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The reported productivity growth would imply that either individuals’ incomes have increased substantially or that profits have increased significantly. Or more likely, adjustments to measurements of price increases understate inflation. With housing costs, health care and energy costs higher, the inflation numbers are suspect. Productivity is that part of GDP not explained by the difference between the values of goods produced and the cost of inputs adjusted for inflation. While incomes are up, profits are down, or so it would seem. Were previous measures of output and profits a result of accounting games?
There are a number of threats to a sustained recovery. Housing prices appear to have peaked and a correction has begun in several major markets. While a major correction in housing prices is not expected in most markets, San Francisco, Denver, Seattle and several other major markets are seeing prices decline and sales slow. Retail sales that looked so good in March were somewhat disappointing in April. Neither number should have moved the market as the date of Easter affected the year-to-year numbers. Consumer credit is relatively high with reserves for bad loans increasing. States are finding themselves in financial difficulty and in some cases holding refunds to consumers. All in all, the economy is not out of the woods yet.
The Stock Market
The stock market is driven by fear. Fear that a major sell off is underway and they will lose more. Fear that a major move up will occur and they will be out of the market. How else do you explain the major moves of the markets, the Dow down 200, up 300, down, up, etc?
Just as it appears the long-awaited capitulation of the investor would announce the end of the downturn in the stock market the markets make a major move up. This week the market moved on the announcement from Cisco that it had beat profit expectations. With revenues down and the anemic profits reported it hardly seemed cause for the market to make a major move up. Caution is necessary, as much of the up volume is short covering. Until more companies report better profits, above the reduced estimates, the markets are unlikely to make a major move up.
These market moves allow us to see the momentum investment at work. After Cisco reported better than expected profits, a number of analysts upgraded the stock to a buy moving the stocks even higher. It seems when enough analysts begin supporting the stock it is ready for a correction downward. Wouldn’t it be great if they upgraded these stocks before they report improved sales and profits?
I still expect the market to trend lower. While there are a few good investments, too many companies’ have price-earnings ratios well above what can be justified given the economic outlook.
Stocks in the News
The HP merger with Compaq will proceed, with the most likely outcome a disappointment of HP shareholders. Only the most optimistic outcome was apparently presented to the board and shareholders. Clara Fiorina will be a winner either way. It appears she will receive a big bonus for making the merger happen and an increase in pay for being the CEO of a larger company. She will walk away with more money, even if the merger flounders, than she would have received as CEO of a successful HP.
The SEC is responsible for protecting shareholders and preventing accounting irregularities such as those of Enron and Xerox. Rather than hold management and the board responsible, they find it convenient to fine the company for this behavior. The investors and employees get a double hit, as the $10 million fine to Xerox reduces cash flow and strains the company’s finances further. Shouldn’t the fine be assessed on those individuals responsible?
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