War Jitters, Weak Retail Sales Push Indexes To The Cellar, & Apple Below US$14

Friday Recap

On Friday the market ended the trading day recording its sixth consecutive week of losses. The major market indexes stood at or near multi-year lows and early indications are that third calendar quarter corporate revenue and earnings reports will show little, if any, improvement over the second quarteris lackluster results.

Last weekis trading was marked by investor preoccupation with the escalating conflict in the Middle East and Americais political, psychological and military preparation for armed conflict with Iraq. Discussions concerning domestic economic matters have been muted by the vocal debate about international affairs.

A perceived lack of a coherent economic policy in Washington compounded by persistent corporate accounting scandals and widespread evidence that unscrupulous executives have systematically looted their companies with apparent impunity, have caused many traders to keep their cash on the sidelines. The nationis small investors continue to seek alternatives to the stock market such as real estate to preserve or enhance their net worth.

Monday Trading

On Monday investors turned their attention to Washington as the nation waited on President Bushis much-publicized address to the American people concerning the motives for and the prospects of military action in Iraq. The West Coast port lockout entered its second week with no evidence that union members and port owners would find an agreement to end their dispute. The economic cost of the lockout is now estimated at about US$2 billion per day. Retail stocks were hit hard on Monday as evidence mounts that consumers, the main catalyst for recent economic growth, may be slowing their pace of spending. The dayis bearish news pushed the major indexes to the cellar.

On Monday, the Dow Jones Industrial Average ended at 7,422.84, down 105.56. The S&P 500 Index finished off 15.30 at 785.28. The NASDAQ Composite Index fell 20.50 to close at 1,119.40. On Monday Apple dropped .26 and ended the day at 13.77, pushing the companyis market cap below US$ 5 billion.

The political events in New Jersey had one more day at center stage of this yearis election circus. Senator Torricelliis decision to withdraw from the New Jersey US Senate race within weeks of Election Day -- based solely on the fact that he decided he could not win after an ethics scandal rocked his campaign -- may have set a new political precedent for growth in two-party power. In this case the national partyis ability to quickly replace a probable losing candidate on a ballot within weeks of an election without direct voter input appears to have been a successful way to circumvent the already tightly controlled two-party candidate nomination process.

On Monday the US Supreme Court refused to consider without comment the Republican Partyis appeal of the New Jersey Supreme Courtis decision to allow state officials to decide whether or not the Democratic Party can replace Mr. Torricelli on the November ballot. Some suggest the high courtis decision not to hear the appeal may be in response to the controversy surrounding the 2000 presidential election when the Supreme Court sided with the Florida Secretary of State and in effect determined the winner of the 2000 presidential election. To other observers the Supreme Court has been consistent in both cases, allowing the constitutionally elected officers in each state to determine ballot and election issues. However, accounting scandals and election unrest do little to restore investor faith in the nationis economic and political systems.


Appleis premium priced .Mac service experienced an unexpected outage on Monday morning, denying subscribers access to their mac.com e-mail among other issues. All services were restored soon after noon Eastern Time, but the service outage came at an inconvenient time for the Mac maker as it pushes users to convert their free iTools accounts to the fee-based .Mac subscriber service by the October 14, 2002 deadline.

Without ceremony or fanfare Apple has reduced the price on the 15" LCD iMac by US$100. The drop in price comes as Apple and other PC makers grapple with sluggish sales while taking advantage of falling component prices. The 15" LCD iMac debuted with a base model at US$1,299 but Apple raised the price soon after introduction due to escalating costs. While the base model LCD iMac has been reduced to its original price, the US$100 drop in prices across the 15" LCD product line reduces the cost to consumers on some models to below their original price tag. Apple also offers a 17" LCD iMac for consumers looking for larger screens and other enhancements.

Interest Rates And The Economy

Interest rates remain at forty-year lows. Many are calling for a further reduction in interest rates in order to boost the stubbornly sluggish economy. However, economists and analysts know the more interest rates are reduced now, the more quickly interest rates may need to be increased later, when the economy shows real signs of sustainable growth.

Todayis interest rate dilemma started in the months before 1/1/2000 when the Federal Reserve Board flooded the economy with liquidity in order to make ample amounts of money available to the public and banks in the event of systemic Y2K glitches. Soon after the start of 2000, the Fed sought to reign in the money supply and dry up excess liquidity, concerned that too much liquidity might spark inflation. The Fedis sharp response to inflation fears caused the nationis money supply to dry up too quickly and contributed to the recession that began in earnest in the first quarter of 2001.

The Federal Reserve Board began to reverse its tightening policy when data indicated that the increase in interest rates and efforts to curtail money supply growth had helped to stall the economy. Consumers, many of whom are homeowners, were faced with some unintended realities when interest rates dropped quickly. The precipitous decline in interest rates reduced the interest expense on variable rate mortgages, thus potentially increasing personal taxes for homeowners because they now paid less in tax deductible interest on their mortgages. Home equity loans and mortgage refinancings to take advantage of low interest rates and untapped home equity have fueled new consumer spending.

Consumers have used the previously untapped equity in their homes to purchase big-ticket items such as cars and other durable goods and finance household expenses. However, a new car or other durable good purchased today may be a new car or other big-ticket item that otherwise would have been purchased six months or a year from now. Additionally, the use of funds from home loans to finance household expenses may hide increasing levels of consumer spending-related debt.

A significant component of the reported growth in consumer spending may be purchases that have been accelerated due to the drop in interest rates rather than a long-term increase in the level of consumer spending activity. In short, the sharp drop in interest rates may be masking fundamental problems in the economy. Recently, banks and other consumer lenders have succeeded in quietly passing federal legislation that makes it much more difficult for consumers to declare personal bankruptcy and walk away from their obligations. Banks and consumer lenders appear to be preparing for a significant increase in consumer insolvency rates that may occur when interest rates inevitably move higher.

In the tech sector, the sharp drop in interest rates has skewed corporate results. Cash rich and well-managed tech companies such as Apple Computer and Dell Computer have seen a significant drop in their interest income due to reduced earnings on their cash and investment assets. Apple has chosen not to use its hefty cash position for other purposes in order to squelch the concerns of rich-averse buyers such as education and government customers who might be concerned about the companyis relatively small market share and thus the companyis prospects for long-term success.

Rightly or wrongly, risk-averse buyers take Appleis strong balance sheet as a sign of the companyis staying power in the market. In contrast, Dell Computer has used about US$3.4 billion over the past several quarters to buy back its own shares, thus helping to maintain the companyis earnings per share growth at a time of falling profit margins.

Apple has judiciously used its cash to make small technology purchases, but few high-tech companies are making large R&D commitments and very large companies such as Hewlett-Packard are carefully watching their R&D expenses. Corporate America is generally not investing in new technology infrastructure, waiting on the much anticipated but elusive turnaround in business spending before making investment commitments.

The question is: How long can the economy continue to show signs of even tepid growth without an increase in business spending?

A portion of the reported economic growth in the first and second calendar quarters of 2002 was due to a build up of business inventories in anticipation of a pickup in corporate spending. Unless business spending activity begins to increase, working down inventories may further slow the subdued pace of current economic growth.

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