Shital Patel and Richard Berner | New York
Business conditions continued to deteriorate, remaining below 50% for the seventh consecutive month, but the deterioration isn’t intensifying. The Morgan Stanley Business Conditions Index (MSBCI) increased by four points in early December to 44%, retracing some of November’s decline. The less-volatile three-month moving average edged up two points to 43%, the highest level since August. At 43%, the fourth quarter average only stands one point above the third quarter average, meaning analysts are essentially just as pessimistic in the current quarter as they were last quarter.
Last month we noted that our bullish forecasts were out of sync with gloomy analyst reports, although we admitted that analysts were more accurate on conditions in the 3rd quarter than we were. Earlier this week, given incoming data, we sharply lowered our near-term GDP forecast, with the three quarter growth rate ending in 1Q07 averaging only 2%. However, there are also glimmers of improvement: A positive employment report and a blow-out retail sales report have led us to revise our current quarter GDP tracking estimate up 0.9 pp to 2.5%. Furthermore, advance bookings were higher in the
Results from this month’s survey suggest that analysts may be preoccupied with slower volume growth and fading pricing power, leading to lower top-line results in nominal terms. On the volume side, the advance bookings index declined three points to 40%, the lowest level of the index since April 2003. Also, our pricing conditions index plunged twelve points to 51%, the lowest level since January 2005. The breadth of responses was roughly equal between lower prices compared to a year ago, unchanged prices, and higher prices; only one-third of analysts said that companies have increased prices, down from the peak of 64% in February.
So what about the bottom line? Despite the moderation in price increases, a full 34% of analysts noted that prices charged have increased faster than unit costs over the past three months, the highest percentage since June. Furthermore, a full 61% said that margins are higher compared to a year ago at companies under their coverage. Luckily, our survey is in line with analysts on the Street: As of this Wednesday, Street analysts expected 61% of companies in the S&P 500 to have rising margins in 2006. S&P 500 earnings revisions have also improved, from 4.8% in early November to 7.9% this week.
We also asked analysts this month about the impact of lower energy quotes and higher materials prices on the bottom line. Lower energy prices will have little to no impact for 65% of the groups and will be a negative factor for the energy and utility companies. Higher metals and industrial commodity and foodstuff quotes will hurt the bottom line somewhat for 17% of the groups and significantly for 9% of the groups. Half of the analysts reported that these commodities have no impact on earnings.
Still, results from this month’s survey suggest that there is no sign of a revival yet, at least according to Morgan Stanley analysts. Along with the dismally low advance bookings index, our business conditions expectations index declined four points to 36%, matching September’s record low. This month, only one-fifth of analysts expect business conditions to improve over the next six months. Plans to hire and increase capex also declined in early December; 35% of groups plan to increase hiring over the next three months, retracing some of November’s record bounce to 41%. Only 43% of groups plan to increase capex, below the historical average of 46%. However, a full 45% of the groups that plan to increase capex plan to do so by 6% or more. We still maintain that there is pent-up demand for capital spending and expect that the deceleration in equipment and software outlays in 2006 will give way to roughly 7% annualized growth in the first two quarters of 2007.
The breadth of results narrowed in early December. 54% of analysts noted that conditions were unchanged over the past month, up from 41% in early November, while the percentage of analysts noting deteriorating conditions was only 30%, down from 41%. No analysts reported either noticeably deteriorated conditions or noticeably improved. Conditions improved for the consumer staples group and marginally for healthcare, while conditions deteriorated for IT, materials, industrials, financials and consumer discretionary.
On a positive note, the credit conditions index remained at 55%, indicating that financial conditions are still supportive of growth. We believe the decline in interest rates, the tightening of credit spreads, and the decline in the dollar have recently made financial conditions easier. We also asked analysts this month how much the declining dollar will contribute to bottom-line results at companies they cover. A full 41% said the dollar will have no impact, while 22% said it would have a marginal impact. The declining dollar will have a larger impact mostly for the consumer staples, IT, and materials groups, but will actually be a negative factor for the wireless services and railroads.