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A Frigid February for U.S. Factories

The Wall Street rally has lifted spirits, but this group of economists and strategists explains why we're far from being out of the woods

By BusinessWeek staff

While the mood has brightened on Wall Street in recent days—U.S. equity indexes were attempting to extened a market rally for a fifth day on Mar. 16 —the economic picture remains grim. Data released on Mar. 16 showed the New York Federal Reserve Bank's economic index falling to an all-time low in March, and a further decline in U.S. industrial production in February. Another worrisome sign: A net outflow of investment capital from the U.S. in January.

BusinessWeek rounded up comments from Wall Street economists and strategists on these and other key topics on Mar 16:

Action Economics

The U.S. Empire State index drop to a new all-time low of -38.23 in March, from -34.65 in February…. We continue to see upside risk in the various factory sentiment measures in March and April due to a reduced pace of decline for gross domestic product and industrial production as we enter the second quarter, given the stabilizing pattern in January and February consumer spending revealed in last week's retail sales report. Yet today's Empire data failed to cooperate with this pattern and raised the risk that the rapid pace of factory sector contraction might continue through March with little letup.

Indeed, today's capital expenditure plans index fell further in March, to -19.10, from prior readings in the already-low but narrow range of -10.64 to -11.49 in each of the last four months. This suggests downside risk in the comparable Philly Fed measure on Thursday from the prior three-month range of -16.4 to -18.4, and ongoing downside risk for business investment as we enter Q2 despite an improved consumer outlook. Continuing weakness in business investment might weigh heavily on factory output in Q2, even as prospects for consumer expenditures improve.

Ted Wiesman, Morgan Stanley (MS)

There was slightly weaker than expected headline Industrial Production result, but with much of the 1.4% further plunge in February production coming from a 7.7.% decline in utility output. The key manufacturing gauge fell 0.7%, a smaller drop than seen in recent prior months thanks to a rebound in motor vehicle output after an enormous collapse in January. Still, manufacturing output was down at a 21% annual rate in the six months through February, one of the worst declines in the long history of these data. Manufacturing Capacity Utilization also fell to another record low, putting increasing pressure on business pricing power.

Beth Ann Bovino, Standard & Poor's (MHP)

The Treasury reported a net capital outflow of $148.9 billion in January, a swing from a net inflow of $86.2 billion in December. The swing was almost entirely accounted for by changes in bank liabilities, which were a net inflow of $60 billion in December and an outflow of $119 billion in January. There was a net outflow of $43 billion in long-term securities, and an official (central bank) outflow of $8.5 billion.

The financial disruptions make this report harder to read, because many of the bank swings are caused by reporting oddities reflecting realization of losses and rescue spending. However, it appears the U.S. is becoming less attractive, perhaps indicating a move away from the recent flight to quality. The dollar has been stable through the period at a higher level against the euro.

Tobias Levkovich, Citigroup (C)

It is fair to suggest that the financials sector is unlikely to provide new equity market leadership since past leaders rarely repeat, but a sharp rebound is possible. Indeed, in 2003, technology names popped far more than the overall market recovery, with many stocks that were "priced-for-extinction" in late 2002 experiencing fourfold or fivefold moves in share prices over the course of a year. This kind of so-called "junk beta" rally could be repeated in the worst performing sector this time around as well. Sell-side ratings are generally bearish, while short interest is high. Anecdotal evidence also demonstrates a lack of interest other than concern that short covering can push prices up and leave investors underexposed for limited periods of time. Furthermore, hedge funds still seem to be slightly underweight in the sector.

However, there is little reason to step up in most investors' minds. A better pricing environment and valuation are supportive of insurance stocks, while diversified financials are closely linked to capital markets. Our underweight in REITs continues, given asset value concerns, while the market weight posture on banks is sustained.

Philip Roth, Miller Tabak

The strong action in the second week of March, including a reversal day and a confirming day, probably started a medium-term recovery. The financial press is rife with comments about the "bear market rally".; Evidently popular opinion is the recovery can't be more than a rally in a downtrend. While we believe a major period of basing will be needed to set the stage for a new bull market, we are not so quick to dismiss the advance as unimportant. After all, bull markets also start with sharp runups.

In any case, we believe the short-term momentum is sufficient for an exploitable advance and good enough to suggest a short term pullback is now likely to be in the form of a test for additional gains, rather than the immediate resumption of a downtrend.

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