News Analysis
BusinessWeek.com
July 21, 2006
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Whole Foods: A Little Too Rich?

The natural-foods retailer boasts strong sales and a solid brand in a fast-growing niche. Trouble is, the stock may be too high

Shoppers at Whole Foods Markets (WFMI ) are used to paying a little extra for the quality they want. The Austin (Tex.) natural-foods giant's shares, too, are trading at a premium, analysts say, even after a two-month decline. While green-focused gourmands will gladly splurge on organic cheese, investors may want to wait for a bigger markdown on the share price before putting Whole Foods in their carts.

Since its first store opened in 1980, Whole Foods has grown into a retail success story to rival coffee giant Starbucks (SBUX). Adjusting for dividends and splits, shares in the health-oriented supermarket chain swelled a staggering 855.8% in the 10 years through late trading July 20.

"We are a lifestyle brand and have created a unique shopping environment built around satisfying and delighting our customers," Whole Foods co-founder and CEO John Mackey said in a May 3 conference call. A Whole Foods spokeswoman declined to comment, citing a quiet period before the company's July 31 earnings announcement.

ON THE REBOUND.  As retail stocks have struggled in recent weeks, Whole Foods has not been immune (see BusinessWeek.com, 7/18/06, "Target: The Canary in the Economy?"). On July 18, the grocer's shares touched a 52-week low of $54.66, down an adjusted 27% for the year. Shares have already rebounded somewhat, to $57.81 in late trading July 20.

Despite recent losses, the future looks relatively bright for the chain. Analysts laud Whole Foods' brand image, merchandising prowess, and store expansion plans. Meanwhile, 10 straight quarters of double-digit same-store sales growth can't hurt. Whole Foods has "revolutionized the way food retailing is being done in this country," says Citigroup analyst Gregory Badishkanian, who has a hold recommendation on the stock. "They do a phenomenal job in terms of their vision and their execution." (Citigroup owns 1% or more of a class of Whole Foods securities.)

Still, Whole Foods' sterling reputation may already be reflected in its share price. The stock trades at a roughly 40% price-to-earnings premium vs. other "best-in-class" food sellers like Starbucks, P.F. Chang's (PFCB ), and Cheesecake Factory (CAKE ), Badishkanian wrote in a May 3 report. Meanwhile, Whole Foods supply-chain partners United Natural Foods (UNFI ) and Hain Celestial Group (HAIN ) offer similar exposure at significantly lower valuations.

ORGANIC TREND.  Demand for natural and organic foods has sprouted rapidly in recent years. Organic-food sales jumped from $3.6 billion in 1997 to $13.8 billion in 2005, according to figures from the Organic Trade Assn. "There are some pretty deep commitments throughout our culture to organic food," observes Bill Wolf, president of New Castle (Va.) organics-market consultancy Wolf & Associates.

Whole Foods isn't the only grocer dedicated to this burgeoning market, but it is the biggest. The company operates 183 locations in the U.S. and Britain, compared with 113 in the U.S. and Canada for its closest rival, Colorado-based Wild Oats Markets (OATS ).

Traditional retailers, too, are catching the green bug. Supermarkets such as Kroger (KR ), Safeway (SWY ) and SuperValu (SVU ) have launched private-label organic lines. More recently, big-box behemoth Wal-Mart (WMT ) announced plans to double its organic offerings as it seeks to attract affluent customers (see BusinessWeek.com, 3/29/06, "Wal-Mart's Organic Offensive"). In general, Whole Foods' wider selection and top-notch customer service give it a leg up on the competition, Badishkanian says.

SOCIAL-ISSUES EMPHASIS.  Moreover, consumers may go to Whole Foods expecting something beyond eggs from cage-free chicken. Like Starbucks or Apple (AAPL), Whole Foods is perceived to offer its customers not just products, but a lifestyle choice, in accordance with its company motto: "Whole Foods, Whole People, Whole Planet." In recent months, Whole Foods has further emphasized its environmentally and socially conscious image by pledging to increase its support for small farms. It has also banned the sale of live lobsters, citing concerns about inhumane treatment such as lobsters being held in storage facilities for several months. (The chain plans to offer frozen raw and cooked lobster products instead of the snapping crustaceans.)

Whole Foods appears better positioned than most retailers to weather a cooling economy (see BusinessWeek.com, 7/5/2006, "Shedding Light on the Second Half"). History shows little to no relationship between the company's sales and data for economic growth, employment, or even consumer spending, according to Bank of America analyst Scott Mushkin, who rates the stock a buy. (Bank of America has an investment-banking relationship with Whole Foods and makes a market in the company's securities.)

Another encouraging sign is that rising oil prices don't appear to have dented margins. In the quarter ended Apr. 9, same-store gross profit rose four basis points as price increases absorbed higher energy costs.

GROWING PROGRESS OR PAINS?  While the company's expansion plans may curb profits in the near term, they should boost sales growth over the long run, analysts say. On May 3, Whole Foods management announced they expected square footage to rise 15% to 20% in stores in 2007, up from an expected 14% rise in 2006.

"We believe the rollout of additional large stores will ultimately prove to be transformative for Whole Foods," noted RBC Capital Markets analyst Edward Aaron in a May 4 report. Aaron has an outperform rating on the stock. (RBC Capital Markets expects to receive or intends to seek investment-banking compensation from Whole Foods and makes a market in the company's securities.)

At the same time, the new store launches could be risky should sales start to slow, others say. "Our major concern is the ability of Whole Foods to manage its expense levels to sustain its contribution margin should it experience a slowdown in its sales growth, which could result in more sudden margin pressure," wrote Bear Stearns analyst Robert Summers, who rates the stock underperform, in a May 3 report. (Bear Stearns make a market in Whole Foods securities.)

COMPARING THE P-E.  The bottom line, some analysts say, is Whole Foods' lofty valuation. Standard & Poor's recently pegged the stock's price-to-earnings multiple at 40.5 using estimated 2006 earnings, while Prudential has cited a forward p-e of 48. That compares to valuation in the teens for standard supermarkets. "We suspect that the name will trade sideways and 'grow' into its valuation," wrote Prudential Financial analyst Robert Campagnino in a May 4 report. Campagnino has a neutral-weight recommendation on the stock. (Prudential owns 1% or more of a class of Whole Foods securities.) Whole Foods has built a healthy business out of consumers' desire for cleaner, greener food offerings. Still, with the stock still trading at robust multiples, investors wishing to play the organic-food boom might want to consider its more attractively valued supply-chain partners until Whole Foods shares slim down a bit more.

News Analysis
BusinessWeek.com
July 21, 2006
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Microsoft Buyback: Should You Bite?

The software giant wants to repurchase up to $20 billion of its shares by Aug. 17. Here's why investors may want to take the offer

Wall Street cheered on July 21 after Microsoft (MSFT ) unveiled a plan to buy back up to $20 billion of its shares next month. Shares of the Redmond (Wash.) software behemoth surged 4.5% to $23.87 at the close of trading July 21, the session following the announcement. Over the next five years, the repurchase program could total $40 billion (see BusinessWeek.com, 7/21/06, "Microsoft's New, Improved Spending").

Microsoft stock's sudden popularity may prove short-lived. Adjusted for splits, the shares have drifted between $20 and $30 for more than four years (see BusinessWeek.com, 6/19/06, "More of the Same for Microsoft Stock?"). Now that the price is up on the latest news, it could be as good a time as any for impatient shareholders to give Microsoft CEO Steve Ballmer his stock back. But Redmond's big move leaves few clear winners—particularly not those who bought the stock anywhere near the peak it reached nearly seven years ago, when it soared as high as a split-adjusted $51.80.

The current $20 billion tender offer calls for Microsoft to buy back as many as 808 million shares, or 8.1% of its outstanding stock, in a reverse Dutch auction. Shareholders can tender their stocks from July 21 through Aug. 17. They can choose the number of stocks they wish to sell and a price between $22.50 and $24.75 a share.

Companies and investors favor buybacks because they reduce the number of shares outstanding, which improves earnings per share. Buybacks also absorb the excess stock created when employees exercise stock options.

THROUGH ANALYSTS' EYES.  Microsoft's repurchase program, revealed alongside a 24% drop in quarterly earnings, comes after shareholders have chastised the software maker for failing to fire up its flagging share price. In April, Microsoft announced bigger-than-expected spending on new investments, and investors sent shares down 11% in one day (see BusinessWeek.com, 4/28/06, "Microsoft's Strange Spending Splurge"). On the heels of a $30 billion buyback over two years, the company is now putting its hefty cash pile—$34.2 billion as of June 30—to the use the Street wanted.

It might not be enough to provide a sustained lift to the shares. While analysts remain mixed on the stock, most don't see the buyback fundamentally altering the challenges Microsoft faces as it transitions from its familiar PC-based model toward faster-growing market segments. The company forecasts $500 million in investments in online services next year, which analysts say could keep it from improving its margins.

Indeed, Microsoft stock may have gotten the bulk of its buyback-related boost even before the July 21 opening bell, some analysts say. "Upside from $20 billion tender offer [is] already in stock pre-open," Merrill Lynch analyst Kash Rangan wrote in a July 21 report. Rangan, who has a neutral recommendation on the stock, also notes that the tender offer probably rules out a major acquisition such as Yahoo! (YHOO ) or eBay (EBAY ) for roughly the next year. (Merrill has an investment banking relationship with Microsoft and makes a market in its securities.)

THE CASE FOR SELLING.  If Microsoft shares break out of their recent rut, it might not happen until fiscal 2008, according to Rangan. The company's online business probably won't become profitable before then, though Microsoft projects 7% to 11% fiscal 2007 growth in this area, which includes services like adCenter, Office Live, and Search. Reaching this milestone could drive the stock higher, Rangan says.

Margins at Microsoft are in a "tailspin," says Citigroup analyst Brent Thill, who has a hold recommendation on the stock. Thill guided his fiscal 2007 operating-margin estimate down from 39% to 35.6% after the announcement, noting that investors had hoped for operating leverage from the new Vista operating system. "Microsoft thinks their stock is cheap, but we think declining operating margins do not warrant significant share appreciation," Thill wrote in a July 21 note to clients. (Citigroup owns 5% or more of a class of Microsoft securities.)

Meanwhile, other tech stocks may offer bigger upside. Credit Suisse analyst Jason Maynard sees superior growth chances in Red Hat (RHAT ), Salesforce.com (CRM ), Google (GOOG ), and Yahoo, plus a better large-cap opportunity in Oracle (ORCL ) because of its exposure to corporate spending. Open-source software, on-demand computing, and advertising-based business models could all cut into Microsoft's revenue, Maynard wrote in a July 21 report. He has a neutral recommendation on the stock. (Credit Suisse has an investment banking relationship with Microsoft and makes a market in its securities.)

REASONS TO STAY.  Still, Microsoft stock has its fans. Morningstar analyst Toan Tran estimates the stock's fair value at $34, hailing the buyback as a smart move to shore up the company's capital structure. "Microsoft is prudently investing to ensure that there are many more chapters ahead for the world's largest software company," Tran wrote in a July 21 report.

Tran says another reason to hang onto the software maker's shares is the pending launch of its new products, including the long-awaited arrival of Vista. On July 21, Microsoft confirmed it would also introduce music hardware and software to compete with Apple's (AAPL ) iPod and iTunes. In 2005, Microsoft rolled out the Xbox 360. The company expects to have shipped as many as 15 million of the video-game consoles by June 30, 2007, amid anticipated competition from Sony's (SNE ) PlayStation 3.

Microsoft's server business is an additional bright spot. The servers and tools segment reported 18% fiscal fourth-quarter growth vs. the same period a year earlier, at the high end of guidance, and should continue to build momentum in the rest of the calendar year, observes UBS analyst Heather Bellini, who rates the stock a buy. (UBS has an investment banking relationship with Microsoft and makes a market in its securities.)

WHICH INVESTORS BENEFIT?  But the stock continues to languish despite the company's successes. Indeed, one factor that may give pause to both sellers and Microsoft's stock price is a lack of upside. The tender offer's $22.50 to $24.75 price range means only an 8% return on the high end, which means the buyback may not get full subscription, notes Merill's Rangan. The remaining $20 billion repurchase through 2011 would likely be more gradual and therefore give the stock a less dramatic jolt.

Further, it's unclear how many investors will really gain at that price. The offer only makes sense for investors who bought the stock before 1999, investors who bought it in the past two months, and those who bought in the intervening years and don't mind taking a loss to reduce their exposure, says Citigroup's Thill.

Microsoft's buyback bid may not make investors rich by Aug. 17 or in the months afterward. But for shareholders seeking an exit strategy after years of stagnant stock prices, it's a chance to reboot.

News Article
BusinessWeek.com
July 18, 2006
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Stocks Inch Higher Ahead of Fed Speech

The producer price index posted a solid 0.5% gain, raising interest-rate concerns ahead of Bernanke's testimony Wednesday. Upbeat blue-chip earnings were also in focus

Stocks finished modestly higher Tuesday, rebounding in the final hour amid solid blue-chip earnings, declining oil prices and a stronger-than-expected report on wholesale inflation. Trading was volatile ahead of Wednesday's data on consumer inflation and testimony by Federal Reserve Chairman Ben Bernanke.

The Dow Jones industrial rose 51.87 points, or 0.48%, to 10,799.23. The broader Standard & Poor's 500 index edged up 2.37 points, or 0.19%, to 1,236.86. The tech-heavy Nasdaq composite added 5.5 points, or 0.27%, to 2,043.23.

Escalating Mideast tensions have added a war-risk premium to the market, some analysts say. "There is the potential for a more significant drop in prices should conditions deteriorate either with the conflict or with the earnings profile for U.S. companies," notes Joe Battipaglia, chief investment officer at Ryan Beck, in a research report.

As the conflict between Israel and Lebanese militants continued, investors were turning toward economic data Tuesday. The producer price index rose 0.5% in June, the Labor Department said. The core index, which excludes food and energy, edged up 0.2%. This reading suggests a treacherous inflation outlook as the Fed prepares for its Aug. 8 meeting, says Action Economics.

On Wednesday, the overall consumer price index is expected to increase 0.2%, accompanied by a 0.2% rise in the core index. Fed Chairman Bernanke is set to give semi-annual testimony before Congress.

Bernanke's remarks may offer little detail on the Fed's interest-rate plans, analysts say. "We suspect the market will not be as confident of a hike at the end of the week as it is today," notes Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

Elsewhere on the economic front Tuesday, the National Association of Home Builders housing-market index fell to 39 in July, its lowest level in more than 14 years.

Upbeat earnings reports garnered some attention. Coca-Cola (KO ) was higher after the beverage maker posted a 7% increase in second-quarter profit, above analyst expectations.

Fellow Dow component United Technologies (UTX ) was also higher after the industrial conglomerate said second-quarter profit rose 14% on 10% higher sales.

Among other Dow members in the news, Johnson & Johnson (JNJ ) shares fell after the diversified healthcare company posted 9% higher profit on record sales.

Fast-food giant McDonald's (MCD) was modestly higher after Goldman Sachs upgraded the stock from neutral to buy, on the heels of strong second-quarter earnings.

Tech bellwethers IBM (IBM ) and Yahoo (YHOO ) were set to announce quarterly results after the close.

Also in tech, Dell (DELL) was lower on a report the computer maker is selling color-laser printers in Japan at lower prices than competing products to expand market share.

The semiconductor group scraped 14-month lows, but Intel (INTC) was higher amid reports Bank of America maintained its buy rating on the stock. The chipmaker is due to report earnings Wednesday.

Other companies slated to release earnings Wednesday include: Bank of America (BAC ), eBay (EBAY ), J.P. Morgan Chase (JPM ), Juniper Networks (JNPR ), Motorola (MOT ), Qualcomm (QCOM ), and Southwest Airlines (LUV ).

In the financial sector, Merrill Lynch (MER ) was down after reporting a 44% rise in second-quarter profit despite stock-market weakness in May and June. Shares in Charles Schwab (SCHW ) rose following a 35% jump in second-quarter profit.

A reduced sales forecast weighed on retail stocks. Target (TGT ) was lower after the big-box retailer guided its July same-store sales lower. Rival Wal-Mart (WMT ) was also down.

Retail peers Abercrombie & Fitch (ANF ), Best Buy (BBY ), and J.C. Penney (JCP ) were lower after A.G. Edwards downgraded the stocks from buy to hold.

Shares in RadioShack (RSH ) declined following the resignation of the electronics-store chain's chief financial officer.

In the energy markets Tuesday, August West Texas Intermediate crude oil futures closed down $1.76 at $73.54, after touching an all-time record $78.40 on Friday. Profit taking and a lack of worsening Mideast news drove selling, says Action Economics.

European markets finished modestly lower. In London, the Financial Times-Stock Exchange 100 index slipped 19.3 points, or 0.34%, to 5,681.7. Germany's DAX index shed 20.11 points, or 0.37%, to 5,396.85. In Paris, the CAC 40 index was down 15.54 points, or 0.33%, to 4,734.54.

Asian markets finished sharply lower. Japan's Nikkei 225 index declined 408 points, or 2.75%, to 14,437.24. In Hong Kong, the Hang Seng index slipped 20.88 points, or 0.13%, to 16,043.94. Korea's Kospi index lost 21.71 points, or 1.73%, to 1,233.42.

Treasury Market

Treasury yields climbed as the solid producer price index fanned fears the Fed may hike interest rates too far. The 10-year note fell in price to 99-30/32 for a yield of 5.13%, while the 30-year bond tumbled to 90-01/32 for a yield of 5.16%.

News Analysis
BusinessWeek.com
July 17, 2006
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The Bunker Portfolio

If the turmoil gripping the Middle East—and the stock market—worsens, these savvy mutual funds should still hold up under fire. But diversification remains a smart strategy in any climate

Tension is high in the Middle East, and so are blood-pressure levels on Wall Street. Oil prices touched an all-time record of $78.40 on July 14 amid escalating violence in Israel and Lebanon, as major indexes ended the week with three straight days of heavy losses (see BusinessWeek.com, 7/14/06, "Stocks Slide as Global Worries Persist"). Geopolitical trouble-spots Iran, North Korea, and Iraq continue to simmer while fears of inflation or recession unsettle the home front.

While it's impossible to predict the outcome of current world events, for the moment let's assume a worst-case scenario. If increased military conflict leads to $100 barrels of oil and a broader U.S. economic slowdown, what should a worried investor do? Under those bearish circumstances, gains would be few and far between. But a "bunker portfolio" with a few smart mutual funds could at least contain the financial damage.

A bunker portfolio would include funds that might outperform the broader market when worst comes to worst. That means natural resources funds, along with balanced funds, long-short funds, and perhaps some low-cost bond funds, analysts say. However, others caution that a properly diversified grouping spanning a full array of asset classes might be the best bunker portfolio of all (see BusinessWeek.com, 7/11/2006, "Time to Put a Premium on Safety").

COMMODITY COVERAGE.  If war is human nature, the sector most likely to gain from continued Mideast turmoil is probably natural resources. Shares of Exxon Mobil (XOM ) gained 3.3% in the week ended July 14, while Chevron (CVX ) advanced 4.2%, despite a 2.3% decline in the Standard— Poor's 500 index. "Energy funds would be a good hedge," says Lipper research analyst Jeff Tjornehoj.

One way to play the natural resources sector is to invest in funds tied directly to commodity prices. For example, PIMCO CommodityRealReturn (PCRAX ) posted a three-year average annualized return of 17.48% through June 30, vs. 13.55% for its mutual fund peers with the same investing style, though it carries a 1.24% expense ratio and a hefty 5.5% sales load. The fund invests in structured notes linked to commodities and tracks the Dow Jones-AIG Commodity index. New exchange-traded funds, or ETFs, such as Deutsche Bank's (DB ) DB Commodity Index Tracking Fund (DBC ), can also provide natural resources exposure.

Funds that invest directly in energy companies are a more straightforward option for investors looking to strike black gold. Vanguard Energy (VGENX ) is a low-cost choice, with an expense ratio of 0.28% compared to a 1.31% peer average. The fund has also turned in an appealing performance, averaging annualized returns of 25.08% in the five years ended June 30, vs. its peers' 19.6%. "It's also going to be a nice long-term holding," says Russel Kinnel, director of mutual fund research at Morningstar (MORN ).

IN CASE OF MARKET MELTDOWN.  Balanced funds and long-short funds may provide additional security for investors who don't want to ride out a down market. "They'll have better down-market performance than indexes, but you'll lag the market on the upside," notes Robert Walsh, a Red Bank (N.J.)-based financial planner with the Alliance of Cambridge Advisers. Still, Walsh says investors may be better off sticking with a few low-cost index funds rather than trying to time the market.

Balanced funds may invest in both stocks and bonds, so managers can shift into fixed-income securities if they foresee a market meltdown. One balanced fund Walsh likes is Greenspring (GRSPX ). This fund's top holdings include semiconductor equipment maker Brooks Automation (BRKS ) and drugmaker Sepracor (SEPR ), while its five-year average annualized return of 8.85% handily tops 3.55% for its peers and 2.49% for the S&P 500. It carries a below-average expense ratio of 1.16%. However, the fund can be volatile, so investors should use it cautiously.

A less-volatile option is Dodge&Cox Balanced (DODBX), with an average annualized five-year return of 9.27% and a 0.53% expense ratio. The fund invests in mid-cap and large-cap stocks such as Hewlett-Packard (HPQ ) and Sony (SNE ), with an emphasis on value. U.S. Treasury bonds are also a top holding, and the portfolio management team boasts an average tenure of 15 years.

BEWARE THE BEAR.  Another value-oriented balance fund, Oakmark Equity & Income (OAKBX), takes an all-cap approach and has benefited in recent years from the outperformance of small-cap stocks. With a 9.4% five-year average annualized return, the fund's biggest holdings are U.S. Treasuries, XTO Energy (XTO ), and EnCana (ECA ). It carries an expense ratio of 0.89%.

Elsewhere, funds that hedge against bear markets by taking short positions could bolster a bunker portfolio, though shareholders risk missing out on market rebounds. Hussman Strategic Growth (HSGFX ) uses put and call options on broad indexes, rather than shorting specific stocks. Its 11.55% five-year average annualized return compares to 2.3% for its peers over the same period, while its 1.24% price tag is just slightly above the category average.

Rydex Investment and ProFunds also manage a variety of funds that use shorting strategies. Meanwhile, ProFunds recently launched its ProShares series of ETFs, which include four funds that seek to match the inverse of a given index's returns (see BusinessWeek.com, 6/22/06, "Spread Your Bets in ETFs"). Four other ProShares ETFs use leverage to try to double those inverses. These funds have limited track records and a high level of risk, so they're probably not for the novice investor.

DIVERSITY IS THE BEST DEFENSE.  In a global downturn, bond funds might be another good safe harbor for risk-averse investors. Vanguard Long-Term Treasuries (VUSTX) has a low expense ratio of 0.26% and invests mostly in long-term Treasuries. Its five-year average annualized return of 6.37% is slightly better than its peers' 5.98% and is close to that of its benchmark, the Lehman Brothers Long Government index, which returned 6.64%. Still, the fund is sensitive to the risk of continued Federal Reserve interest-rate hikes (see BusinessWeek.com, 7/11/06, "Don't Bet on a Bond Rally").

These defensive strategies may outperform in case of a global economic calamity, but financial advisers caution that a well-diversified portfolio is generally the best approach for long-term investment success. Diversification typically diminishes a portfolio's volatility. "When I think of a bunker portfolio I think of one that is really well diversified," says William Cuthbertson, principal at San Juan Capistrano (Calif.)-based financial planning firm Fiscalis Group.

It's important to remember that the best tool for reducing risk is time, notes Richard Bernstein, chief investment strategist at Merrill Lynch. "The probability of losing money in an investment generally decreases as the investment time horizon lengthens," Bernstein wrote in a July 17 report. "The probability of losing money is 46% when investing in the S&P 500 for one day, and that probability gradually decreases as time goes on."

A worst-case scenario hasn't arrived, and investors shouldn't bet on one, analysts say. Still, if oil does hit $100 a barrel and the economy sputters, a good bunker portfolio can protect your hard-earned money without the discomfort of sticking it under the mattress.

News Article
BusinessWeek.com
July 14, 2006
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Stocks Tumble Amid a Sea of Troubles

Wall Street's woes mounted as crude oil hit a record, the Israel-Lebanon conflict escalated, and tech names posted weaker earnings

Stocks ran a gauntlet of gloomy news Thursday, finishing sharply lower for a second straight session (see BusinessWeek.com, 7/12/06, "Mideast, Tech Worries Sink Stocks"). Investors weighed rising Mideast tensions, an uncertain earnings season, and record-high oil prices. A midsession recovery attempt fizzled on afternoon reports of fresh clashes between Israel and Lebanese fighters.

On Thursday, the Dow Jones industrial average fell 166.89 points, or 1.52%, to 10,846.29, led downward by General Motors (GM ) after rival Ford (F ) cut its dividend in a bid to trim costs. The broader Standard & Poor's 500 index dropped 16.06 points, or 1.28%, to 1,242.54. The tech-heavy Nasdaq composite tumbled 32.61 points, or 1.56%, to 2,057.63.

The scope of the market's problems has broadened, with fresh worries seemingly popping up daily. Geopolitical flashpoints in Iran and North Korea have now been joined by the Israel-Lebanon conflict, and new violence by militants in Nigeria has endangered energy supplies there.

The global woes exacerbate an already ticklish situation for U.S. equity investors. Markets are also contending with the prospect of additional rate hikes from the Federal Reserve (see BusinessWeek.com, 6/30/06, "Bernanke's Timely Balm"). Other shadows lurking on Wall Street: slowing economic growth, and cooling corporate profits in the second quarter and beyond (see BusinessWeek.com, 7/07/06, "Gearing Up for Second-Quarter Earnings").

What should investors expect in the days ahead? Wall Street strategists will likely adopt a more cautious stance as the market's woes persist, and investors' appetite for risk diminishes. Indeed, Standard & Poor's cut its recommendation on the information technology sector to marketweight from overweight on Thursday -- at the same time boosting its call on the traditional defensive haven of consumer staples to overweight from marketweight (see BusinesWeek.com, 7/13/06, S&P Cuts IT Sector, Boosts Consumer Staples.

Economic reports may pile on more worries, some analysts say. "Next week, it will probably be inflation jitters again," notes Ed Yardeni, chief investment strategist at Oak Associates in a dispatch to clients. The Labor Department is set to release new readings for two key inflation gauges, the producer price index July 18 and the consumer price index July 19.

Despite market nervousness, the global economy continues to expand, others observe. "There are very few areas of the world outside the U.S. (and even here tentatively, for now) where the trend for activity and employment growth is taking a turn for the worse," points out Goldman Sachs economist Francesco Garzarelli in a report.

Geopolitical tensions remained in focus Thursday, as Israel bombed an airport in Beirut and Lebanese militants rocketed the port city of Haifa. Separately, Iran shrugged off a referral to the United Nations Security Council over its nuclear program. The news followed a bombing in India and escalating aggression from North Korea.

The Mideast unrest, coupled with an attack on a pipeline in Nigeria, sent oil prices to all-time highs. August West Texas Intermediate crude oil futures surged to a record $76.85 a barrel in afternoon trading before closing up $1.75 at $76.70.

Traders found little relief in corporate news Thursday. Analyst downgrades sank Dow members Disney (DIS ) and Wal-Mart (WMT ) lower. Shares in Merck (MRK) declined despite a legal victory. A New Jersey jury found that the drugmaker's Vioxx painkiller did not cause a woman's heart attack.

Tech stocks extended their recent woes. Dell (DELL) was lower after the computer maker unveiled plans to simplify pricing and reduce promotions, while reports of job cuts weren't enough to keep Intel's (INTC ) shares afloat. Peer Apple (AAPL ) was also lower a day after Credit Suisse warned that the iPod maker may trim its September-quarter revenue outlook.

Earnings worries continued to roil chip stocks. Cree (CREE ) was sharply lower after the semiconductor maker said late Monday that it missed profit forecasts for the June quarter due to a production problem and higher taxes. The news follows recent bearish guidance from tech bellwethers Lucent Technologies (LU ), Advanced Micro Devices (AMD ) and EMC (EMC ) as well as upbeat comments from Kla-Tencor (KLAC ).

Software maker SAP (SAP ) joined the chorus of downbeat tech reports. Shares fell after the Germany company posted lower-than-expected second-quarter profit amid its first market-share decline in three years.

In other earnings news, newspaper publisher Tribune (TRB ) and hotel operator Marriott (MAR ) declined as their quarterly results that missed Wall Street forecasts. Shares in PepsiCo (PEP ) rose after the soft-drink maker reported a 14% rise in second-quarter net income.

Companies reporting earnings Friday include General Electric (GE ). Second-quarter earnings season kicks into full gear next week.

Elsewhere, M&A activity was buzzing. Carlos Ghosn, CEO of Renault and Nissan (NSANY ), reportedly said an alliance with General Motors (GM ) could yield sizeable long-term benefits. Insurer AmerUs (AMH ) was modestly higher after U.K. insurance heavyweight Aviva agreed to acquire the company for $2.9 billion.

On the economic front, initial jobless claims rose 19,000 to 332,000 in the week ended July 8, according the Labor Department.

Investors will be digesting a full plate of data Friday. Retail sales are expected to rise 0.6% in June, says Action Economics. Other data releases on tap include May business inventories, June import prices, and the preliminary July reading of the University of Michigan's consumer sentiment index.

European markets finished sharply lower Thursday on tech earnings worries. In London, the Financial Times-Stock Exchange 100 index slid 95.6 points, or 1.63%, to 5,765. Germany's DAX index tumbled 110.53 points, or 1.96%, to 5,527.29. In Paris, the CAC 40 index was down 89.21 points, or 1.81%, to 4,852.52.

Asian markets also finished lower. Japan's Nikkei 225 index declined 151.37 points, or 0.99%, to 15,097.95 amid nervousness ahead of the Bank of Japan's monetary policy decision Friday. In Hong Kong, the Hang Seng index skidded 216.73 points, or 1.31%, to 16,305.48. Korea's Kospi index lost 11.67 points, or 0.9%, to 1,285.02.

Treasury Market

Treasuries gained in price as stocks sank. The 10-year note rose to 100-12/32 for a yield of 5.07%, while the 30-year bond climbed to 90-22/32 for a yield of 5.12%. Global risk aversion helped support Treasury prices, says Action Economics.

News Analysis
BusinessWeek.com
July 13, 2006
Link

J.C. Penney's Stock: Wearing Well

The department store chain's turnaround has meant handsome profits for shareholders. Will the stock stay in fashion or be a fad?

A slave to fashion? Not J.C. Penney (JCP ). With weak stocks the hot retail trend this season, the Plano (Tex.)-based department store chain's shares have been strutting to multiyear highs. More gains could still be in store for the 104-year-old retailer, but they won't come easily for a company just completing a lengthy turnaround.

Penney hasn't always been in style with investors (see BusinessWeek.com, 1/9/06, "Penney: Back in Fashion"). The stock fell below $10 in 2000 following a period of declining sales growth, as chief rival Kohl's (KSS ) and discounters such as Target (TGT ) and Wal-Mart (WMT ) began stealing market share from the company and other traditional retailers such as Sears (SHLD ), Dillard's (DDS ), and Macy's (FD). In the early 2000s, Penney embarked on a restructuring program that included overhauling its merchandising and selling its Eckerd drugstore chain.

SAME-STORE STORY.  Since then, the revamp has paid off with improved revenues, earnings, and, most recently, stock prices. On July 12, Penney shares reached $69.34, their highest level since June 23, 1998, and a 24.7% jump since the beginning of 2006. Shares eased to $64.78 at the close July 13 amid broader market weakness. "We have a growing company with new stores, powerful private brands, and the leading department store Internet business," Penney President Ken Hicks said in a May 11 conference call. Company spokespeople were unavailable to comment prior to deadline.

Despite an ominous economic horizon, Penney's remarkable comeback will likely continue, analysts say. However, it's less certain whether the stock can keep rising beyond its recent peaks. As the company shifts from righting the ship to facing fresh challenges, investors may want to strike a cautious pose.

Penney's resurgence is particularly noteworthy when compared to its competitors' recent stock performance. The Standard & Poor's retail index was down 6.3% for the year through July 13. Same-store sales reports for June were mixed across the sector, with Wal-Mart, Federated (FD ), and Limited (LTD ) among retailers disappointing the Street. By contrast, Penney's 4.3% sales growth handily beat projections for a 2.8% increase.

ANALYST EXPECTATIONS.  At the same time, some analysts say the retail sector's shrinking payrolls bode poorly for the economy at large (see BusinessWeek.com, 7/12/06, "The Real Problem with Job Growth"). Retail employment has recorded year-over-year declines, which had previously only ever happened during a recession, points out Jan Hatzius, chief U.S. economist at Goldman Sachs (GS ). "What do retailers know that the rest of us don't?" Hatzius asked in a July 10 report.

Still, Penney may have a leg up on some of its department-store competitors, analysts say (see BusinessWeek.com, 1/24/06, "Analysts' Picks: Energy, Retailers, Steel"). Strong sales, higher markups from private-label business, and more efficient operations should allow the stock to trade at higher price-to-earnings multiples compared to the market, according to a June 30 report by Merrill Lynch (MER ) analyst Stacy Turnof, who targets a price of $74 for the stock. (Merrill expects to receive or intends to seek compensation for investment banking services from Penney, makes a market in the company's securities, and owns 1% or more of its common stock.)

Other analysts have been revising their estimates higher for Penney, as well. On July 6, analysts from Citigroup (C) and Goldman Sachs raised their earnings forecasts for the retailer after the company reported better-than-expected June sales and guided its second-quarter profit upward.

SEVENTH INNING.  Nevertheless, the company isn't impervious to bearish macroeconomic headwinds. Its core middle-income customers may soon have less cash for clothes, analysts say. "Strong merchandise initiatives may not be enough to offset an expected consumer slowdown, driven by higher interest rates, higher gasoline and energy prices, and a slowing housing market," noted Deutsche Bank (DB ) analyst William Dreher in a June 9 report. Dreher has a hold recommendation on the stock. (Deutsche Bank makes a market in Penney securities and owns 1% or more of any class of its common equity securities.)

Even setting aside economic concerns, it's unclear how much further Penney's performance can improve following its successful recovery. On July 10, Prudential initiated coverage of the stock with a neutral rating. "We are tremendously impressed with what Penney has accomplished over the last five years," analyst Lizabeth Dunn wrote. But she added: "Earnings growth should normalize going forward."

Others argue that Penney's comeback still has further to go. The turnaround is merely "in the 'seventh inning of a doubleheader,'" wrote Citigroup analyst Deborah Weinswig in a June 27 report. The stock's optimistic outlook justifies a higher price-to-earnings multiple for 2007, says Weinswig, who gives it a buy rating. (Citigroup has a non-investment-banking relationship with and a significant financial interest in Penney and also makes a market in the company's securities.)

PRIVATE LABELS.  Either way, Penney is moving from cleaning up its past problems to launching new initiatives. One of those is an anticipated expansion. While the department store has typically been located in malls, the company is stepping up its presence in locations where customers are used to seeing Target or Wal-Mart stores. Earlier this year, Penney unveiled plans to open more than 175 new stores through 2009, primarily in off-mall sites.

Some retail observers worry that Penney's growth push is a case of misplaced priorities. The company should concentrate first on new private-label likes like a.n.a. and East 5th, or its Sephora cosmetics sections, according to Credit Suisse analyst Michael Exstein, who has a neutral rating on the stock. "We would rather see a focus on improving the productivity of the existing store base," Exstein wrote in a May 11 report. (Credit Suisse has an investment-banking relationship with Penney and makes a market in the company's securities.)

With other retailers' shares heading south, Penney's surge could make the formerly dowdy chain look positively alluring to investors. Still, they would be wise to consider just how much room the stock has left to grow before they try it on for size.

News Analysis
BusinessWeek.com
July 11, 2006
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Don't Bet on a Bond Rally

Bill Gross and other bond bulls are calling for a rebound, but it's not a sure thing. Why? An uncertain Fed outlook

Bonds are coming off a lackluster six months. One popular benchmark, the Lehman Brothers U.S. Aggregate Index, lost 0.7% in the first half of 2006, compared with a 2.5% gain for the same period a year earlier. Now some analysts say the tide may be turning, amid signs of a slowing economy and favorable price trends for Treasury issues.

Nevertheless, with inflation still a worry and the Federal Reserve expected to raise interest rates again at its Aug. 8 meeting, bonds may not be out of the woods yet. Until the Fed signals the end of its rate-hike campaign, investors should exercise caution.

Bond-fund guru Bill Gross has been among the most vocal forecasters of a turnaround (see BusinessWeek.com, 3/30/06, "Bill Gross: Harbor Bond Fund". "The bond bear market is beginning to go into hibernation, which is the same thing as saying the bear market is over," the Pimco chief investment officer said in a July 7 television interview. "While we're not about to reap huge capital gains, bonds will do better from here in terms of price."

A RALLY "NEAR"? He's not the only bond-market observer seeing positive signals. David Rosenberg, U.S. economist at Merrill Lynch (MER), also sees a potential lift ahead. Why? As of July 10, the entire Treasury yield curve is trading below the 5.25% federal funds rate. This scenario has played out only four times in the past 25 years, notes Rosenberg.

"Each of these preceded either a downturn in the economy, a major financial strain, or both," Rosenberg wrote in a July 10 report. "What transpired on average over the next six months was a major rally in the bond market, led by the shorter end of the yield curve."

Technical analysts, too, are projecting a bond comeback. Both daily and weekly indicators "may suggest that a rally in bonds is near and that yields have peaked or are close to peaking for the immediate term," noted Mark Arbeter, chief technical analyst at Standard & Poor's, in a July 7 report.

WAITING AND WATCHING.  The U.S. Treasury market, in particular, is enjoying increased investor optimism. A Ried Thunberg survey showed money managers are more bullish on government debt. The research firm's index on the outlook for 10-year Treasury notes through year-end rose to 57 on July 7, its highest level since Sept. 14, 2001.

Still, it's too soon to tell if a bond rally is really on the horizon, other analysts maintain. Unexpected changes in the outlook for inflation or Fed interest-rate hikes could sidetrack a recovery, according to Steven C. Shachat, senior portfolio manager of the Alpine Municipal Money Market Fund (AMUXX ) and Alpine Tax Optimized Income Fund (ATOIX ).

"While we're not quite as bearish today as we were six months ago, we're still standing on the sidelines a little bit until we get a greater understanding of what all this tightening has accomplished," Shachat says.

GO SHORT-TERM.  Even if the Fed chooses not to increase rates in September, the pause will likely only be temporary, according to Steven Ricchiuto, chief U.S. economist at ABN Amro. In the immediate term, he expects both stocks and bonds alike to drift. "A lack of fundamental information will leave the debt and equity markets looking for direction from both the currency and commodity markets, even though the [second-quarter] earnings season officially kicks off this week," Ricchiuto wrote in a July 10 report.

Until the Fed picture changes, fixed-income investors should stick with shorter-term securities, observes Kim Daifotis, chief investment officer of fixed income at Charles Schwab Investment Management (SCHW ). "An ultra-short bond fund has been ideal in this environment," Daifotis says. "It's not the time to go to longer-term bonds just yet."

Two funds to consider in this area are Fidelity Ultra-Short Bond (FUSFX ) and Payden Limited Maturity (PYLMX). Fidelity's offering posted an average annualized return of 2.33% over the past three years, compared with a peer average of 1.67%, with an expense ratio of 0.45%, according to S&P. Meanwhile, the Payden fund turned in an average annualized return of 1.92%, with expenses of 0.4%.

LOW-WORRY FUND.  Cost is a particularly important factor because lower-fee bond funds have typically had an advantage over their costlier brothers, according to Morningstar (MORN ) senior fund analyst Scott Berry. He likes the relatively inexpensive bond-fund lineups at Vanguard and Fidelity, including the Vanguard Total Bond Market Index (VBMFX ).

The fund has earned a three-year return of 1.82% on an average annualized basis, in line with its peers, and carries a price tag of only 0.2%. "It's not terribly exciting in that you're basically getting exposure to the entire investment-grade bond market, but it keeps costs low and it's a fund that investors really don't need to worry about," Berry says.

When bonds do rally, long-term bond funds would be expected to enjoy the biggest rebounds. One example, Vanguard Long-Term Investment Grade (VWESX ), is down 5.14% through July 7 and carries a 0.25% expense ratio. "If the market turns, that fund should turn right along with it," Berry says.

WRONG BEFORE.  Long-term Treasury funds, meanwhile, have shed about 3% for the year to date. These funds "are generally among the most volatile bond categories, but when rates are falling they do much better than any other," says Lipper research analyst Jeff Tjornehoj. Funds investing in Treasury Inflation-Protected Securities, or TIPS, may also have room for substantial improvement, Tjornehoj says (see BusinessWeek.com, 6/21/06, "Investor TIPS for Fighting Inflation").

While bonds can be an integral part of any portfolio, financial advisors generally advise against betting on fixed-income performance. "Fixed income is not for speculating on bear or bull markets," says Doug Taylor, a financial planner at Taylor Wealth Management in Torrance, Calif.

Indeed, today's bond bulls have been wrong before. Pimco's Gross has consistently undershot the Fed's interest-rate increases. In a January, 2005 outlook, Gross predicted that the Fed would keep interest rates "relatively low" and pointed to federal funds rates of 2.5%, 2.75% , or 3.5% as potential stopping points. The Fed has already raised rates to 5.25%.

The bond market may well be due to improve, as some analysts say. But investors may want to avoid going overboard in their bond exposure as long as the Fed's course remains unclear.

News Article
BusinessWeek.com
July 11, 2006
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Positive Tech News Lifts Stocks

Bullish comments from chip-gear outfit KLA-Tencor boosted sentiment. Traders looked past a revenue shortfall at Alcoa and blasts in India

Stocks finished higher Tuesday, recovering from early lows after upbeat comments from a semiconductor bellwether. Disappointing Alcoa (AA ) revenue and reduced guidance from Lucent Technologies (LU ) kept major indexes underwater for most of the session. Explosions on a commuter train in India added to worries, says Standard & Poor's Equity Research.

The Dow Jones industrial average rose 31.22 points, or 0.28%, to 11,134.77, paced by Hewlett-Packard (HPQ ) and Intel (INTC ). The broader Standard & Poor's 500 index added 5.18 points, or 0.41%, to 1,272.52. The tech-heavy Nasdaq composite climbed 11.93 points, or 0.56%, to 2,128.86.

NYSE breadth was positive, with 21 issues advancing for every 12 declining. NASDAQ breadth was 17-13 positive.

The afternoon resurgence could suggest upbeat sentiment toward earnings and the Federal Reserve's interest-rate policy, some analysts say. "You can never say for sure what turned everything around," says Joe Battipaglia, executive vice president and chief investment officer for Ryan Beck. Still, he says recent economic data "does give us reason to believe that the Fed is somewhere going to finish what they set out to do with rate tightening, and that corporate profits will be good once again for the second quarter."

On the other hand, the late rebound may represent merely short-covering ahead of the close, rather than the beginning of an extended uptrend, says Action Economics, noting that the gains drew little reaction from Treasuries.

The first companies reporting quarterly earnings are not necessarily a good predictor of overall earnings growth, others observe. "The bottom line is that attempting to draw conclusions about the earnings season too early can be misleading," notes Jeff Kleintop, chief investment strategist at PNC Wealth Management.

Second-quarter earnings season remained in focus Tuesday. Bullish remarks from KLA-Tencor (KLAC) helped lead the tech sector's bounce. The semiconductor company said its fiscal-fourth quarter bookings may come in higher than previously projected.

Aluminum producer Alcoa posted 62% higher profit after the closing bell Monday, but shares were lower Tuesday, as sales came in below some analyst expectations.

Traders were also digesting an earnings warning from Lucent Technologies. The telecommunications equipment maker said after Monday's close that its second-quarter profit and revenue will miss Street forecasts.

Fellow tech outfits EMC (EMC ) and Advanced Micro Devices (AMD ) also issued lower guidance recently. Merrill Lynch has made a bearish call on the sector.

Meanwhile, Pepsi Bottling Group (PBG ), which manufactures and distributes PepsiCo (PEP ) beverages, was up after reporting higher-than-expected second-quarter profit and raising its 2006 guidance.

Drugmaker Genentech (DNA ) was set to report earnings after the close. PepsiCo and General Electric (GE ), among others, are also set to unveil quarterly results this week.

Outside of earnings, Microsoft (MSFT ) was lower following a report that the European Commission will raise the cap on potential future fines against the software giant to $3.8 milllion a day. Separately, Microsoft Chairman Bill Gates reportedly said there was an 80% chance the company's new Vista operating system would be ready in January.

Airline shares were lower after Merrill Lynch lowered its ratings on American Airlines (AMR ), Continental Airlines (CAL ) and U.S. Airways (LCC ).

In other analyst calls, 1-800-Flowers.Com (FLWS ) was higher after Goldman Sachs upgraded the company from sell to neutral.

The economic calendar was relatively quiet Tuesday. Chain store sales rose 0.2% in the week ended July 8, the first increase in four weeks, according to a weekly survey released by the International Council of Shopping Centers (ICSC) and UBS. Data releases on tap later this week include June retail sales, May trade, June import and export prices, July preliminary consumer sentiment, and May business inventories.

In the energy markets Tuesday, August West Texas Intermediate crude oil futures rose 55 cents to $74.16 a barrel after Iran said it would stand firm on its nuclear program. A weekly inventory report is due Wednesday.

European markets finished lower. In London, the Financial Times-Stock Exchange 100 index shed 39.6 points, or 0.67%, to 5,857.3. Germany's DAX index slid 90.28 points, or 1.58%, to 5,616.04. In Paris, the CAC 40 index was down 68.09 points, or 1.37%, to 4,914.39.

Asian markets finished mostly lower. Japan's Nikkei 225 index declined 78.99 points, or 0.51%, to 15,473.82. In Hong Kong, the Hang Seng index lost 113.68 points, or 0.68%, to 16,490.13. Korea's Kospi index inched higher 1.15 points, or 0.09%, to 1,300.44.

Treasury Market

Treasury yields dipped following news of the India blasts. The 10-year note rose in price to 100-06/32 for a yield of 5.1%, while the 30-year bond climbed to 90-08/32 for a yield of 5.14%.

News Analysis
BusinessWeek.com
July 6, 2006
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The S&P 500's Hottest—and Coldest—Stocks

Metals outfit Allegheny Technologies led the pack while KB Homes brought up the rear. Both could improve in the months ahead

Red-hot metals and cooling housing. For the first half of 2006, the best- and worst-performing stocks in the Standard & Poor's 500 index reflected those two themes. Coming off a surge in commodity prices, metals producer Allegheny Technologies (ATI ) sprinted to the head of the index with a 92% half-year gain. On the flip side, homebuilder KB Homes (KBH ) brought up the rear with a 37% loss amid a softening housing market (see BusinessWeek.com, 7/5/06, "Second-Half Outlook: Housing").

What's next for the leader and the laggard? The two stocks have taken different paths in 2006, but each could have room to grow in the year's second half, analysts say. Recent market volatility may signal an opportunity to buy Allegheny on the cheap, according to some analysts. Meanwhile, homebuilders may not be out of the woods yet, but KB's high profit margins and favorable valuation could put in prime position when the housing market recovers.

One caveat—both stocks have exposure to cyclical industries, so investors should bear those risks in mind. Here's the down and dirty on each:

Allegheny Technologies
Pittsburgh-based Allegheny makes stainless steel, titanium alloys, and other specialty metals. The jump in its share price came amid strong demand for metals, as the company unveiled expansion plans and posted healthy profits. "The outlook remains strong for our major markets," which include defense, chemicals and energy, noted Patrick Hassey, the company's chairman, president, and CEO, in a June 6 slide show presentation.

On May 11, Allegheny hit a 52-week high of $87.50 as metals producers soared. Prices have since cooled, to $68.71 on July 6, but not enough to displace the stock as the S&P 500's first-half leader. "We've had good operational execution, and we continue to invest for growth," says Dan Greenfield, a company spokesperson.

Continued client demand has enabled the metal producer to keep raising prices. On Apr. 22, Allegheny reported 68% higher first-quarter profit. Its key growth markets—aerospace and defense, the chemical process industry, oil and gas, electrical energy, and medicine—accounted for 62% of a company-record $1 billion in sales, Hassey said in a prepared statement. Allegheny typically posts second-quarter earnings in late July.

Growth initiatives have also propelled Allegheny's stock, and could provide further upside. On June 26, the company announced its latest expansion, a $325 million titanium sponge plant in Utah. With no demand slowdown in sight, this and other recent additions should increase Allegheny's capacity without leading to overbuilding, analysts say.

SOMEWHAT SHIELDED.  "We continue to favor [Allegheny] as 'quality on sale,'" Citigroup analyst John Hill wrote in a June 26 report. Hill has a buy recommendation on the stock. (Citigroup has an investment-banking relationship with and a significant financial interest in both Allegheny and KB. Citigroup also makes a market in the companies' securities.)

As a specialty metals producer, the company is shielded to an extent from the recent speculative frenzy in exchange-traded base metals, Hill says. Meanwhile, the markets Allegheny serves, such as the defense sector, are typically considered less susceptible to broad economic downturns.

The stock also has exposure to the red-hot ethanol market. Corrosion-resistant materials such as stainless steel are essential to ethanol production, and Allegheny received orders related to constructing about 20 ethanol facilities in the first quarter, Bear Stearns analyst Anthony Rizzuto pointed out in a June 22 report.

Rizzuto has an outperform recommendation on the stock and a year-end price target of $80, which he deems "conservative." (Bear Stearns has a non-investment-banking relationship with Allegheny and is affiliated with the specialist that makes a market in the company's common stock.)

KB Homes
Headquartered in Los Angeles, KB is the fifth-largest company in its industry, focusing on homes for first-time and move-up buyers. KB wasn't the only homebuilding stock hammered in a tough six months for the housing sector. Smaller rivals like Hovnanian (HOV ) and Ryland (RYL ) posted modestly bigger percentage losses, though they aren't S&P 500 members. But KB still has its fans. "KB Homes is one of the best-managed home builders, if not the best," says S&P equity analyst William Mack.

The first half of 2006 was a trying time for KB stockholders, as data releases indicated a gradual slowdown in the housing market (see BusinessWeek.com, 6/21/06, "Housing's Steady Foundation"). On June 13, shares in the homebuilder scraped a 52-week low of $41.95, before recovering to $46.05 on Jul. 6. The drop came after Morgan Stanley analyst Robert Stevenson downgraded his industry view from attractive to cautious.

Declining home demand and rising cancellation rates hampered KB's first-half performance, said Bruce Karatz, the company's chairman and CEO, in a June 16 conference call. "While it is difficult to predict, we do believe that the cancellation rates will begin to subside," he added. A company spokesperson said executives were unavailable to comment further prior to deadline.

BACKLOG BOOST.  Despite housing-market softness, KB's second-quarter earnings report June 15 still beat Wall Street expectations, though the company also trimmed its full-year guidance. An increase in average order prices should keep margins strong, and the stock is trading well below its average price-to-earnings multiple, according to UBS analyst Margaret Whelan, who rates the stock a buy. (UBS has an investment banking relationship with KB and makes a market in the company's securities.)

A higher-than-expected backlog in the second quarter should help boost revenues in the second half of the year, observes Citigroup analyst Stephen Kim, who also has a buy rating on the stock. "As a result of their ability to better navigate supply constraints, the public builders are rapidly growing their share of a highly fragmented market, fueling double-digit long-term revenue growth potential," Kim wrote in a June 19 report. The homebuilder also recently knitted a potentially lucrative branding alliance with Martha Stewart Omnimedia (MSO ).

Nevertheless, it's anybody's guess when the housing market will hit bottom. Credit Suisse analyst Ivy Zelman made this point in a June 19 report lowering the 12-month price target for KB from $55 to $49, also citing the company's high exposure in California and Nevada. Credit Suisse has an underperform recommendation on the stock. (Credit Suisse has an investment banking relationship with KB and makes a market in the company's securities.)

Metals and housing may not remain the big stories in the second half. Still, Allegheny's fundamentals suggest the metals producer could continue its rise. And if KB can weather a cooling market and rising interest rates—a big if, admittedly—the homebuilder might just position itself for a rebound.

News Article
BusinessWeek.com
July 6, 2006
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Stocks Edge Higher Before Jobs Data

A tobacco-industry victory buoyed the Dow, as investors anticipated Friday's employment report

Stocks finished modestly higher Thursday, as investors traded cautiously ahead of Friday's closely-watched June employment report. Tame economic data drove down Treasury yields and countered speculation that the jobs number Friday could stoke inflation worries, says Standard & Poor's Equity Research.

The Dow Jones industrial average rose 73.48 points, or 0.66%, to 11,225.3. The broader Standard & Poor's 500 index edged up 1.75 points, or 0.08%, to 1,274.07. The tech-heavy Nasdaq composite improved 3.16 points, or 0.25%, to 2,155.09.

Volume was low. NYSE breadth was positive, with 21 issues advancing for every 13 declining, while NASDAQ breadth was 16-14 positive.

A fresh batch of economic data helped ease interest-rate fears. "The market was fueled by some weaker economic data and the fact that we didn't have any real follow-through in energy prices on the upside due to a less bullish oil inventory build-up," says Peter Cardillo, chief market analyst at SW Bach. "The market is now basically struggling to keep its head above water as we enter the major report of the month."

Friday's employment report is the main event this week. Nonfarm payrolls are expected to rebound 230,000 in June after two months of lackluster growth, says Action Economics. Wednesday's solid ADP job-market report caused some analysts to raise their estimates.

Investors were digesting mild weekly unemployment data Thursday. Jobless claims dropped 2,000 to 313,000 in the week ended July 1, from an upwardly revised 315,000. In related news, ADP National Employment rejected rumors that it planned to restate yesterday's surprisingly strong job-market reading.

Separately, the Institute for Supply Management's index of non-manufacturing business activity slipped to 57.0 in June from 60.1 in May, weaker than expected. The pending homes sales index climbed 1.3% to 113.4 in April, according to the National Association of Realtors, ending a streak of three consecutive monthly declines.

In corporate news, a court decision sent shares in Altria ("MO" ) up nearly 6%. The Florida Supreme Court overturned a $145 billion punitive damage award against tobacco companies, deeming it "excessive."

Tepid retail sales reports were also in focus. Wal-Mart ("WMT" ), Costco ("COST" ), Pier One ("PIR" ), Gap ("GPS" ) and Limited Brands ("LTD" ) were among retailers reporting June same-stores sales that fell below Street forecasts. On the positive side, Bebe ("BEBE" ), JC Penney ("JCP" ) and AnnTaylor ("ANN" ) turned in higher-than-expected results.

Elsewhere, Intel ("INTC") was higher after the chipmaker unveiled plans to invest $600 million in wireless broadband provider Clearwire (see BusinessWeek.com, 7/6/06, Intel's $600 Million WiMax Bet).

Aerospace company Boeing ("BA" ) was higher after the Canadian government said it will likely order at least 16 CH-47 Chinook helicopters and four C-17 Globemaster transport airplanes.

Satellite radio outfit XM Satellite Radio ("XMSR" ) reported slower subscriber growth in the second quarter, while competitor Sirius Satellite Radio ("SIRI" ) posted subscriber increases that exceeded analyst expectations.

Semiconductor maker Microchip Technology ("MCHP" ) was higher after Citigroup raised its price target for the shares by 7% to $46.

In the energy markets Thursday, August West Texas Intermediate crude oil futures closed down 5 cents at $75.14 a barrel despite a weekly inventory report showing an unexpectedly large decline in crude supplies. A surprising increase in gasoline stocks weighed on crude prices, says Action Economics.

European markets finished higher. In London, the Financial Times-Stock Exchange 100 index rose 63.3 points, or 1.09%, to 5,890. Germany's DAX index bounced 69.84 points, or 1.24%, to 5,695.47. In Paris, the CAC 40 index was up 45.15 points, or 0.92%, to 4,966.45.

Asian markets finished mixed. Japan's Nikkei 225 index fell 202.54 points, or 1.3%, to 15,321.4. In Hong Kong, the Hang Seng index rebounded 173.81 points, or 1.07%, to 16,440.99. Korea's Kospi index declined 15.89 points, or 1.24%, to 1,263.96.

Treasury Market

Treasury yields dropped after the mild economic data. The 10-year note rose in price to 99-18/32 for a yield of 5.18%, while the 30-year bond climbed to 89-03/32 for a yield of 5.23%. Short-covering ahead of Friday's jobs report contributed to rising Treasury prices, says Action Economics.

News Article
BusinessWeek.com
July 5, 2006
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Stocks Fall on North Korea News

Investors also considered strong employment data. Crude futures jumped above $75, touching an all-time high

Stocks finished sharply lower Wednesday, as missile tests by North Korea weighed on sentiment amid record-high oil prices. Profit-taking after recent gains probably exacerbated stock weakness, while a solid report on the labor market fanned concerns about inflation and further interest-rate hikes, says Standard & Poor's Equity Research.

The Dow Jones industrial average fell 76.2 points, or 0.68%, to 11,151.82, led downward by Intel (INTC ) after UBS lowered its earnings forecast for the chipmaker. The broader Standard & Poor's 500 index shed 9.28 points, or 0.72%, to 1,270.91. The tech-heavy Nasdaq composite tumbled 37.1 points, or 1.69%, to 2,153.34.

NYSE breadth was decidedly negative, with 24 issues declining for every 9 advancing, while NASDAQ breadth was 21-10 negative.

However, strong corporate profits could help buoy stocks in the weeks and months ahead, some analysts say. "It is my belief that the rally we've seen over the last few days is the beginning of something that has more legs," notes Ed Keon, senior vice president and director of quantititative research with Prudential. "I expect earnings to be terrific, up 13%-15%. I think stocks are going to do well between now and the end of the year and think that the people who think we are going to sit in the doldrums over the summer are going to be mistaken."

The economy may have reached a key turning point, others say. "The outlook for the U.S. economy and interest rates is now at a crucial juncture," says Mark Miller, an economist at HBOS Treasury Services. "Growth appears to be slowing under the weight of higher energy prices and prior policy tightening."

Traders returned from the July 4 holiday to find geopolitical concerns back in the spotlight Wednesday. North Korea reportedly launched seven missiles early Wednesday, among them a long-range Taepodong-2 considered capable of reaching U.S. soil. 

nvestors were also sifting through surprisingly strong jobs data. The ADP national employment report showed a net gain of 368,000 jobs in June, much higher than expected, after a 122,000 rise in May. The figures are fanning speculation about a similar jump in Friday's closely watched payrolls report, says S&P Equity Research.

Another labor report showed a different picture. The Hudson employment index was little changed at 102.4 in June, after a reading of 102.3 in May.

Also on the economic docket, U.S. factory orders rose 0.7% in May, slightly above expectations, following a revised 2.0% decline in April.

The economic calendar is busy again Thursday. Interest-rate decisions are due from the Bank of Japan and the European Central Bank. Data releases include weekly unemployment claims and a June reading of the Institute for Supply Management's index of non-manufacturing business activity.

On the company side Wednesday, AT&T (T ) was little changed after Bank of America upgraded the phone giant from neutral to buy, citing valuation.

Shares in MasterCard (MA ) rose modestly after Citigroup initiated coverage of the credit-card company with a buy recommendation.

Other stocks in focus include Nissan (NSANY ) after the automaker's board approved proceeding with exploratory discussions related to a potential alliance with U.S. rival General Motors (GM ).

In technology, Google (GOOG) was slightly lower even after Merrill Lynch raised its estimates for the Internet search company's second-quarter earnings and revenue.

Shares in Apple (AAPL) fell after the computer maker announced a new model of its iMac computer for the education market. The machine will sell for $899 to customers that qualify for Apple's educational discount, compared to $1,299 for the cheapest iMac without the special pricing.

On the M&A front, Univision (UVN ) was lower after media company Televisa (TV), which owns an 11.4% stake in the Spanish-language broadcaster, declined to participate in Univision's merger with a consortium of investors.

Meanwhile, Oracle (ORCL ) was lower following a report the software maker plans to buy Asian companies to win market share.

Elsewhere, Maxim Integrated Products (MXIM) was lower on reports the circuit maker has received a subpoena from the U.S. Attorney's office as part of an investigation into stock-options practices.

A figure in an earlier market scandal also returned to the news. Convicted Enron founder Ken Lay reportedly died of a heart attack Tuesday night in Aspen, Colo. His sentencing for fraud and conspiracy related to the energy company's collapse had been scheduled for Oct. 23.

In the energy markets Wednesday, August West Texas Intermediate crude oil futures closed up $1.26 to $75.19 a barrel, after touching an all-time high of $75.40. Iran postponed talks with the European Union over the Mideast nation's nuclear program, helping drive the energy complex higher.

European markets finished lower. In London, the Financial Times-Stock Exchange 100 index dropped 56.8 points, or 0.97%, to 5,826.7. Germany's DAX index skidded 103.38 points, or 1.8%, to 5,625.63. In Paris, the CAC 40 index was down 62.58 points, or 1.26%, to 4,921.3.

Asian markets finished lower amid worries about North Korea's missile launches. Japan's Nikkei 225 index fell 114.56 points, or 0.73%, to 15,523.94. In Hong Kong, the Hang Seng index lost 101.8 points, or 0.62%, to 16,326.66. Korea's Kospi index declined 6.07 points, or 0.47%, to 1,279.85.

Treasury Market

Treasury yields pushed higher on the strong ADP job-market report. The 10-year note fell in price to 99-07/32 for a yield of 5.22%, while the 30-year bond dropped to 88-17/32 for a yield of 5.27%.