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Up or Down Hill
A leading earnings researcher tells local analysts that the U.S. economy isn't out of the woods yet.
By Francis X. Gilpin
Associate Editor
Charles L. "Chuck" Hill is on the verge of unemployment. At age 66, that's not a nice prospect. But Thomson First Call's departing research director isn't nearly as concerned about the jobs picture - America's, not his own - as he is about more disturbing trends that he sees.
"It's not quite as bad as it might look," Hill says of the jobless character of the sputtering economic recovery in the United States. "But it is a problem."
Hill spoke at a March 9 dinner meeting of The Financial Analysts Society of Tampa Bay. A week earlier, Thomson Corp.'s financial data division announced that Hill's job would be eliminated in a restructuring at its First Call unit. Coming off prostate cancer surgery, Hill appeared to be taking the setbacks in stride at the St. Petersburg Yacht Club.
Hill recalled addressing a similar organization in Canada since his operation and was apprehensive when a comic started warming up the audience before his talk.
"In the interest of full disclosure, I had to admit that I was standing before them, as I am tonight ¦ in diapers," Hill joshed. "Let me tell you, if you're listening to a comedian and he's funny, that's a real incompatible thing with incontinence. No comedians, when I'm around."
Indeed, there was little levity in Hill's outlook.
The aftermath of the 2001-2002 recession isn't playing out in usual fashion, according to Hill, who has been an earnings and technology analyst for more than 25 years. "The uncertainties are huge, as far as how this recovery is going to unfold," says Hill. "What I've said all last year and so far this year is my crystal ball is as foggy as it's ever been."
A typical recession comes when production capacity falls behind overheated consumer demand, forcing the Federal Reserve to raise short-term interest rates to head off inflation. Consumer demand slackens for a while as prices rise, then slowly builds again in better balance with the ability of manufacturers to meet the pent-up demand.
"But this one was different," says Hill. "The consumer never fell off like they normally do because the Fed never raised rates and because the problem was too much capacity. Capacity was coming on faster than demand, even as fast as demand was."
Hill acknowledges that manufacturing accounts for only about 18% of gross domestic product.
But much of the American service sector depends on manufacturing. Measuring capacity in service industries can be problematic.
"We can in some, like the airlines," says Hill. "Clearly, we had an over-capacity problem there that was documented quantitatively - and corrected. Put a bunch of planes out in the Arizona desert and got load factors back up to normal rates. But, with a much lower number of planes, so revenues are less. But at least earnings-wise, we got the load factors back by retiring a lot of capacity."
Other industries, service or otherwise, haven't bitten the bullet, in Hill's estimation.
"The problem is, we got too much out there, whether it's burger joints, whether it's auto assembly plants, whether it's aluminum smelters, whether it's teenage apparel retail stores," he says. "We clearly have persistent excess capacity and we've had no pent-up demand to kick start this recovery."
That's why Hill says the tax relief signed into law last year by President George W. Bush has led to few new manufacturing plants. "There were tax breaks for business. They didn't do anything. You had too much capacity," he says. "It doesn't matter what kind of tax breaks there are or how low interest rates are. You're not too interested in expanding."
The best economic stimuli from the federal government came last summer in the form of child-care tax credits and lower employee withholding due to mid-year tax cuts, according to Hill.
Hill says the 8 %-plus jump in GDP during the third quarter of 2003 will be the biggest surge of this recovery. Home-equity borrowing is largely over. "Our ATM machine has been shut down, as far as refinancing the house goes," he says.
As for this year, Hill says: "The expectations are pretty reasonable for the first half and they're already factored into the market, that earnings are going to slow down."
The equities market may not be a place that investors want to be right now. "Should we be paying this much for stocks? I don't think so. I think we're overvalued, relative to the risk," says Hill. "Just looking at the numbers, tech's overvalued, has been overvalued for a while."
Hill displayed a series of charts for the technical analysts in his St. Petersburg audience.
Even with the recent declines in the Dow and other indices, some of the more feverish analysts are still touting a big stock market rebound. "It just blows my mind. In the beginning, it was pretty rational," he says. "But now we're back to, 'Gee, it may be up 100%, but they're still 50% below their peak. So they're undervalued.' They never should have been anywhere near that. What kind of yardstick is that to say that they're undervalued? Baloney."
Despite that, the economy should hold up in this presidential election year. "It's the second half of 2005 that worries me," says Hill.
The manufacturing capacity coming online in China, which has helped push prices upward in America for products such as petroleum and wood, is grossly excessive.
"They already have more auto assembly plants than they need, and they're building more," says Hill. "When you put in one of these extra auto assembly plants that you don't even need anyhow, it's not the usual thing that you see in a developing country. You buy some used equipment or bring it over from the 'States or whatever and take advantage of low labor to turn out cars. They're putting in state-of-the-art automated auto assembly plants."
The world's most populated nation is in a classic economic bubble. "China's in one, a big one, a huge one," says Hill. If it bursts, the U.S. economy is in trouble.
"I just think the uncertainties are such that you keep your powder dry until we get some better visibility as to what's to come in the second half of '04 and in '05," Hill told the local analysts.
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