The industrial economy appears to be showing signs of recovery, following 12 months of contraction. ...
The industrial economy appears to be showing signs of recovery, following 12 months of contraction. First quarter 2002 consumer data has exceeded its fourth-quarter average, industrial production and orders are improving and the Fed's Beige Book's round- up of regional activity is equally upbeat.
Such reassuring data suggests the recession is bottoming out and that a return to economic growth could be realised sooner than expected. However, neither investors nor corporate leaders are yet espousing such sanguine views. On the contrary, analysts' near-term expectations generally point to a pick-up in corporate earnings in the second, as opposed to the first half of 2002.
Nevertheless, we believe there is a stronger possibility of upside earnings surprises than of seeing a profitless recovery. US firms have arguably responded faster to the latest downturn than ever before. So, as the global economy stabilises, margin improvements could drive profit growth in excess of expectations. Three key drivers of margin recovery can be identified.
First, US firms have reacted to the economic slowdown by aggressively re-assessing their cost structures. Headcount reductions of permanent employees have been complemented by a rapid decrease in the use of temporary staff and consultants. In addition, US firms have outsourced many non-core activities over recent years, therefore, reducing manufacturing costs.
Second, many US firms have increased productivity by utilising resources more efficiently. Better business practices and increased investment in new technology are contributing factors. For instance, computerised order-tracking and inventory control systems have resulted in greater levels of real-time information being available.
In turn, businesses have been able to adapt production schedules and budgets more rapidly to changing levels of demand. These points are illustrated by reference to Cisco System's development over the past few years. After implementing new technologies, the IT hardware giant has achieved far more control over its businesses. This has enabled it to respond more rapidly to the latest business trends.
As a result, Cisco's operating margin has already rebounded to levels in excess of those expected by analysts, with a recovery in revenue yet to come.
Last, US firms have shown themselves to be more innovative than their overseas competitors. Heavy investment in R&D has helped generate many new products. Technology investments have also paid off by reducing the time taken to develop and launch a new product. This has enabled US companies to build leadership in higher value, more profitable goods and services.
However, it is too early to ascertain the true extent of any recovery. The apparent mildness of the 2001 recession raises nagging questions as to whether the imbalances in the US economy have really been rigorously overhauled.
So while it is possible that the economic uplift we are experiencing may not last, the actions taken by US companies during the downturn suggest that when growth does stabilise, corporate US could emerge in even better shape.
Possibility of upside earnings surprises.
Industrial production and orders improving.
Recession is bottoming out.
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