Reply #40: Higher Interest Rates and Slower Earnings Growth

[54anickel]

http://www.prudentbear.com/midweekanalysis.asp

The Federal Reserve increased its target rate by 25 basis points to 2.5%. This was the sixth consecutive increase. The Fed only omitted the word “earlier” in its description of rising oil prices, otherwise the language of the release was exactly the same. With the FOMC meeting being a non-event for most investors, the last week of earnings season was the focus of the week. After last week, just over half of the S&P 500 had reported fourth quarter earnings. Growth estimates for the fourth quarter jumped to 18%, from 16.5% the prior week. Unfortunately, estimates for the current quarter dropped again. Earnings growth for the first quarter of 2005 for the S&P 500 is expected to be 6.6%, down from 7.3% last week and 7.6% at the beginning of the year.

The steel companies achieved tremendous operating leverage during 2004 as the price of steel more than doubled. This continued during the fourth quarter. At US Steel, sales jumped 51% in the fourth quarter and EPS was $3.55 compared to a loss of $0.26 per share last year. AK Steel reported that revenue increased 36%. Higher prices drove most of the increases, which were up 31% compared to last year, volume increased 4%. The company expects prices to increase another 8% from the fourth quarter to the first quarter 2005. It also reversed a $0.31 per share loss last year to a $0.68 gain. Steel companies remain optimistic and expect demand and prices to remain at current levels. While it should be expected for the steel companies to be optimistic, most of their customers do not see much relief from the high prices either. Eaton said, “We don’t anticipate we’re going to see significant metals cost retrenchment during 2005. The strong production requirements in each of our end markets, the continued strong demand, are tending to put a demand floor underneath the demand for metals, and frankly, for oil as well.” Caterpillar echoed similar comments, “As we enter 2005, we are not anticipating significant steel price declines until the second half of the year at the earliest. We expect our costs for the first half of 2005 will appear substantially higher than costs in the first half of 2004 because the comparison will contain the relatively low steel cost experienced at that time.”

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Along with the ISM survey that reported an improved labor market, the latest job-cut report from Challenger, Gray & Christmas said there were 92,350 announced job cuts in January. This was the lowest number of layoffs since August and the lowest number of layoffs announced in January since 2000. Additionally, there were announcements to hire almost 30,000 workers, up from 21,262 in December.

After earnings, the big focus for the week is Friday’s nonfarm payroll report. Economists currently expect nonfarm payrolls to increase by 200,000. There has been quite a bit of anecdotal evidence showing the labor market continued to improve in January and it appears that the economy is expanding and an increase in payrolls should not be a surprise. There is also evidence that the labor market is tighter than the current data reveal. This along with the pricing pressure throughout the manufacturing will either pressure margins or lead to higher inflation. It is doubtful that the economy will be able to continue to expand without inflation pressure or margin compression. This will happen at the same time as earnings growth slows and should have a negative impact on earnings multiples.

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SHOULD have a negative impact on earnings multiples, then again there's that tax-break luring corps to repatriate their bucks and more and more stock buy back announcements with all the excess cash floating in their coffers. Will be interesting...:shrug: