More pain to come for equities (page 1 of 2)

We have now record auto sales as a result of zero interest auto loans, yet the stocks of General Motors and Ford are making 52 weeks new lows and are now lower than they were in 1990! So, clearly the market has serious reservations about the prospect of both companies - and with good reasons.

According to the GM 2001 annual report, the company's retiree benefit plans, including pensions and health care, have unfounded liabilities of $61 billion, which is up from $34 billion in 1999. Unless the stock market rebounds convincingly in the next few years these liabilities are likely to increase and the company will have to make massive contributions to its benefit plans, which will reduce earnings. But this is probably only a minor problem about which the market is concerned.

The poor stock performance of both Ford and GM amidst strong car sales rather reflects the fact that the stock market simply does not believe that the present auto boom is sustainable and that it will shortly give way to an auto slump! The auto industry is on track to sell more than 17 million vehicles this year, thanks to interest free financing. This would mark the fourth year in a row that total vehicle sales exceed 17 million units.

By comparison, before the 1990s, the US auto market averaged annually 14.6 million sold units. Based on an analysis by an automotive consultant, who took vehicle sales and driving age population into consideration, auto ownership has risen from about 90% of the population at the beginning of the last decade to 99.8% of the population.

Moreover, about two-thirds of the cars and trucks on the road in the US were purchased since the mid 1990s buying binge began - indicating that the car population age has declined significantly in the late 1990s (which reduces the need for replacement). According to this consultant, there is now an auto bubble and 'Americans could buy somewhere between 30% and as much as 50% fewer vehicles per year for four or five years and still very adequately meet their transportation needs.'

But there is another observation I wish to make about the fact that both GM and Ford are below their 1990 highs. If this were an isolated case, it would be of no great concern. But, the fact is that so many other stocks are either lower than they were in 1990 or barely above the 1990 level that the market is suggesting that something is really rotten in the US economy.

Otherwise, how could it be that after the longest economic expansion on record, which was followed by an extremely mild and brief recession in 2001, so many stocks are back to where they were when the 1990s economic 'miracle' got underway?

According to Adam Barth, who writes occasionally for the www.PrudentBear.com website, 'share repurchases went from 3% of total earnings in 1972 to 5% in 1980, before skyrocketing to over 50% of earnings in 1998. In the pre-1980 period, more than 50% of earnings were retained to build corporations' equity base. By 1998, less than 2% of earnings were retained to increase equity. Instead, these earnings were used to repurchase stock to counter the dilution caused by stock option grants to top management. In effect, common shareholders were left with a progressively smaller amount of equity and a rapidly increasing amount of debt'.

It should also be noted that the distribution of options is very much in favor of executives. According to the National Center for Employee Ownership, the top five executives of a company hold 75% of all US companies' options outstanding.