COMMENTS WEEK OF 1/10/00-1/14/00
sales smash expectations, the stock market rejoices that Goldilocks never
leaves home without her American Express card, and the bond market nervously
twitches its thumbs as it watches the equity market soar and waits for the
big man to speak.
There's nothing like a strong set of
economic figures to get the stock market's pulse racing and bring the buy
orders out of the woodwork....and there's nothing like a soaring stock
market to induce the consumer to keep spending like there's no tomorrow.
The stock market's daily stomp to new
records during 1999's final months appears to have convinced the consumer,
armed with cash derived from capital gains in one hand and a charge card
in the other hand, that there was no better time to rush out to the mall
and go on a spending rampage than the present.
December retail sales rose a much
stronger than expected 1.2%, with Retail Sales growth, ex-auto, rising at
twice the consensus forecast. December's strong retail sales numbers
pushed retail sales growth for 1999 to its best year since 1984, up 8.9%
for the year.
While the strong sales growth
experienced by grocery stores (+2.0%), gas stations (+2.5%), and drug
stores (+1.7%) during the month is probably in no small part due to the
Waiting for Y2K Armageddon Brigade's final preparations for a meltdown
that never came, the acceleration in interest rate sensitive furniture and
home furnishing sales (+1.3%) and auto sales (+1.1%) cannot be attributed
to Y2K stockpiling (perhaps we are wrong and there really were people
saying, "Y2K is coming, I must redecorate my home and buy a shiny new
car", but somehow we don't think there were).
The pick up in sales of big ticket items
during the final two months of last year, coinciding with a euphoric stock
market rally and coexisting with soaring long term interest rates, is
something that the economic textbooks tell us is not supposed to
happen--the fact that it did happen will have the Fed whistling a far less
cheerful tune than the one many stock traders have been whistling since
the release of the numbers.
Chances are, many Fed members started
whistling the morose tune "Our Efforts Have Been For Naught"
even before the release of this morning's numbers. Like today's
retail sales data, yesterday's release of the latest survey from the
Mortgage Bankers Association of America showed that interest rates are
rising and consumers could care less about their rise.
The latest weekly figures on mortgage
activity showed an unexpected jump, with total mortgage activity during
the week increasing 8.6% on a seasonally adjusted basis. The sharp
rise in mortgage activity occurred even as mortgage interest rates were
rising to their highest levels in over three years. According to the
latest weekly survey on single-home mortgage rates released by
Bankrate.com today, 30-year mortgage rates averaged 8.24% in the latest
The inability of rising rates to curb
consumer spending growth is an issue that must be addressed, probably
sooner rather than later, by the Fed. The fact that the Fed's course
of action to date, market hand holding and quarter-point rate increases,
has been ineffective in taming the savage economic growth spurring beast
known as the wealth effect, is an issue that even Mr. Gradualist himself,
Alan Greenspan, will have to address at some point.
Today's numbers continue to argue for a
50-basis point hike in rates at the next Fed meeting. Although
Greenspan's heart likely calls for a 25 basis point hike, the
ineffectiveness of the Fed's first three rate hikes when combined with the
election-year necessity to get the dirty work done during the first half
of the year could cause even our fearless Fed leader to have a change of
A 50 basis point rise in interest rates
by itself will not slow an economy driven by an equity owning consumer who
sees 30% annual gains as a given, but the shock to the markets that a
50-basis point rise would produce just might cause the consumer to keep a
tighter hold on his wallet. While such a hike would produce a
momentary bit of discomfort, the discomfort felt by all will be far
greater if the Fed falls behind the curve.
Finally, a little bird outside of our
window just started singing a refrain familiar to many "It's a
beautiful present day in the low inflation neighborhood". Long
time readers will already have delved under the hood of today's Producer
Price numbers and noticed that intermediate goods prices continued their
year long creep upward, ending the year up 3.9% after having fallen 3.3%
in 1998-- with global economic growth on the rebound, the upward trend in
intermediate goods prices is likely to accelerate this year, leaving
producers with two choices (and leaving investors with two losing
propositions): pass the price increases along to the consumer or watch
|Commentary on AOL/Time
Warner deal is available here
The greatest point gain in history, day
two, erased all memories of last week's short but sharp correction from
the minds of investors ravenous for a taste of technology.
Yesterday was also day two of the market's
newest craze: the megarally created by a favorable take on bad news.
On Friday, investors cheered on continued signs of economic strength even
as a stronger than expected employment report made a February rate hike a
done deal. Yesterday investors rallied around the AOL-Time Warner
megadeal even as the deal sounded the death rattle for AOL's days as an
The AOL-Time Warner deal created a
buying frenzy for both old and new media companies, but as we explored in
more depth in our commentary
on the AOL merger, the deal transforms AOL from an Internet company with a
projected growth rate of 49.4% over the next 5 years into a media company
with a projected annual growth rate of 21%--a growth rate that no longer
justifies stratospheric Internet-like valuation levels.
Just as AOL's current shareholders could
wind up the losers in yesterday's deal, the investors who bid up Yahoo
yesterday could also come short if the company decides to go on the
acquisition trail. A Yahoo purchase of Disney would transform Yahoo
from an Internet company with earnings growing at a 55.3% annual rate into
an entertainment company growing at a 15.5% annual clip--a lowered growth
rate that would induce a severe case of (P/E) multiple contraction.
Multiple contraction could soon become a
word on the tips of many investors tongues, not only because the new
media/old media merger feeding frenzy that is expected to develop in the
wake of yesterday's merger will force a rerating of many companies, but
also because despite Friday's Employment report induced exuberance
interest rates are headed higher--possibly much higher.
The bond market's short lived rally last
week is now looking like nothing more than a temporary bout of short
covering as bond yields once again shoot up, hitting 6.65% this morning,
on further signs of Fed hawkishness and strong European economic growth.
Richmond Fed President Alfred Broaddus
gave the bond market a push to the downside last night when he said the
economy's rapid rate of growth has increased the risks of inflation
developing this year. Bonds received a second jolt with the release
of the latest trade figures from Germany, which showed exports pushing
Germany's trade surplus to a record DM15.6 billion in November. The
report increases the likelihood of further rate hikes by the European
Central Bank, and the strong growth in exports to the U.S. puts additional
pressure on the FOMC to act decisively to curb domestic U.S. consumer
This week's slew of economic data, with
PPI and Retail Sales on Thursday and CPI on Friday, could prove to be a
turning point in bond market sentiment--a turning point even further to
the downside. With the bond market only expecting a 25 basis point rate
hike on February 2nd, any above consensus readings from this week's round
of economic reports could tilt expectations towards a 50 basis point
hike--a tilt in expectations that would prove to be only a minor sting for
the bond market, but could send the stock market reeling.
In today's trading, rising interest
rates and the possibility of a 1/2 point rate hike in 3 weeks will
not effect a stock market still dancing in the warm rays of merger mania
and with its eyes focused on the post-close release of Yahoo's earnings,
but later in the week it could be a different story if any upside
surprises rear their heads in Thursday's and Friday's batch of
Online Inc (AOL)
and Time Warner Inc (TWX)
agreed to merge today in a $190 million stock and debt deal. Under
the terms of the deal, Time Warner shareholders will receive 1.5 shares of
the new company, to be called AOL Time Warner, for each TWX share held.
Based on Friday's closing prices, the deal values each Time Warner share
at $112, a 72% premium to their Friday close. AOL shareholders will
own 55% of the new company after the merger.
The deal creates a dominant $40 billion
in annual revenues powerhouse against which all other media and Internet
companies must be measured, uniting old media and new media,
offering consumer's a full range of name brand content that can be
delivered via broadband, Internet, print, cable, traditional
broadcast--from e-commerce to CNN, from instant messaging to the Cartoon
Network and HBO, the new company will have it covered and will be able to
deliver it any way the consumer wants.
The deal instantly makes also-rans of
other companies in the field who must now struggle to find merger partners
if they hope to compete with the new leader. AOL rivals Yahoo (YHOO),
and Excite AtHome (ATHM)
will be forced to go on the acquisition trail in search of a Disney (DIS)
or News Corp (NWS)
in order to remain contenders in the suddenly changed landscape. The
smaller players Lycos and Excite AtHome could themselves become takeovers
targets as the deal ignites a flurry of frantic mergers by major players
desperate to play catch up.
Although we love the new company's
business, we question whether current AOL shareholders will be as enamored
of the deal after the initial cheering wears off. The deal turns AOL
from a pureplay Internet stock, the stuff of which bubbles are made by
overzealous fans, into a slower growing media stock.
Prior to the deal, AOL investors were
willing to pay 32 times sales for AOL's $5.25 billion in annual revenues
and $715 million in EBITDA. Time Warner investors, by contrast, were
able to pick up a share of their $23.5 billion in revenues, $6.4 billion
in EBITDA company for the miserly price (by today's standards) of 3.6
With the new company's revenue base set
to be dominated by the former Time Warner businesses, a set of properties
which were projected to grow at a 13.8% annual pace over the next five
years, the question becomes whether investors who prior to the deal had
been willing to plunk down 32 times sales for the 49.4% projected growth
of AOL will now be willing to pay the same premium for a company whose
growth rate is dramatically lower.
The answer is, probably not. We
would expect the valuation levels accorded the new company to settle into
a mid-ground between those currently enjoyed by AOL and Time Warner.
For current AOL shareholders, today's cries of joy over the creation of a
new powerhouse could quickly turn into cries of sorrow as they watch the
inevitable process of multiple contraction take its toll.
We have nothing but praise for the new
company that has been created today, but we'll take a raincheck on its
stock--lower prices lie ahead.