacity in enough industries to cause the capital spending to open wider from the present trickle.

It's all a matter of timing. A temporary dividend tax cut is the last thing needed at the moment. We subscribe to the merits of doing away with the double taxation on dividends and realize this is one of the few times of doing something about it. But it would have been better to pass a cure but delay implementation for a few years until when the economy will hopefully be back on track. The Senate's current proposal is the worst of all worlds in that it does very little in providing the stimulus where needed and does not make the cure permanent.

Will the Republicans please swallow hard and pass some of the Democratic proposals that put more money in the consumers pockets and help state and local governments more to reduce their need for tax and fee increases! Unfortunately, at this point it looks like the die is pretty well cast as to what we will get. A package may be passed this week or next.


There is nothing worrisome so far in the aggregate pre-announcement data for 2Q03. What is worrisome is that the warnings in the consumer cyclical sector are running quite negative. The ratio of negative to positive pre-announcements (82 to 27) in this sector are at 3.0, well above the 2.1 ratio for all companies in First Call. Although the sample size is small (25 to 7), the 3.6 ratio for the materials sector will be a problem if it holds as more materials companies pre-announce.

So far only five DJIA companies, Wal-Mart, General Motors, DuPont, Microsoft, and Eastman Kodak, have warned on 2Q03. None have come out with a positive pre-announcement.

In the critical consumer cyclical sector, 2Q03 warnings issued from major companies since the start of the 1Q03 reporting season include retailers Wal-Mart, Federated, and Sears, auto makers GM and Ford, and furniture makers Furniture Brands and Leggett & Platt. A handful of restaurants warned, as well as a number of smaller retailers.

In the very economically sensitive materials sector, at least one major paper, metals, and chemical company have warned.

In the tech sector, six tech canaries have warned, including contract manufacturers Flextronics, Plexus, and Celestica, distributors Ingram Micro and Avnet, and connector maker Molex. So far, no tech canaries are singing sweetly with a positive pre-announcement. Also, in the economically sensitive semiconductor industry, Texas Instruments, Motorola, TriQuint, and RF Micro Devices warned, but LSI Logic, Nvidia, and Broadcom had positive pre-announcements. Break out the caution flag, but don't unfurl it yet.


The good news continues to be that the earnings estimates in the aggregate for 2Q, 3Q, and 4Q of this year continue to hold up well. The 2Q03 earnings growth estimate for the S&P500 only dropped from 6.0% to 5.9% last week, while the estimate for 3Q03 was unchanged at 12.4%, and the estimate for 4Q03 actually went up 0.1 percentage point to 21.0%.

A bit of a caution flag within that good news continues to be the downward revisions in the materials and consumer cyclical sectors. Expected 2Q03 earnings growth for the materials sector have dropped from a 3% gain on 1 April to the current 7% decline. Over the same period, the 3Q03 expectations dropped from a 26% gain to 15%. Similarly, in the consumer cyclical sector the downward revisions for 2Q03 was from a 3% decline to a 7% decline, and for 3Q03 from a 7% gain to a 5% gain. On the other hand, tech estimates continue to hold up well.

The bad news is that the crystal ball remains very fuzzy. There is so far very little to support the realization of the ambitious 3Q03 and 4Q03 estimates. The economic data and, to a lesser extent so far, the earnings estimate revision and earnings pre-announcement data give pause to concerns on consumer spending. But the underlying cause for uncertainty continues to be the fact that this recession was so different from any in our lifetime and, therefore, that we have not experienced a recovery of this kind.