In summary, here are the issues that plagued stocks the past week.
The fear is that the U.S. economy is growing too quickly and the jobless rate is too low. These fears sound perverse, but they aren't. The average S&P 500 company grew earnings a strong 21% in the fourth quarter of 1999, compared to the same quarter in 1998, and the U.S. jobless rate is at record lows. Scarcity of people to fill jobs creates wage inflation, or rising salaries. Rising salaries increases production costs, which can be a precursor to rising inflation. Widespread inflation can lead to a recessionary economy.
To keep inflation in check, the Federal Reserve raises interest rates, which increases the cost of borrowing money. This in turn causes companies to borrow less money and expand less. Related to this, higher interest rates also help slow earnings growth. In moderation, this is good for the economy (but feared by stock investors) if it helps keep inflation low. Finally, higher interest rates also make interest-bearing investments such as bonds more attractive when compared to stocks. So, stocks may decline in a higher interest-rate environment for two reasons: 1) because earnings growth may slow, and 2) because interest bearing investments look more attractive.
But what we really have here is greed, or just plain self-centeredness, on the part of some stock investors. These investors want the best of both worlds, it seems: they want low inflation and high growth, and they want it without increases in interest rates.
That would be swell, but typically you need to give a little in order to get a little. Greenspan and the Federal Reserve understand this. Greenspan gives a little by raising interest rates, and that in turn helps the economy grow steadily (not overly fast) and also keeps inflation in check. Yes, sometimes you must give a little to receive. You need to give up some higher growth to ward off inflation. It's a near-term "ouchie" for, ideally, a long-term victory. Investors selling stocks the past week apparently aren't willing to compromise even in the near term.
If you're a long-term investor and all of this seems largely irrelevant to you, you're right -- it is, or it should be. If you have confidence in the Federal Reserve's ability to manage the economy whatever ways it can, then you should simply sit back and watch your tax dollars at work. So far, Greenspan and Company have been legendary at doing the right thing. This week when they meet Tuesday and Wednesday, they may raise interest rates 1/4 point or 1/2 point (probably on Wednesday), in order to ward off inflation. Whatever they do, they're interested in long-term growth without high inflation. Bravo! Let's wish them continued success.
Starbucks (Nasdaq: SBUX) bucked the downward trend on Nasdaq this morning and continued to rise after last week's estimate-topping quarter and the company's guidance to raise this year's earnings estimates approximately three cents per share, to about $0.70 per share. At $31, the stock is at 44 times estimates for the year ending in September while earnings should grow about 27%.
eBay (Nasdaq: EBAY) also continued to be strong following last week's news that it doubled earnings estimates to end 1999. I believe that eBay is one of the most compelling online-based businesses for long-term investment. In seventeen pages, I explained why so many other investors and I like eBay's prospects. This took place in November's Motley Fool Internet Report on online auctions. The long-term analysis of eBay's potential hasn't changed. You can buy individual Internet Reports, like this one on eBay, for $20. Revenue goes to feed a large, growing, cash-hungry monster called "The Fool."
We see quarterly results from Amazon.com (Nasdaq: AMZN) on Wednesday and Paul Larson (TMF Parlay) will be here to consider them with us. On Friday, Paul outlined Amazon's current investments in other companies. Add Audible (Nasdaq: ADBL) to the list. Today, Amazon took a 5% stake in the audio online company, plus, Amazon will be paid $30 million by Audible over three years for promoting Audible's services on Amazon. (Cha-ching!)
Today's news completes three large revenue-generating deals worth around $200 million to Amazon in two weeks alone (the others are Greenlight.com and Drugstore.com). This type of revenue stream isn't typical of a traditional off-line retailer, of course. In fact, it may be time to start calling Amazon a diversified retail portal host, given that the company's highest margin revenue is now derived by promoting other sites. Whatever plan CEO Jeff Bezos has for eventual profitability (which he alludes to in interviews), of course he won't share it now. What company gives its strategy away? Investing in Amazon is believing in Mr. Bezos and his so far visionary leadership and aggressive management.
A good deal of noise was made after Friday's news that Amazon will lay off about 2% of its staff, or 150 people. The Wisest, dumbest quote that I saw on the news came from an analyst who said, "Clearly this shows that the [Amazon business] model isn't working."
Yikes! Somebody likes to jump to conclusions.
We actually took the news as a good sign that Amazon's management has the courage to make difficult decisions. Amazon has broken growth records. It is growing so quickly, it isn't surprising that it over-hired in some areas and can stand a trimming of its employee "tree." Once it trims itself and sees its inherent shape, it'll begin growing again. (Amazon shared that fired staffers can reapply for new jobs within the company.)
So, it's much better that Amazon makes the hard decision now to let people go, takes stock of its needs, and then grows from there, rather than continue to grow with a bloated employee structure. The firing is not a sign, as some analysts argued, that the business is "peaking." We'll be smiling wide at that trite notion a year from now, not to mention in 10 years.
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