Feeling Bubbly
A last-minute merger frenzy and cheery CEOs augur well for the economy in 2005
Multibillion-dollar deals in telecom, healthcare, and software. Bullish forecasts from blue chips like GE and FedEx. Measured monetary policy moves from the Federal Reserve Board. The biggest dip in weekly jobless claims in five months. A Dow near its 52-week high. A strong, if not spectacular, Christmas shopping season. Even a dip in oil prices.
As 2004 winds down, there's reason to be jolly about the U.S. economy. Sure, the dour Grinch will still have reason to sneer: The pace of job growth remains below that of a few years back, the dollar is slumping despite a pep talk from the president, and consumers are going into hock to buy their presents.
But, as Jack Stack, CEO of engine supplier SRC Holding Corp., told Vice President Cheney at a recent two-day economic gabfest in Washington, "the bottom line, in summary, is that we have elevated from cautiously optimistic to optimistic." The proof may be in the recent flurry of put-your-money-where-your-mouth-is deals demonstrating that Wall Street and corporate America are back in growth mode.
Merger madness
In an end-of-the-year frenzy, mergers totaling about $90 billion were announced in one week of December. Oracle and PeopleSoft ended an 18-month hostile takeover battle and agreed to combine in a deal worth $10.3 billion. Sprint and Nextel plan to join forces to become the third-largest wireless provider in a $35 billion merger. Software maker Symantec agreed to acquire Veritas Software in an all-stock deal worth $13.5 billion. And Johnson & Johnson is buying Guidant for $25.4 billion to become the largest provider of heart devices. There were also some smaller deals, including industrial conglomerate United Technologies Corp.'s buying Britain's Kidde for $2.8 billion.
These deals cap off a year of double-digit growth for merger and acquisition activity. Some $768 billion worth of deals have been announced in 2004, up from $544 billion in 2003, according to Thomson Financial. Investment banks are clearly reaping the benefits. Lehman Brothers announced better-than-expected quarterly earnings due in part to a 95 percent rise in M&A revenues over the same period a year ago. Goldman Sachs also beat earnings estimates.
"A lot of corporations are flush with cash, so it's not surprising they are going on a buying spree," says Nariman Behravesh, chief economist at Global Insight. Behravesh doubts rising interest rates will be enough to choke off the M&A pipeline and anticipates an even more eventful 2005 on Wall Street.
One reason for optimism is increasing exports, the offspring of a weak dollar that is making U.S. goods cheaper in foreign markets. On that note, China sent an early Christmas present by announcing it would impose export tariffs on its own textile manufacturers beginning January 1, when long-standing quotas governing the global textile trade are due to expire. The move comes as Washington is weighing whether to impose restrictions on Chinese-made clothing.
Any break for American firms, though, would probably amount to temporary patchwork at best. China already controls about a quarter of the world textile market, and that is likely to grow to 60 percent within several years--regardless of any new tariffs--according to Credit Suisse First Boston. But on the selling side, China has become relatively accessible to U.S. and other western businesses trying to tap into the country's burgeoning wealth. Another recent policy change will allow retailers like Wal-Mart to open branches anywhere in China, with few restrictions--a significant easing of prior rules. Another recent government move will open up all of China to U.S. insurance companies, such as AIG.
While the brand-name mergers get most of the attention, other companies are choosing to return some of their cash hordes to shareholders, either through new or increased dividends or through stock buybacks. General Electric announced in mid-December that it would repurchase as much as $15 billion worth of its stock over the next three years, while also raising its 2005 earnings outlook. Kimberly-Clark, Kraft Foods, and Deere & Co. also committed to significant stock buybacks. According to Standard and Poor's, U.S. companies bought back $178 billion in stock this year through October, 52 percent more than last year. Christmas also came early for Microsoft investors, who just received $3 per share in a $32 billion special dividend payout.
Wall Street's memory may be short, but the wounds from the 2001 crash are fresh enough that many corporate treasurers maintain a decidedly conservative approach to cash management. "I think the current thinking is that disciplined use of cash is highly valued," says Ron Sargent, CEO of Staples, which recently announced a stock buyback and its first dividend. "The era of the go-go growth in the '90s is being replaced by an era of conservative financial management." -Megan Barnett and Richard J. Newman
Hiring uptick
The flush treasuries and ambitious growth plans also are yielding a benefit beyond the investor class: Those making New Year's resolutions to get new jobs may actually be able to keep them. Corporate managers are becoming slightly more optimistic with their hiring plans for the coming months, according to several polls. In a survey of 1,600 companies, employment services firm Manpower found that 24 percent expect to increase hiring in the first quarter of 2005, up from 20 percent in the same quarter of 2004. Still, 10 percent said they plan to decrease hiring, and 59 percent expect no change. The sectors most likely to post help-wanted ads: construction, finance, public administration, and mining.
Even with brimming corporate coffers, increasing head count is still not a priority for many employers. "It actually fits a very typical psychological pattern," explains Gary Burnison, of the recruitment firm Korn/Ferry International. Employees are usually the last cutback during a downturn--and the last to return in a rebound. Temporaries and consultants, however, often come first, and such hiring is up 14 percent over last year, says the American Staffing Association.
Still, CEO s remain hopeful that the economy will continue to expand and that the expansion will ultimately lead to job growth. In the December CEO Economic Outlook Survey from the Business Roundtable, 40 percent of CEO s said they expect to invest in more personnel in early 2005. And Burnison points to the impending flood of baby boomer retirees as an indicator that the job market is poised for expansion. "The economy can't continue to grow without adding jobs," he says. "Companies, at the end of the day, rely on people to execute strategies." Recent jobs figures from the Labor Department seem to reflect an improving, if erratic, job climate. More than 2 million jobs have been added in the past 12 months, though it was an impressive 303,000 jobs in October followed by a lackluster 112,000 in November. -Megan Barnett
Good tidings
America's bonhomie was center stage at the recent White House economic conference. The mostly corporate executives and pro-administration economists in attendance cheered the current state of the economy loudly and in lockstep. "We are actually very hopeful and positive on the economy as measured by technology spending, since technology has become a large portion of overall capital expenditures and correlates very nicely with GDP," said Dell CEO Kevin Rollins.
The president got full credit for the happy days that are here again, winning praise for his tax cuts, including the one that lowered the take on dividend income. "We expect dividends to be up about 12 percent this year and an additional 18 percent next year. So it's a wonderful example of how enlightened tax policy can achieve great results," added Mary Farrell, chief investment strategist at UBS Wealth Management.
Earlier in the same week, chief economic soothsayer Alan Green-span and his colleagues at the Federal Reserve signaled their own sanguineness with another quarter-point hike in short-term interest rates, part of a gradual tightening of the money supply intended to prolong the low-inflation expansion.
Greenspan, due to retire as Fed chief in 2006, was also rumored to have declined a feeler from prominent Republicans to replace John Snow as treasury secretary. For now, Snow will remain in his job, one that will be critical to pushing Bush's second-term economic agenda, which includes reining in trial lawyers, overhauling the tax code to shift the burden toward consumption and away from investment, and partially privatizing Social Security.
"Now is the time to confront problems," Bush told the conference. But he also acknowledged that the chief obstacle to his aggressive second-term economic agenda is the Senate. There he may need someone of Greenspan's stature to convince wary legislators that his economic policy is the right one for 2005 and beyond. -Matthew Benjamin
This story appears in the December 27, 2004 print edition of U.S. News & World Report.