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Contradicting this is the recent Federal Reserve’s “beige book” which reports the economy slowing rather than recovering. Durable goods orders are up but below the past few years. First time claims for unemployment insurance are up, and the unemployment rate is expected to continue to increase at least in the short term. The help wanted advertisement index is the lowest since 1982 according to the Conference Board. The University of Michigan‘s consumer sentiment index rose, but it still points to a continued recession. Consumer sales were up in October, primarily due to auto sales. November numbers are expected to be lower, although retailers are trying to draw consumers into stores with bargains. How this will impact profits is uncertain but it is doubtful profits will improve.
The one bright spot in the economy is home sales, which have held up over the past few months as mortgage rates have dropped. Recently these rates have begun to increase, suggesting this segment of the market may also be in trouble. Only the recent rise in the stock markets seems to be pointing to a quick recovery, perhaps as early as the second quarter of 2002.
The bad economic news and the Fed’s “beige book” report would support an additional rate cut by the Fed. That is good news/bad news in that a rate cut “may” slow or reverse the economic deterioration but the fact that it is needed suggests economic conditions are worse than believed by many economists and the stock market. The question to ask is if the current rate cuts and the potential for a stimulus package out of congress have not provided enough stimulus for the economy to recover, what is expected of the next rate cut?
The Stock Market
Could the stock market’s rise be nothing more than a bear trap? The market appears to be driven by fear, which in this case does not portend the end of the market correction. Investors seem to be afraid they will miss the next upward market move, not fear that the market is over extended.
The market seems to be rising on the basis of low inflation, which will allow the Fed to reduce short-term rates further. While low rates of inflation may be good for the consumer, they are not necessarily good for the stock market. Low rates of inflation make it more difficult for producers and retailers to force price increases on customers. In many cases, suppliers are being forced to cut prices as seen in the auto industry. If the manufacturer or the service companies are unable to raise prices, profits are unlikely to rebound quickly.
Investors appear to expect a quick and sharp recovery in profits. The valuation of stocks before this recent run up in prices was already high by historic standards. Even based on, in my opinion, somewhat optimistic projected profits, the market appears over valued. Without the ability to raise prices, profits are unlikely to rebound, at least not to the extent priced into the stock market
Stocks in the news
Enron and Microsoft have been making the news lately. Enron’s and Microsoft’s problems are unlikely to have a long-term effect on the market. Just as the lawsuits are unlikely to have a material impact on Microsoft’s operations, Microsoft’s new XP operating system will have little impact on investment or consumer spending.
It doesn’t appear that Microsoft’s legal problems are over. The antitrust settlement fails to satisfy a number of states and competitors. It appears that Microsoft’s political contributions have paid dividends in getting the federal government and several states to agree to an unenforceable agreement with few penalties. I find it hard to believe the court will accept the agreement given the findings of the appeals court, but who would have believed on the current proposed settlement just a short time ago.
Even the consumer lawsuits appear to have been settled favorably for Microsoft. The lawyers for the consumer complaints arranged a settlement that certainly achieved the lawyer’s objectives, getting paid. The proposed settlement of these lawsuits “forced” Microsoft to provide schools with computer hardware and software. I’m not sure how this compensated the consumer for their supposed loss.
The cost to Microsoft of providing schools with computers and software is much less than reported. The only surprise is that Microsoft or the Gates Foundation didn’t see this as an excellent marketing opportunity and had not already developed such a plan. But then again, who is to say they hadn’t.
These consumer lawsuits should be considered frivolous. Microsoft provided the market with the benefits of a standard operating system. Competition existed in the past, and as we have seen from the response to XP the old operating systems, still provide competition today, for that market. While many people upgraded to the current operating systems, the average consumer has had little need to upgrade after Windows 95. ( I am typing this on my old 486 100 using Windows 95. This machine can do everything I need including accessing the web.) To the extent the consumer upgraded constantly they must have perceived the benefits of that upgrade.
With Enron, as with most of the dot com stocks, we see the problem in investing in stocks when we have trouble understanding how they make money. Highly leveraged trading companies such as Enron offer opportunities for great returns but also represent great risk. Unfortunately, Enron’s problems have cast concern about other energy companies, either their business model or exposure to trading companies. As a result, the Enron fiasco will provide opportunities in energy stocks over the next several months as events unfold.
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