Signs of a Slowdown Surfacing in Important Sectors
Housing, manufacturing and consumer spending--especially for “big-ticket” items--all are showing signs of weakness as the U.S. economy apparently has begun the slowdown engineered by the Federal Reserve’s yearlong campaign of interest-rate hikes.
And now some of the fallout for stock-market investors is starting to appear, in the form of scattered warnings of sales and earnings shortfalls due to the slowdown.
Consider Thursday’s surprising announcement by North Carolina banking powerhouse Wachovia Corp. that revenue and earnings are slowing and--more ominously--that borrowers are having trouble repaying loans.
Wall Street reacted by lopping 20% off Wachovia’s stock last week and taking down the rest of the banking sector as well, reasoning that if a conservative lender such as Wachovia was seeing deteriorating credit quality, then more aggressive banks might have even worse problems.
The Wachovia news took analysts by surprise because credit problems generally don’t show up until people start losing their jobs, which emphatically has not happened yet in this economy--outside of a handful of “dot-coms” starved for cash by suddenly skeptical investors.
Apart from the banking sector, the economic slowdown has hit more predictably in sectors that suffer when oil prices rise and consumer demand starts to tail off.
The impact has been muted so far, probably because it’s too early to know whether the economy will make the “soft landing” the Fed is hoping for--a deceleration to annual growth rates of 2% to 3% in gross domestic product--or if it will tip into recession.
“It smells like a turning point,” Bruce Steinberg, chief economist at Merrill Lynch, said last week. “It feels like we’re going from the truly spectacular to the merely good.”
Of course, there remains the third possibility that the recent signs of weakness will prove a mirage and the economy will go roaring off again. Most economists find this scenario less likely, given the Fed’s six consecutive interest-rate increases and its determination to keep squeezing until the slowdown is achieved.
Negative earnings “pre-announcements,” as tracked by the research firm First Call, have been running at a lower rate than usual for this time of year, with many of the warnings “company specific” rather than pegged to economic conditions.
A big test will come next month as the retail industry gets ready to report second-quarter earnings. If consumer spending has truly weakened, there could be a slew of profit warnings from retailers in July, a First Call analyst said.
Some of the worst-performing industry groups within the Standard & Poor’s 500 in recent months include auto makers, manufacturing conglomerates and firms that deal in basic or intermediate materials such as chemicals, metals, paper, wood and steel. All those groups are cyclical and rise or fall with the economy.
High prices at the pump naturally affect auto sales, but so does a slackening economy. When consumers anticipate a pinch, they tend to put off purchases of higher-priced items such as cars.
That goes double--at least--for recreational vehicles. National R.V. Holdings this month laid off 350 people--16% of its work force--saying it expects second-quarter profit to be well below estimates. Rival Winnebago Industries just completed a strong quarter for sales and profit but, like National R.V., warned that high gasoline prices and rising interest rates would take a bite out of sales in the quarter ahead.
The housing sector is a mixed picture. The National Assn. of Homebuilders’ index of housing-market activity has fallen to a two-year low, with traffic at home sites and future-sales expectations declining.
But, as economist Ian Shepherdson of High Frequency Economics in Valhalla, N.Y., notes, the NAHB survey conflicts sharply with Mortgage Bankers Assn. data showing continued strong demand for home loans.
Unsettled as the situation may be, there are signs of weakness among companies that cater to homeowners.
Investors battered Circuit City Group two weeks ago after the big electronics retailer reported softer May sales of big appliances. It would be only natural for sales of washers, refrigerators and air conditioners to fall off in a housing slump.
Home Depot, similarly, was downgraded last week by an analyst who suggested that higher interest rates were causing people to delay home-refurbishing projects. The company’s stock closed the week at $49.81 a share on the New York Stock Exchange, down 27% from its recent peak in late March.
What we’re seeing is the usual pattern in a slowdown: Basic materials firms and heavy manufacturers start feeling it first, then the housing and auto sectors and finally retailing.
On the positive side, if the Fed is indeed ready to declare victory and stop raising interest rates, the result could be pleasant for the broad stock market.Broad market indexes tend to perform very well in the year after the Fed completes a round of tightening, Steinberg said.
Wachovia’s announcement Thursday echoed several warnings issued earlier this year by the Fed, which told bankers that it feared creeping credit-quality problems. There is evidence that banks responded by tightening lending standards, yet some pockets of risk remain.
Credit cards may be one of them.
Christopher Low, chief economist at First Tennessee Capital Markets, said there has been a “phenomenal” increase in credit-card debt since around last Thanksgiving, as if consumers had run out of cash but were reluctant to end their spending spree.
Many people may have been confident that they could cover their credit card bills with stock market gains--a bad bet if they were heavily invested in technology stocks.
A worse-than-expected slowdown could cause problems for big credit card lenders, particularly those that have competed aggressively for market share by extending credit to younger and riskier customers.
On the other hand, if the economy keeps growing, few economists expect a broad deterioration in credit quality, Wachovia notwithstanding.
“You don’t stop paying off your loans because you think you might lose your job,” Shepherdson said. “You do it when you actually lose your job.”
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Where Wall St. Smells Trouble Fear that the apparent U.S. economic slowdown might cut deeply into companies’ sales and earnings has slammed some stock sectors particularly hard in the last month. The worst-performing stock groups in the Standard & Poor’s 500 index in the 30 days ended Thursday: Automobiles: -21.9%
Electronic instruments: -20.5%
Restaurants: -18.1%
Office equipment: -18.0%
Paper and lumber: -16.4%
Shoes: -15.7%
Misc. metal mining: -15.0
Steel: -14.6%
Conglomerates: -13.4%
Textiles: -13.1%
S&P; 500: -1.8%
Source: Bloomberg News
