Tuesday, June 27, 2006

Stocks Fall as Fed Meeting Looms

News Article
June 27, 2006

Business Week Online

Stocks Fall as Fed Meeting Looms

Worries about a larger rate hike pushed the indexes down. Also in focus: reports on June consumer confidence and May existing home sales

Stocks finished sharply lower Tuesday, giving back the previous session's gains as investors grew skittish ahead of the Thursday's Federal Reserve decision on interest rates. The perceived risk of a larger-than-expected hike fanned concerns, and declines in Treasury yields from multi-year highs failed to aid equities, says Standard & Poor's Equity Research.

The Dow Jones industrial average fell 120.54 points, or 1.09%, to 10,924.74, despite a 1% gain by Exxon Mobil (XOM ). The broader Standard & Poor's 500 index shed 11.37 points, or 0.91%, to 1,239.19. The tech-heavy Nasdaq composite declined 33.42 points, or 1.57%, to 2,100.25.

NYSE breadth was decidedly negative, with 24 issues declining for every 9 advancing, while Nasdaq breadth was 23-8 negative.

High bond yields could limit stock gains in 2006, some analysts say. "Based on past historical relationships, a 10-year yield at 4.4%, where we started the year, would be associated with a target for the S&P 500 of 1,500," says Henry McVey, chief U.S. investment strategist at Morgan Stanley. "A 10-year yield of 5.25% would lower the target to 1,380, and a yield of 5.5% would bring it down to 1,340. In addition to this source of valuation pressure, we are somewhat less optimistic on the outlook for growth in the second half."

Investors were weighing modestly better than anticipated economic data Tuesday. Consumer confidence rose unexpectedly to 105.7 in June. Separately, existing home sales declined 1.2% to 6.67 million in May, in line with a gradually cooling housing market, says Action Economics.

The economic docket is quiet Wednesday. The Fed will kick off its meeting, but central bankers aren't set to unveil their next interest-rate move until Thursday. The Fed is widely expected to raise rates 25 basis points, though there has been speculation of a 50-basis-point hike (see BusinessWeek.com, 6/27/06, "Is a Fed Surprise on Tap?").

On the company side, M&A activity remained in focus Tuesday. Spanish-language broadcaster Univision (UVN ) was higher after the company's board agreed to a $12.3 billion ($36.25 cash per share) takeover bid from a consortium of investors.

In technology, Intel (INTC ) was lower after the semiconductor company sold its communications-chips unit to Marvell Technology Group (MRVL ), which has made chips for the BlackBerry (RIMM ) and Treo (PALM ) handheld devices. Shares in Marvell fell sharply.

Among other stocks in the news, General Motors (GM) was lower after the automaker said it was reviving its zero-percent financing sales incentive. Earlier, shares rose on reports that about 47,600 workers have decided to leave the automaker and auto-parts supplier Delphi through buyouts or early retirement.

Fellow Dow member DuPont (DD ) was lower after Vivendi sold its entire stake in the chemical company for $671 million.

Elsewhere, Goodyear Tire & Rubber (GT) was down following a report that Tokyo-based rival Bridgestone guided its earnings lower by 35% and said its annual profit may fall for the first year in five.

Shares in Nortel Networks (NT ) dipped on news the telecommunications equipment maker will cut 1,100 and change pension programs to reduce costs.

In earnings news, shoe giant Nike (NKE ) is set to report quarterly results after the close.

In the energy markets, August West Texas Intermediate crude oil futures closed up 12 cents at $71.92 a barrel ahead of a weekly inventory report Wednesday.

European markets finished lower. In London, the Financial Times-Stock Exchange 100 index fell 28.9 points, or 0.51%, to 5,652.3. Germany's DAX index dropped 55.48 points, or 1.01%, to 5,459.15. In Paris, the CAC 40 index was down 30.25 points, or 0.63%, to 4,771.24.

Asian markets finished mixed. Japan's Nikkei 225 index rose 19.41 points, or 0.13%, to 15,171.81. In Hong Kong, the Hang Seng index slipped 30.11 points, or 0.19%, to 15,774.7. Korea's Kospi index added 9.49 points, or 0.77%, to 1,247.54.

Treasury Market

Treasury yields declined after the dip in existing home sales. The 10-year note rose in price to 99-11/32 for a yield of 5.21%, while the 30-year bond climbed to 88-30/32 for a yield of 5.24%. The Treasury curve remained inverted, with the yield on the 2-year note topping the 10-year by 3 basis points. An inverted yield curve is taken by some forecasters as a sign of impending recession.

Monday, June 26, 2006

Will Earnings Boost Stocks?

News Analysis
June 26, 2006

Business Week Online

Will Earnings Boost Stocks?

Companies in the S&P 500 should report decent results for the second quarter. That might not be enough to prevent a summer slump

In the next few weeks, investors may get some relief from second-quarter earnings reports. But given the high anxiety about higher interest rates and a slowing economy, analysts say another quarter of solid earnings might not be enough to calm a choppy stock market.

The current quarter could test the Standard & Poor's 500 index's streak of 16 consecutive quarters with double-digit percentage earnings growth. S&P projects that second-quarter earnings will increase 9.1% from the same period a year earlier. Declining consumer spending and higher energy costs are among factors contributing to slower earnings growth, according to Howard Silverblatt, senior index analyst at S&P. "While that will still be record earnings, it's going to be somewhat of a disappointment to a lot of investors because it's single digits," he says.

Slower earnings growth is not the only problem. Worries about inflation and a global uptrend in interest rates are likely to keep the market on its current unsteady course, some analysts say. "Solid real growth and the return of a little bit of pricing power will extend the already-record string of double-digit earnings for S&P 500 companies," wrote Steven Ricchiuto, chief U.S. economist at ABN AMRO (ABN ), in a June 26 report. "Upbeat earnings, however, will not provide much support for stocks."

GREAT EXPECTATIONS.  So far, second-quarter earnings releases have been promising. Big investment banks Bear Stearns (BSC ), Goldman Sachs (GS ), Lehman Brothers (LEH ), and Morgan Stanley (MS ) reported surging profits (see BusinessWeek.com, 6/22/06, "Boom Times for the Powerhouse Banks"). Results from tech bellwether Oracle (ORCL ) and transportation company FedEx (FDX ) also topped analyst estimates.

Coming next will be a report from aluminum giant Alcoa (AA ) on July 10. Then the season gets into full swing the week of July 17, with releases from closely watched companies such as Citigroup (C ), Johnson & Johnson (JNJ ), Yahoo (YHOO ), Apple Computer (AAPL ), Intel (INTC ), and Microsoft (MSFT ).

A lack of negative guidance bodes well for the companies yet to report, notes David Chalupnik, head of equities at First American Funds. "Typically, if corporations were running into trouble relative to expectations, you would see a lot more companies coming out and reducing expectations," says Chalpunik, who expects 11.5% earnings growth. "We've seen very few of those."

OVERCOMING OBSTACLES.  Investors can expect a few positive surprises, some analysts say. Earnings have beaten sell-side analysts' predictions for 10 consecutive quarters, and there's a chance they could do so again, according to Tobias Levkovich, chief U.S. equity strategist at Citigroup. "Many investors remain worried about margin pressures and a sense that all good things must come to an end," he wrote in a June 22 report.

The energy and financial sectors will probably post the biggest profits gains, according to Joe Battipaglia, chief investment officer of Ryan Beck. He expects additional strength from the industrial sector, and to a lesser extent, technology companies. (S&P forecasts a 1.9% second-quarter profit decline for the technology sector.)

"This is going to be a better-than-expected earnings season," Battipaglia says. "The message from the companies will be that despite obstacles, they're still hitting their profit targets."

LIMITED GAINS.  As was demonstrated last week, any market bounce from second-quarter earnings surprises will likely be similarly short-lived, some analysts say. Jeff Kleintop, chief investment strategist at PNC Wealth Management, forecasts another quarter of double-digit earnings growth as low labor costs keep profit margins wide.

However, he believes that midterm elections, hurricane season, and the housing slowdown will limit gains in stocks. "There's probably not a whole lot more downside to this market, but I think we'll need to get used to these 100-point daily moves," Kleintop says.

Indeed, a quarter of solid but slower earnings growth may already be priced into the markets, says Art Hogan, chief market strategist at Jefferies & Co. He projects an increase in second-quarter profit of 8.5% to 10%. "Are equity prices already reflecting what is the inevitable earnings growth deceleration, or are they just reflecting concerns that the Fed is going to raise interest rates too much?" Hogan asks. "It's certainly a combination of both."

PERKING UP.  Market players will be keeping a close eye on companies' earnings guidance. Eventually, rising interest rates worldwide are going to dampen economic growth, notes Quincy Krosby, chief investment strategist at The Hartford (HIG ). "That is going to have an effect on earnings," she says. "The key for us is, how much of an impact."

Actually, later in the year, corporate profits are expected to perk up again. S&P forecasts earnings growth of 13% for the third quarter and 11% for the fourth quarter, for a full-year gain of 12.1% from 2005. "We believe consumer spending is going to come back," Silverblatt says.

One thing investors should remember: Not all earnings growth is created equal. A flurry of share buybacks has made earnings-per-share increases at companies like ExxonMobil (XOM ) look even more dramatic, inflating price-to-earnings ratios, says S&P's Silverblatt (see BusinessWeek.com, 5/5/06, "Second-Quarter Preview"). And with jitters already haunting investors, any slipup could keep the markets on edge.

Thursday, June 22, 2006

Spread Your Bets in ETFs

News Analysis
June 22, 2006

Business Week Online

Spread Your Bets in ETFs

Newfangled exchange-traded funds are hitting the market. But you may want to stick with a handful of simple, smart standbys for a diversified portfolio

It's a confusing time for investors. Wall Street has been twisting and turning, with the Dow Jones industrial average hitting a six-year high as recently as May 10, only to tumble 8% through June 13. Since then, the blue chip average has stubbornly rebounded 3.5%. Bulls and bears come and go, but exchanged-traded funds (ETFs) can provide a smart path to long-term diversification for buy-and-hold investors.

Despite the market's ups and downs, investors continue to pour money into ETFs, baskets of securities that trade throughout the day like stocks. Investors poured $14.9 billion into ETFs during the first four months of the year, according to the latest data from mutual-fund industry group Investment Company Institute. Over the same period, total ETF assets climbed 11.6%, from $296 billion to $334.9 billion.

MANY NEW OFFERINGS.  Lately, ETFs are getting more complicated. Once known as an easy, low-cost way to achieve broad diversification, ETFs are becoming increasingly focused, allowing institutional investors and other experts to gain exposure to ever-narrower sectors (see BusinessWeek.com, 05/05/06, "ETFs: Sliced, Diced and Razor-Thin"). Fund companies have rolled out 45 new ETFs so far this year, according to Boston-based Financial Research Corp.

More are on the way. On June 22, State Street Global Advisors will launch six new ETFs. The new portfolios are: SPDR Metals and Mining (XME ), SPDR Retail (XRT ), SPDR Pharmaceuticals (XPH ), SPDR Oil & Gas Equipment & Services (XES ), SPDR Oil & Gas Exploration & Drilling (XOP ) and streetTRACKS KBW Regional Banking (KRE ). Each will carry an expense ratio of 0.35%. "What we're providing is pure exposure to each one of these industries," says Greg Ehret, senior managing director at State Street.

Meanwhile, ProFunds introduced eight ProShares ETFs on June 21. Four will seek to double the market’s performance while the others will aim for the inverse of market returns. On June 26, Rydex Investments will unveil a set of six currency ETFs, called CurrencyShares: Australian Dollar Trust (FXA), British Pound Sterling Trust (FXB), Canadian Dollar Trust (FXC), Mexican Peso Trust (FXM), Swedish Krona Trust (FXS), and Swiss Franc Trust (FXF).

"PASSIVE STRATEGY."  While such funds could have many uses, some of the more exotic ones don't make sense for average investors, financial advisers say. "ETFs in my mind are a great structure for very prudent, long-term investing, as opposed to what some people use them for, which is short-term speculation," says John Gay, an adviser at Frisco Financial Planning in Frisco, Texas.

With more ETF choices than ever, which ones do most investors really need? "Somebody who is buying an ETF has accepted a passive strategy," says Alec Young, equity market strategist at Standard & Poor's Equity Research Services. "They're not trying to beat the market." This Five for the Money looks at five ETFs that give simple, smart diversification no matter which way the market swings.

1. Vanguard Total Stock Market VIPERs (VTI )
When it comes to U.S. stock exposure, Vanguard Total Stock Market VIPERs run the gamut. With more than 3,700 securities, this $71.7 billion portfolio invests in companies of all sizes, across a wide variety of sectors. Its biggest holdings include ExxonMobil (XOM ), General Electric (GE ), and Microsoft (MSFT ).

Simplicity is the main draw here, but Vanguard Total Stock Market's low cost enhances its appeal. The fund carries an expense ratio of 0.07%, compared to a category average of 0.21%, according to Chicago-based fund tracker Morningstar (MORN ). "That's a relatively low hurdle to jump to beat its peers over the long term," says Morningstar ETF analyst Dan Culloton.

This ETF also wears many caps. That is, it spans across companies of different market capitalizations. That's good, analysts say, because funds focusing exclusively on small-cap or large-cap stocks will have to sell holdings when a company reaches a certain size, incurring transaction costs. "If you buy a broader index, you avoid those commissions," says Rick Miller, CEO of Sensible Financial Planning in Cambridge, Mass.

2. iShares MSCI EAFE Index (EFA )
With the U.S. stock market covered, it's time to look overseas. iShares MSCI EAFE Index tracks the leading benchmark for foreign developed-market stocks, offering exposure to companies in Europe, Australia, and Asia. Rather than invest in each of the thousands of issues in the index, the fund holds about 800 stocks, including BP (BP ) and Toyota Motor (TM ).

The $28.5 billion fund has performed solidly tracking an index that few of its actively managed peers have been able to beat. iShares MSCI EAFE Index boasts an average annualized return of 24.67% over the past three years, slightly better than its style peers, according to S&P. The stocks represented by this fund make up about 46% of global market capitalization, notes S&P's Young.

However, with a price tag of 0.36%, this fund isn't the cheapest option among foreign large-blend ETFs. Investors could also cobble together the Vanguard European Stock VIPERs (VGK ) and the Vanguard Pacific Stock Vipers (VPL ) for similar exposure and an expense ratio of 0.18% on each. "But that requires a lot more work," says Culloton. Investors would have to maintain a proper allocation between the two ETFs, which along with the extra hassle might tack on additional trading costs.

3. iShares Vanguard Emerging Markets Stocks Vipers (VWO )
Don't be wary of emerging markets after the recent declines, which many market watchers consider a natural break from their strong run. Investors with a long time horizon should view these markets an important part of a well-diversified portfolio. The Vanguard Emerging Markets Stocks Vipers holds nearly 700 stocks, including Taiwan Semiconductor (TSM ), in this infamously volatile asset class.

Again, Vanguard's fund has a cost advantage over its competitors. The portfolio's 0.3% expense ratio is below the category average of 0.53%, according to Morningstar. The $9.6 billion ETF has only been available since March, 2005, but its corresponding traditional mutual fund, Vanguard Emerging Markets Stock Index (VEIEX ), has posted an average annualized return of 19.9% over the last five years, in line with its style peers.

Why invest in emerging markets now? "It still makes sense to have exposure to all portions of the global economy in your portfolio," says Morningstar's Culloton. Just be aware that emerging-market stocks tend to swing dramatically.

4. iShares Lehman Aggregate Bond (AGG )
Fixed-income ETFs are still relatively few and far between, so it's best to keep things simple. The iShares Lehman Aggregate Bond is the only ETF tracking the Lehman Aggregate, a commonly used benchmark for bond funds. It wouldn't be cost-effective to follow the entire index, so the ETF owns about 100 issues, including U.S. Treasuries.

The iShares Lehman Aggregate Bond has a 0.2% expense ratio, but its track record only extends to its launch in September, 2003. The fund posted an average annualized return of -0.72 for the one-year period ended May 31, slightly below its corresponding index.

Indeed, it's difficult for the fund to hew closely to the enormous Lehman Aggregate, and that concerns some analysts. Still, others say the ETF's low cost may be enough reason to invest in it rather than a traditional bond fund. "When you buy bonds it's all about expenses," says Sensible Financial's Miller. "First of all, 0.2% is pretty low. There aren't a lot of funds around that are less than that."

5. Vanguard REIT Index VIPERs (VNQ )
If you can tune out the housing market bears, the Vanguard REIT Index VIPERs is a cheap way to get exposure to real estate. The fund invests in real estate investment trusts (REITs), tax-advantaged companies that hold a portfolio of real estate properties. After all, there's much more to real estate than just the cooling residential-housing market.

Vanguard REIT Index tracks the MCSI U.S. REIT index, a broad benchmark with geographic diversification and exposure to various types of properties, including offices, apartments, and malls. Its corresponding traditional mutual fund, Vanguard REIT Index (VGSIX ), has averaged an annualized return of 19.07% over the past five years, in line with its style peers. Sticker shock won't be a problem with this ETF. Vanguard REIT Index VIPERs' expense ratio of 0.12% is well below its 0.33% category average. The fund is also "more efficient" than its rivals, Miller says. Just like a stock, remember that commissions can cut into returns when ETFs are traded frequently. These funds are best for buy-and-hold investors, and could make your financial life a lot less confusing.

Stocks Fall after Soft Economic Data

News Article
June 22, 2006

Business Week Online

Stocks Fall after Soft Economic Data

May leading indicators dropped 0.6%, meeting Street expectations. Weekly jobless claims rose as projected

Stocks finished lower Thursday following a report indicating a slowing economy. Trading was cautious ahead of next week's Federal Reserve meeting, says Standard & Poor's Equity Research. The Fed is widely expected to raise the key federal funds rate to 5.25%.

On Thursday, the Dow Jones industrial average fell 60.35 points, or 0.54%, to 11,019.11, led downward by McDonald's (MCD ) despite a 4% jump by General Motors (GM ). The broader Standard & Poor's 500 index shed 6.6 points, or 0.53%, to 1,245.6. The tech-heavy Nasdaq composite was down 18.22 points, or 0.85%, to 2,122.98.

Volume was solidly below 20-day averages. NYSE breadth was decidedly negative, with 22 issues declining for every 11 advancing. Nasdaq breadth was 18-12 negative.

Technical measures are sending mixed signals about the market's direction, some analysts say. It's unclear whether Wednesday's surge "was the summer rally" or was merely the beginning of one, says Roger Volz, chief technical analyst at Swiss American Securities.

Market players were digesting another light plate of economic data Thursday. The index of leading economic indicators fell 0.6% to 137.9 in May, as projected. Initial jobless claims rose 11,000 to 308,000 in the week ended June 17, in line with expectations. Friday's docket holds May durable goods order, expected to rise 0.5%.

In corporate news, Boston Scientific (BSX ) and Johnson & Johnson (JNJ) were lower after a report that some cardiac centers are reducing use of drug-coated stents, which both companies supply, due to concerns over blood clots. Separately, a heart device made by Boston Scientific-owned Guidant reportedly may fail about 10 times more often than forecast, according to a regulatory analysis released in a Texas lawsuit.

Among other stocks in focus, Adobe (ADBE ) was higher and Google (GOOG) was slightly lower on news the multimedia software maker agreed to distribute Google's search software with Adobe's Shockwave media player.

Home furnishings retailer Bed Bath & Beyond (BBBY ) was lower after a Jefferies & Co. analyst said the company projected earnings below Wall Street forecasts.

Shares in Jabil Circuits (JBL) fell after the computer-equipment maker lowered its third-quarter earnings forecast. The company also received a subpoena from the U.S. Attorney's office for information on stock-option grants and was notified by the SEC of an informal inquiry.

On the brokerage front, General Mills (GIS ) was higher after Merrill Lynch upgraded the packaged-food maker from neutral to buy.

M&A talk continued to swirl. Spanish-language broadcaster Univision (UVN ) was down after private equity firms Kohlberg Kravis Roberts and Blackstone Group dropped out of a planned bid for the company.

Meanwhile, department-store operator Federated (FD ) was higher after selling its Lord & Taylor unit for $1.2 billion to a property development group.

In earnings news, software bellwether Oracle (ORCL ) was set to announce quarterly results after the close.

In the energy markets Thursday, August West Texas Intermediate crude oil futures closed up 51 cents at $70.84 a barrel. Rising gasoline prices drove other energy futures higher, says Action Economics.

European markets finished higher. In London, the Financial Times-Stock Exchange 100 index rose 19.1 points, or 0.34%, to 5,684.1. Germany's DAX index was up 30.01 points, or 0.55%, to 5,533.42. In Paris, the CAC 40 index gained 28.56 points, or 0.6%, to 4,803.29.

Asian markets finished higher. Japan's Nikkei 225 index rallied 491.43 points, or 3.36%, to 15,135.69. In Hong Kong, the Hang Seng index climbed 167.34 points, or 1.07%, to 15,826.7. Korea's Kospi index added 11.64 points, or 0.95%, to 1,238.83.

Treasury Market

Treasuries were lower amid strength in foreign stock markets, Fed policy speculation and news that Atlanta Fed President Jack Guynn is retiring. The 10-year note fell in price to 99-15/32 for a yield of 5.19%, while the 30-year bond dropped to 89-04/32 for a yield of 5.23%. The Treasury curve remained inverted, with the yield on the 2-year note topping the 10-year by 4 basis points. An inverted yield curve is taken by some forecasters as a sign of impending recession.

Wednesday, June 21, 2006

Stocks Rally on Earnings News

News Article
June 21, 2006

Business Week Online

Stocks Rally on Earnings News

Higher profits at Morgan Stanley and FedEx boosted sentiment as investors hunted for bargains

Stocks rallied Wednesday, boosted by solid earnings reports. Upbeat comments about the economy from FedEx (FDX ), which posted firm quarterly results, calmed recent fears that economic growth is slowing too quickly, says Standard & Poor's Equity Research. Morgan Stanley (MS ) also announced strong numbers, lifting sentiment.

On Wednesday, the Dow Jones industrial average rose 104.62 points, or 0.95%, to 11,079.64, paced by Hewlett-Packard (HPQ ), DuPont (DD ) and Caterpillar (CAT ). The broader Standard & Poor's 500 index added 12.08 points, or 0.97%, to 1,252.2. The tech-heavy Nasdaq composite climbed 34.14 points, or 1.62%, to 2,141.2.

Trading volume was higher Wednesday. Price strength on the session likely reflected some bargain hunting, notes S&P.

Market players are keeping an eye on commodities prices, as well as corporate earnings, some analysts say. "If the sell-off in commodities continues, I think we're going to see more of a sell-off in the global markets," says Quincy Krosby, chief investment strategist at The Hartford. "Obviously, we're all getting ready for the Fed meeting, but ultimately the earnings are going to be crucial in this because if you believe that we're in the midst of a global slowdown you're going to have to expect that earnings are going to come in."

Investors had little economic news to go on Wednesday. Reports on leading indicators and durable goods are due later in the week. Neither is likely to affect the outlook for an expected interest-rate hike at the Fed's June 28-29 meeting, says Action Economics.

On the company side, Morgan Stanley was higher after the investment bank said its second-quarter net income more than doubled.

Also in earnings, FedEx was up after the express transporter reported a 27% increase in fourth-quarter profit.

Among other stocks in the news, shares in Ford (F) rose despite reports the automaker said it may fail to meet its goal of returning to profit in North America by 2008, citing falling sales of sport-utility vehicles.

Chipmaker Texas Instruments (TXN) was modestly higher following a report that Moody's raised its rating on company's long-term debt to A1 from A2, citing more predictable profitability.

In broker calls, J.P. Morgan Chase (JPM ) was higher despite an analyst downgrade. Prudential lowered the stock from overweight to neutral weight and trimmed its price target from $51 to $45.

In the energy markets Wednesday, August West Texas Intermediate crude oil futures climbed to $70.37 a barrel, contributing to bullish stock sentiment since recent weakness in crude has been taken as a sign the energy market was pricing in economic weakness.

European markets finished modestly higher. In London, the Financial Times-Stock Exchange 100 index rose 6.8 points, or 0.12%, to 5,665. Germany's DAX index was up 9.8 points, or 0.18%, to 5,503.41. In Paris, the CAC 40 index edged higher 4.31 points, or 0.09%, to 4,774.73.

Asian markets finished mixed. Japan's Nikkei 225 index edged down 4.15 points, or 4.15%, to 14,644.26. In Hong Kong, the Hang Seng index rose 50.39 points, or 0.32%, to 15,659.36. Korea's Kospi index crept higher 1.36 points, or 0.11%, to 1,227.19.

Treasury Market

Treasuries closed little changed Wednesday, keeping yields stable ahead of the FOMC meeting next week. The 10-year note was unchanged in price at 99-13/32 for a yield of 5.159%, while the 30-year bond ended flat at 89-19/32 for a yield of 5.19%. The Treasury curve remained inverted, with the yield on the 2-year note topping the 10-year by 4 basis points. An inverted yield curve is taken by some forecasters as a sign of impending recession.

Tuesday, June 20, 2006

Stocks Finish Mixed as Rebound Fizzles

News Article
June 20, 2006

Business Week Online

Stocks Finish Mixed as Rebound Fizzles

Market players remained skittish despite a greater-than-expected rise in May housing starts

Stocks finished mixed Tuesday, after an early rebound on a solid housing report fizzled amid caution ahead of next week's Federal Reserve meeting. Worries about slowing economic growth, rising inflation and a global uptrend in interest rates continue to weigh on sentiment, says Standard & Poor's Equity Research.

The Dow Jones industrial average rose 32.73 points, or 0.3%, to 10,974.84, led by Verizon (VZ ). The broader Standard & Poor's 500 index edged down 0.02 points, or less than 0.01%, to 1,240.12. The tech-heavy Nasdaq composite slipped 3.35 points, or 0.16%, to 2,107.06.

Volume was low compared with 20-day averages. NYSE breadth was slightly negative, with 18 issues advancing for every 15 declining. Nasdaq breadth was 17-13 negative.

Some analysts say they like the market where it is. "Despite all the hand-wringing, eight out of 10 S&P sectors are still up year-to-date, with small caps up 3.5% and transports up 10%," notes Henry McVey, chief U.S. investment strategist at Morgan Stanley. "This has not been a 1990, 1998, or 2002-style event. We may see a continued bounce here since the market is oversold, but for the sustained upside we look for in the second half, we would like to see a broadening of leadership, more analysts trimming estimates, and a peak in the CPI [consumer price index] later in the summer."

An upbeat housing report was in focus Tuesday. The Commerce Department said housing starts rebounded 5% to 1.96 million units in May after an upwardly revised 1.86 million in April. That's slightly stronger than expected, says Action Economics, but any market impact may be offset by a 2.1% decline in building permits.

The report suggests the housing market is slowing, but not crashing, analysts say. "We view this morning's data as further evidence the housing market is in a downturn, but that it is not headed for collapse," explains Carl Riccadonna, an economist at Deutsche Bank Securities. "Nonetheless, the housing market is an important leading indicator of the overall economy, and the fact that it is slowing tells us that both consumption and overall growth are also likely decelerating."

The pace of the expected housing cooldown may prove difficult to predict, others say. "A significant miss in the timing of the economic slowdown related to housing could alter forecasts for inflation and the Fed," observes Lehman Brothers economist Drew Matus. "These developments demand close attention be paid."

The economic docket is lean again Wednesday, highlighted by mortgage applications and oil inventories. Other upcoming releases include leading indicators Thursday and durable goods Friday. Neither is likely to affect the outlook for an expected interest-rate hike at the Fed's June 28-29 meeting, says Action Economics.

In corporate news, JetBlue Airways (JBLU) was higher after Morgan Stanley initiated coverage of the aircraft with an overweight recommendation. The broker also started coverage of American Airlines parent AMR Corp. (AMR ) and Continental Airlines (CAL ) with equal-weight ratings and Southwest Airlines (LUV ) with underweight.

In other broker calls, Applied Materials (AMAT ) was higher after Prudential upgraded the chip-equipment maker from neutral to overweight. However, chipmakers Intel (INTC ) and Advanced Micro Devices (AMD ) were down modestly.

On the earnings front, Kroger (KR ) was higher after the supermarket chain reported a 4% increase in first-quarter profit. For-profit education company Apollo Group (APOL ) was lower after posting a flat profit for its fiscal third quarter.

Elsewhere, retailer Target (TGT ) was modestly lower after the company said June sales are trending toward the upper end of its forecasts.

Aircraft maker Boeing (BA ) was little changed in choppy trading as European rival Airbus faced a possible cancellation of a $3 billion order after delays in the jets' delivery.

M&A activity continued apace. Dow member General Electric (GE ) struck a deal for Swedish medical instruments maker Biacore International. Pharmaceutical company Pfizer (PFE ) holds 41% of Biacore.

In the energy markets Tuesday, July West Texas Intermediate crude oil futures closed down 4 cents at $68.94 in volatile trading as the July contract expired. A weekly inventory report is on tap for Wednesday.

European markets finished higher. In London, the Financial Times-Stock Exchange 100 index rose 32.1 points, or 0.57%, to 5,658.2. Germany's DAX index climbed 54.38 points, or 1%, to 5,493.61. In Paris, the CAC 40 index was up 41.4 points, or 0.88%, to 4,770.42.

Asian markets finished lower. Japan's Nikkei 225 index retreated 211.94 points, or 1.43%, to 14,648.41. In Hong Kong, the Hang Seng index lost 159.89 points, or 1.01%, to 15,608.97. Korea's Kospi index sank 25.84 points, or 2.06%, to 1,225.83.

Treasury Market

The solid housing report drove Treasury yields higher, says Action Economics. The 10-year note slipped to 99-26/32 for a yield of 5.15%, while the 30-year bond fell to 89-19/32 for a yield of 5.19%. The Treasury curve remained inverted, with the yield on the 2-year note topping the 10-year by 4 basis points. An inverted yield curve is taken by some forecasters as a sign of impending recession.

Friday, June 16, 2006

Stocks Stumble after Two-Day Climb

News Article
June 16, 2006

Business Week Online

Stocks Stumble after Two-Day Climb

Firm economic data, hawkish Fed comments, and the quarterly expiration of options and futures weighed on the market. Also in focus: Microsoft regime change

Stocks couldn't quite make it three in a row Friday, finishing modestly lower as investors took profits after a two-day rally. The quarterly expiration of options and futures drove volume higher and probably affected price direction, says Standard & Poor's Equity Research.

The Dow Jones industrial average edged down 0.64 point, or 0.01%, to 11,014.55, despite strength in Hewlett-Packard (HPQ ), en route to a 1.1% gain on the week. The broader Standard & Poor's 500 index dipped 4.62 points, or 0.37%, to 1,251.54, finishing the week little changed. The tech-heavy Nasdaq composite shed 14.2 points, or 0.66%, to 2,129.95, a weekly decline of 0.2%.

Worries about inflation, economic growth, and rising interest rates globally continued to loom over stocks. Bulls speculate that the market has found a near-term bottom, but they're waiting for gains on heavy volume to be sure, says S&P.

The Fed is widely expected to hike interest rates at its June 28-29 meeting. With a rate increase and slowing economic growth likely priced in, some analysts say the market is unlikely to establish a trend in either direction until the subsequent Fed meeting, which will be held Aug. 8.

"Some people are questioning whether the market's gone a little too far in pricing in slow growth," says Brian Gendreau, investment strategist at ING Investment Management. "I don't think the market's going to go much of anywhere for the next couple of months. There's an unusual amount of uncertainty."

The latest comments from Federal Reserve members reflect the murky outlook. On Friday, a pair of speeches by Fed policymakers maintained a hawkish tone on inflation. Fed Governor Donald Kohn said containing inflation could be "difficult and costly," while St. Louis Fed President Bill Poole said the data may actually understate inflation's extent.

Another set of economic figures was in focus Friday. The preliminary June reading for University of Michigan consumer sentiment rose to 82.4 from 79.1, slightly more than expected. The first quarter current account deficit came in better than forecast, moderating to $208.7 billion from the fourth quarter's downwardly revised $223.1 billion. Next week's calendar is light on economic data. Still, investors will be weighing reports on housing starts, leading indicators and durable goods. The releases shouldn't change Fed expectations, says Action Economics.

In corporate news Friday, Microsoft (MSFT) was modestly higher in choppy trading after Bill Gates announced a two-year transition period that will remove him from his day-to-day role at the company.

Also in software, Oracle (ORCL ) was higher after the company guided its fourth-quarter earnings higher.

Shares in another software maker, Adobe(ADBE ), rose after the company known for its Photoshop and Acrobat applications posted an 18% drop in earnings.

Homebuilder KB Home (KBH ) was higher after the company announced a 14% rise in profits but reduced its earnings outlook for fiscal year 2006.

Among other stocks in the news, Winnebago Industries (WGO) was higher after the maker of motor homes and recreational vehicles posted earnings for its fiscal third quarter that topped analyst estimates.

In the energy markets Friday, July West Texas Intermediate crude oil futures closed up 38 cents at $69.88 a barrel. Short-covering offset early selling pressure on relatively upbeat Iran news, says Action Economics.

European markets finished lower. In London, the Financial Times-Stock Exchange 100 index slipped 21.9 points, or 0.39%, to 5,597.4. Germany's DAX index fell 46.21 points, or 0.85%, to 5,376.01. In Paris, the CAC 40 index dropped 29.69 points, or 0.63%, to 4,694.89.

Asian markets finished solidly higher. Japan's Nikkei 225 index climbed 408.58 points, or 2.82%, to 14,879.34. In Hong Kong, the Hang Seng index was up 407.57 points, or 2.64%, to 15,842.65. Korea's Kospi index rallied 42.79 points, or 3.51%, to 1,262.19.

Treasury Market

The 10-year note fell to 100-00/32 for a yield of 5.12%, while the 30-year bond dropped to 89-29/32 for a yield of 5.17%. Bond bulls "have been few and far between since the inflation data earlier in the week," says Action Economics.

Cuban's Maverick Stocks Site

News Analysis
June 16, 2006

Business Week Online

Cuban's Maverick Stocks Site

The tempestuous NBA team owner aims to expose corporate shenanigans with a new Web site. Raising eyebrows: He'll base stock plays on that info before making it public

Tech billionaire Mark Cuban may soon go from making the news to breaking it. The high-profile owner of the NBA's Dallas Mavericks is throwing his financial clout behind a new Web site aimed at ferreting out corporate fraud. This time, though, he may be out of bounds.

The reason: Cuban has said he'll buy and sell stocks based on scoops the site uncovers, even before they're published. “There are a million ugly stories in the financial underground,” Cuban told BusinessWeek.com in an e-mail. “We plan on finding and sharing and profiting from them.” He declined to comment further.

The fledgling Web publication will have an experienced journalist at the helm. St. Louis Post-Dispatch business reporter Christopher Carey is leaving the newspaper after 17 years to become the editor of the site, called Sharesleuth.com. Carey was a finalist in 2005 for the Gerald Loeb Award, business journalism's highest honor, and he recently completed a prestigious fellowship at the University of Michigan.

CONFLICT OF INTEREST.  While Cuban's Mavs seem close to an NBA championship, his online venture is hardly a slam-dunk. Cuban's plan to buy and sell stocks based on Carey's reporting should pose inevitable conflicts of interest, and the site's business model remains unclear. Further, Carey says he and the famously mercurial Cuban—whom the NBA has fined more than $1 million for his sideline behavior—have only communicated via e-mail.

“At first blush, it just sounds so weird it's kind of hard to get my mind around,” says Dean Mills, dean of the School of Journalism at the University of Missouri-Columbia. “Whether online or in print or any other form, the main mission of journalism is to give the best, most accurate, most objective news it can to its readers. You just have to think that this kind of personal individual investment motive would contaminate the journalism.”

On his blog, Blog Maverick, Cuban has swept aside questions of journalism ethics. “A journalistic conflict you say?” he wrote May 31. “Not anymore. Not in this world. It will be fully disclosed and explained.” Neither he nor Carey would reveal the amount of Cuban's investment in Sharesleuth.com.

Meanwhile, Carey maintains that Cuban's trading decisions won't affect his reporting, hinting that the rules are different online. Critics “are viewing this as a traditional journalistic enterprise,” Carey says. “I am going to do things the way I always do things. Our stories are going to be based on facts. Let's face it, when you write these kinds of stories, it's pretty high-risk stuff. You need to be right -- otherwise you're likely to get sued.”

WHISTLE- BLOWING.  Ethical questions aside, the site's aim in itself seems laudable. Searchsleuth.com will focus on investigative journalism, seeking to find unsavory companies and share the tales behind their malfeasance, Carey says. The stories will take an “anti-fraud, pro-investor” point of view and will likely steer away from the “he-said, she-said” approach of much contemporary journalism.

Nor is Cuban's plan necessarily illegal. Under the law, Cuban must disclose his interest in the securities Carey covers and Carey's stories must be true, according to Mike Missal, a partner at Kirkpatrick & Lockhart Nicholson Graham specializing in securities regulatory matters. “Then they'll probably be OK,” Missal says.

As an enforcement attorney for the Securities & Exchange Commission in the 1980s, Missal prosecuted a landmark case of journalist insider-trading. Then-Wall Street Journal reporter Foster Winans was convicted of fraud in 1985 for passing tips to stock brokers about information that would appear in upcoming Heard on the Street columns. The brokers allegedly reaped about $675,000 from the arrangement and paid about $31,000 to Winans and his partner. However, one key element in that case was that Winans didn't disclose the trading up-front, according to Missal.

BUSINESS PLAN.  It's uncertain whether Sharesleuth.com has a feasible economic model. The site was originally conceived as a subscription-based service intended for traders, money managers, and other high-end users, according to Carey. “Then Mark decided that, rather than cast about for subscriptions without a track record, we should just put it all up there in a blog-style format for a year or so.” After the site proves its value, so the plan goes, its founders will look for ways to generate revenue.

Cuban's multimedia empire could give the business a boost. His film-production companies backed the Oscar-nominated biopic Good Night, and Good Luck and documentary Enron: The Smartest Guys in the Room, and he owns the high-definition television network HDNet (see BusinessWeek.com, 4/24/06, "Almost Ready for Prime Time"), a movie distributor, and the Landmark Theatres chain. Sharesleuth.com would take advantage of those capacities, as reporting done for the website could be adapted to other media, such as video.

It also helps that overhead will probably be low. Carey says he'll do most of the reporting, aided by some paid stringers. He also expects help from a network of amateur researchers, “people with whom I've been corresponding for years,” he says. “In essence, they provide tips and some supporting documentation and I take it from there.”

THE NEW JOURNALISM.  This collaborative vision of the future of online journalism may not even be far off the mark. “Does anyone in mainstream media honestly believe user-generated content stops with parodies of “Lazy Sunday” [a popular Saturday Night Live sketch]?” (see BusinessWeek.com, 4/3/06, "Designs on the Disaffected"Cuban wrote on his blog. “Troll through MySpace (NWS ). It's not only for personal branding.”

Still, even if NBA officials long ago stopped calling traveling violations, credibility remains the cornerstone of the journalistic endeavor. Carey says doing business with Cuban solely through e-mail “is not uncommon.” Nevertheless, their virtual relationship will soon become a working relationship. It will be worth watching how long a veteran reporter and an entrepreneur notorious for his tantrums can continue to break the news before the news breaks up their partnership.

Thursday, June 15, 2006

Stocks Jump amid Firm Earnings, Data

News Article
June 15, 2006

Business Week Online

Stocks Jump amid Firm Earnings, Data

The major indexes climb for a second day amid solid earnings from Bear Stearns, firm economic data, and a dovish tone on inflation from Bernanke

Stocks jumped on Thursday, building on Wednesday's gains amid short covering, a fresh batch of economic data, and tame words on inflation by Federal Reserve Chairman Ben Bernanke. The recovery reflects sentiment that worries about inflation and higher interest rates have been digested, says Standard & Poor's Equity Research.

The Dow Jones industrial average jumped 198.27 points, or 1.83%, to 11,015.19, paced by Caterpillar (CAT ). The broader Standard & Poor's 500 index rose 26.12 points, or 2.12%, to 1,256.16. The tech-heavy Nasdaq composite climbed 58.15 points, or 2.79%, to 2,144.15.

Short covering in the wake of solid earnings by investment bankers this week had a hand in the rally, says Action Economics. Fed Chairman Bernanke spoke, but didn't spook the market, saying longer-term inflation expectations "bear watching." Says Action Economics: "The speech and Q&A by Bernanke also largely avoided major pitfalls that could rattle investors and appeared a little more even-handed on the topic of inflation gaining traction from higher energy prices."

Other Fed speakers on Thursday included Boston Fed President Cathy Minehan, who said domestic inflation is increasingly affected by global forces. Meanwhile, Fed Governor Randall Kroszner stayed away from policy in a speech before a banker's assocation. The Fed is widely expected to raise interest rates when it meets June 28 and 29.

Solid economic reports were in the spotlight Thursday. Initial jobless claims unexpectedly fell 8,000 to 295,000 in the week ended June 10. The Empire State index of manufacturing activity surged to 29.01 in June, more than triple the expected reading, according to Action Economics, while the Philadelphia Fed index slipped to 13.1 from 14.4 in May. Industrial production dropped 0.1% in May after rising 0.8% in April.

The lower industrial production number is no cause for worries about economic growth, some analysts say. "Despite the decline, the three-month growth rate in manufactured production is fairly robust at 4.4%," notes John Ryding, chief U.S. economist at Bear Stearns. "Although capacity utilization slackened a little in May, it is still significantly above its long-run average and likely to be a concern to the Fed from an inflation perspective."

Reports coming Friday include the preliminary June reading for University of Michigan consumer sentiment, whihc is expected to stay fairly stable at 79.0 from 79.1. The first quarter current account deficit is expected to moderate to $222 billion from the fourth quarter's record of $225 billion.

Among stocks in focus Thursday, Bear Stearns (BSC ) gained ground after the brokerage reported an 83% jump in second-quarter profit.

Meanwhile, Goldman Sachs (GS ) was higher after a consortium led by the brokerage raised its bid for Associated British Ports. Also reportedly bidding for the U.K. ports operator is a group led by Macquarie Bank.

Shares in Intel (INTC) also rose, extending the its gains the previous session after Goldman raised its recommendation on the chipmaker's stock to outperform.

On the downside, General Mills (GIS ) was lower after the packaged foods maker lowered its earnings guidance for fiscal year 2007.

On the brokerage front, Morgan Stanley upgraded 3Com (COMS ) from underweight to equal-weight. UBS Financial boosted SanDisk (SNDK ) from neutral to buy.

In the energy markets Thursday, July West Texas Intermediate crude oil futures rose 36 cents to $69.50 a barrel.

European markets finished solidly higher. In London, the Financial Times-Stock Exchange 100 index advanced 112.5 points, or 2.04%, to 5,619.3. Germany's DAX index added 116.23 points, or 2.19%, to 5,422.22. In Paris, the CAC 40 index was up 109.14 points, or 2.36%, to 4,724.58.

Asian markets finished mostly higher after the Bank of Japan voted to keep interest rates at essentially zero. Japan's Nikkei 225 index rose 161.2 points, or 1.13%, to 14,470.76. In Hong Kong, the Hang Seng index climbed 187.16 points, or 1.23%, to 15,435.08. Korea's Kospi index slipped 2.33 points, or 0.19%, to 1,219.4.

Treasury Market

Yields pressed higher as yesterday's core CPI gain was followed with another round of stronger data, signs of lower foreign demand for U.S. assets and firm-but-balanced Fedspeak on inflation risks ahead, says Action Economics. Equities rebounded aggressively and commodities generally sought equilibrium levels, which also reduced some safety premium on bonds as well, says Action Economics. The 10-year note yield rose to 5.098%.

Wednesday, June 14, 2006

A Summer Slump for Stocks

News Analysis
June 14, 2006

Business Week Online

A Summer Slump for Stocks

Interest-rate and inflation fears are hammering stocks around the globe. Market pros advise some defensive moves to avoid getting burned

Summer doesn't officially begin until June 21, but investors are already feeling burned. Stocks have tumbled almost across the board since May 10, as worries about inflation, rising interest rates, and slowing economic growth caused a flight from riskier asset classes (see BusinessWeek.com, 6/1/06, "A Miserable May for Markets"). As the meltdown continues, many market strategists recommend that investors seek protection and stay defensive.

The numbers don't look pretty. Through June 13, the Dow Jones industrial average was down 8% since May 10, when it reached a six-year closing high of 11,642.65. Over the same period, the broader Standard & Poor's 500 dropped 7.5%, and the tech-heavy Nasdaq composite lost 10.7%. All three of those indexes are in negative territory for the year. The late spring swoon has spread to major equity indexes in other countries, as central banks across the globe joined the rate-hike party (see BusinessWeek.com, 6/9/06, "A Global Assault on Inflation").

It's no coincidence that the Dow's peak coincided with the Federal Reserve's most recent meeting on interest rates. Stocks' rally in April and early May owed partly to expectations the Fed would stop hiking rates after May 10, analysts say. Instead, policymakers left the door open to further increases, rattling the markets. "The Fed's suddenly inconsistent communication caused volatility to quickly rise," wrote Richard Bernstein, chief investment strategist at Merrill Lynch, in a June 13 report.

FEARFUL FED.  The nasty climate for stocks could linger. Pending any clear signal from the Fed, the markets should continue to see-saw, with sellers in charge of the action, according to some strategists. "Until there is evidence that slower growth will contain inflation, market price movements will probably be quite 'choppy,'" wrote Gordon Fowler, chief investment officer of the Glenmede Trust Co., in a June 12 report.

The Fed is widely expected to raise the federal funds rate to 5.25% when it meets June 28 and 29. Its next step after that is anybody's guess. Fed Chairman Ben Bernanke and other policymakers have sounded a hawkish note on inflation in recent speeches. On June 12, Dallas Fed President Richard Fisher noted the central bank is feeling "some angst" over the issue.

Nevertheless, inflation fears may be overdone, some analysts maintain. Gold prices, traditionally an indicator of inflation, have fallen sharply after surging earlier this year. On June 13, gold fell to $566.80, its lowest level since March and down 22.6% from a 26-year high of $732 reached May 12.

Energy prices, too, have been on the downswing. Oil futures fell to $68.56 a barrel on June 13, after hitting a record $75.35 in April. Meanwhile, the International Energy Agency recently lowered its forecast for global oil demand in 2006 to 1.24 million barrels a day, down 30% from its projection in January.

GROWING PAINS.  A key wholesale inflation reading came out in line with Wall Street expectations on June 13, with data on consumer prices due on June 14. Figures so far in the second quarter suggest inflation is moderating, according to John Ryding, chief U.S. economist at Bear Stearns. "If consumer spending continues to grow at the slower pace in June, the Fed may be encouraged to take no action in August and wait for data on the strength of the third-quarter economy," Ryding notes.

Indeed, some market watchers say concern about growth, not inflation, is what's actually roiling markets. " 'Growth fears' are driving the markets lower," Citigroup analyst Albert Richards wrote in a June 12 report. "The market seems to be thinking that growth (and earnings) may well suffer as a result of the inflation fight."

Others say the recent global downtrend stems from a reassessment of the risks in various asset classes after a long period of rosy outlooks. The market has simply been pricing in the uncertainty about the Fed's plans, explains Joseph Battipaglia, executive vice-president and chief investment officer at Ryan Beck & Co. "Investors shouldn't go for the head fake that there's a recession looming, but rather, that certain markets are cheaper than others, that the Fed will not aggressively move higher on rates, that the inflation surge will subside, and the economy can continue to expand into 2007," Battipaglia says.

SIDELINE SAFETY.  From a technical standpoint, stocks don't seem to have touched bottom yet, analysts say. Leading up to the Fed meeting, expect anxiety to continue as markets zig-zag lower in volatile trading, says Chris Johnson, managing quantitative analyst at Shaeffer's Investment Research. "Until we see buyers start to enter into the fray, the market's not going to have much stability under it," he says.

In the meantime, investors might want to consider the safety of the sidelines. "Now's not a bad time to get a little bit more defensive," says Bill Larkin, portfolio manager of fixed income at Cabot Money Management. He says raising cash levels and taking advantage of high short-term bond yields could be smart moves within a well-diversified portfolio.

The winners of the past few years — such as emerging markets, energy stocks, and small-cap stocks — will continue their recent downtrend, predicts Jeffrey Knight, chief investment officer of global asset allocation at Putnam Investments. "This isn't a run-of-the-mill correction," Knight says. "This is a very important transformational event."

LARGE CAPS, LONG TERM.  As volatility continues, Knight likes cash and Treasury bonds. After the dust settles, he recommends an emphasis on large-cap stocks and stocks with high dividend yields.

Indeed, many market pros favor relatively stable U.S. large caps. "We would be wary of small caps, and we would prefer larger caps at this juncture," wrote Tobias Levkovich, chief U.S. equity strategist at Citigroup, in a June 9 report. Stocks he likes include United Technologies (UTX ), Federated Stores (FD ), Johnson & Johnson (JNJ ), General Electric (GE ), Wal-Mart (WMT ), Caterpillar (CAT ), Merrill Lynch (MER ), and Cisco Systems (CSCO ), among others.

Investors generally shouldn't try to time the market, because they'll tend to lose, others say. "Ordinary investors shouldn't really change from what their long-term strategies are," says Stewart Beach, senior vice-president at Old Second Wealth Management. "If you were waiting to add money to equities, take the volatility as an opportunity. If you were thinking of changing your allocation to having 40% stocks instead of 50%, you take this weakness to be gradually adding in." If you take that tack, just be more defensive to avoid getting hurt.

Monday, June 12, 2006

A Tale of Two Retailers

News Analysis
June 12, 2006

Business Week Online

A Tale of Two Retailers

Drugstore chain Rite Aid recently hit a 52-week high, while RadioShack smacked a 52-week low. Neither stock looks like an impulse buy

One sells drugs, the other plugs. You may be able to cruise by Rite Aid (RAD ) and RadioShack (RSH ) on the same trip -- maybe even in the same strip mall -- but the two retailers' stocks have been moving in opposite directions. Rite Aid shares climbed recently as demographic trends have pointed in the drugstore chain's favor. Meanwhile, investors have so far left electronics merchant RadioShack's nascent turnaround effort on the shelf.

On June 5, Rite Aid's share price touched a 52-week high of $4.90, up 51.7% from a low of $3.23 set on Nov. 14, 2005. The stock's rise followed surprisingly strong earnings reports the previous session from larger rivals CVS (CVS ) and Walgreen's (WAG ). Shares in Camp Hill (Pa.)-based Rite Aid sold for $4.59 in afternoon trading on June 9.

RadioShack shares scraped their 52-week low of $14.17 on June 8, amid a severe intraday equity market selloff on worries about rising global interest rates (see BusinessWeek.com, 6/9/06, "A Global Assault on Inflation"). A day earlier, Stifel Nicolaus analyst David Schick downgraded the stock from hold to sell. Shares in the Fort Worth-based retailer were at $15.16 in afternoon trading on June 9, down 44.3% from a high of $27.24 reached on Aug. 11, 2005.

PHARMACY GAME.  Is it time for these stocks to reverse course, or will they each remain on their respective tracks? Well, sometimes a product's sticker price is just right. Although Rite Aid's shares have risen and RadioShack's have tumbled, analysts suggest that neither stock is poised for a significant move anytime soon, for better or for worse.

Rite Aid runs about 3,300 drugstores in 28 states and Washington, D.C. On Apr. 6 the company posted fiscal fourth-quarter profits that fell below some analyst estimates, boosted by a 9.9% increase in sales. Despite positive long-term trends, Rite Aid faces a number of challenges as it jostles for space in an increasingly competitive industry, analysts say. A company spokesperson declined to comment on the share price.

The drugstore business overall stands to gain over the long term from aging baby boomers, who will presumably buy more medications, analysts observe. Pharmacy sales were a bright spot in the company's fourth-quarter results, increasing 2.5% amid gains related to Medicare Part D, the new drug benefit plan. Rite Aid's fundamental outlook remains difficult, but upside is large if a solid (although not heroic) turnaround occurs, wrote Credit Suisse analyst Edward Kelly in a May 4 report rating the stock outperform. (Credit Suisse acts as a market maker in Rite Aid and RadioShack securities.)

EXPANSION BENEFITS.  Still, Rite Aid's dependence on filling prescriptions could also be a liability. The company's relatively low profit margins mean that changes in Medicaid, Medicare, or generic drugs will have a greater impact on Rite Aid than on its rivals, according to HSBC Global Research analyst Mark Hutton in an Apr. 28 report. Hutton has an underweight rating on the stock.

At the same time, Rite Aid's front-of-the-store sales (i.e., nonpharmacy) lag behind those of its competitors, but analysts say that's not a critical variable. Given the company's well-developed merchandising skills, this laggard performance remains a bit of a mystery, writes Goldman Sachs analyst John Heinbockel in a May 4 report. Nevertheless, Heinbockel rates the stock a buy. (Goldman owns 1% or more of Rite Aid common equity, expects or intends to seek compensation for investment banking services from Rite Aid, and had an investment banking relationship with Rite Aid in the past 12 months.)

Rite Aid's share price hit its peak as the drugstore industry is enjoying an expansion phase. Some say Rite Aid's additions have been right on the money. Their growth has been pretty savvy, says George Whalin, president and CEO of San Marcos (Calif.)-based Retail Management Consultants.

SHACK SHAKEUP.  However, Rite Aid's low cash flow relative to its peers may impose another hurdle as the company tries to keep getting bigger. With major competitors also focusing on expanding their asset bases, and competition increasing from other formats, we remain concerned that [Rite Aid's] high debt levels may limit its longer-term growth prospects, wrote Standard & Poor's analyst Joseph Agnese in January. He has a hold recommendation on the stock. Still, Rite Aid has slashed its debt to about $3 billion from $6 billion in 1999, when the company brought in new management.

Meanwhile, RadioShack faces challenges of its own. The company runs about 6,600 stores under company-owned and dealer-franchised formats, making it the largest electronics retailer by number of locations, but it lags behind Best Buy (BBY ) and Circuit City (CC ) in sales. We clearly have a lot more work to do to get this company back to levels of profitability and growth that we all expect, said Claire Bobrowski, president and acting CEO of RadioShack, in an Apr. 21 conference call. (A company spokesperson declined to comment on financial performance before second-quarter earnings are announced on July 21.)

A management shakeup is only one of the question marks hanging over the company. On Feb. 20 then-CEO Dave Edmondson stepped down following a report that he did not have the bachelor's degree listed on his résumé (see BusinessWeek.com, 2/22/06, "RadioShack's Lesson: Trust, But Verify"). A search for a permanent CEO is ongoing.

The recent turmoil in company leadership&ellip;has, as we expect, introduced an element of turmoil throughout the organization, wrote Raymond James analyst Budd Bugatch in an Apr. 24 report reaffirming a market perform rating. (Raymond James expects to receive or intends to seek compensation for investment banking services from RadioShack.)

SERIES OF LETDOWNS.  RadioShack's cell-phone business also continues to ring up disappointment following last year's switch of carrier affiliation from Verizon (VZ ) to Cingular. The transition remains challenging, Deutsche Bank analyst Mike Baker noted in a May 15 dispatch, with the main issue being a slow ramp in Cingular trends in areas where the company does not have a large market share.

Baker likes the company's decision to reduce capital expenditures on new wireless kiosks but says the lack of share buybacks forecast in 2006 is a bad signal. He rates the stock a hold. (Deutsche Bank makes a market in RadioShack securities, owns 1% or more of the company's common equity securities, and expects to receive or intends to seek compensation for investment banking services from RadioShack.)

Unlike Rite Aid, RadioShack has many locations in enclosed malls. These roughly 1,200 stores could represent one of the bigger issues long-term, writes Credit Suisse analyst Gary Balter, who has a neutral rating on the stock. Mall traffic -- which skews toward teenagers, mothers, and senior citizens -- isn't necessarily ideal for RadioShack's product mix, analysts say.

Then there's customer service. Higher staffing levels contributed to higher first-quarter spending, but the effort was less successful in driving sales than executives had hoped. Meanwhile, rival Best Buy has scored a marketing success with its Geek Squad, a 24-hour customer-service group.

BOTTOMING OUT.  RadioShack's customer-service push may face an uphill battle, according to some analysts. That's fine to talk about, but to actually implement it, and implement it from mall-based locations? says Michael Tesler, president of Norwell (Mass.) retail consulting firm RetailConcepts.com. I wish them luck.

While the electronics retailer's stock might look like a deep-value opportunity at current lows, some analysts caution against buying too soon. Although the stock has already shed half its value in 18 months, share prices may not be ready to rise, analysts say. We believe results could be so far below current consensus that EPS estimate revisions could be tough on share performance in the near term, Stifel Nicolaus' Schick wrote on June 7. (Stifel Nicolaus expects to receive or intends to seek compensation for investment banking services from RadioShack.)

Consumers seeking blood-pressure pills or RCA cables may need to pay Rite Aid or RadioShack a visit. But investors might not want to put the retailers' stocks on their shopping lists just yet.

Friday, June 9, 2006

A Global Assault on Inflation

News Analysis
June 9, 2006

Business Week Online

A Global Assault on Inflation

From Ankara to Washington, central banks are hiking rates -- and investors are spooked. What lies ahead?

For many market observers, June 8 seemed to be World Tightening Day. The European Central Bank raised its benchmark interest rate by 25 basis points, to 2.75%, as expected. But in a surprise move, South Korea's central bank hiked its key interest 25 basis points, too, to 4.25%. Central banks in Denmark, India, South Africa, and Turkey raised rates as well.

The moves by inflation-wary central bankers have put world equity markets on the defensive, as investors seek the safety of less-risky vehicles (see BusinessWeek.com, 6/8/06, "Stocks Recover Amid Bargain Hunting"). With further monetary tightening expected, investors may have to face continued volatility in the months ahead, analysts say.

TWO EXCEPTIONS.  Stock markets worldwide took the June 8 rate-hike spree hard. Asian markets got the ball rolling downward, with both Japan's Nikkei and Korea's Kospi indexes falling more than 3%. European bourses also suffered, as major indexes in Britain, Germany, and France each shed more than 2.5%.

In the U.S., the Dow Jones industrial average recovered from triple-digit intraday losses to finish up 0.07%. The broader Standard & Poor's 500 squeaked higher by 0.14%, and the tech-heavy Nasdaq composite dropped 0.3%.

Two other central banks stood pat on June 8, but they might be the exceptions that prove the rule. The Reserve Bank of New Zealand, which held its rate at a lofty 7.25%, cited a worse-than-expected outlook for inflation. While the Bank of England left British interest rates at 4.5% for the 10th straight month, it's less likely to do so next time, analysts say.

"What we're seeing is a global full-court press on inflation control," says Alan Gayle, senior investment strategist at Trusco Capital Management (STI ).

THE PARTY'S OVER.  Against this backdrop, U.S. central bankers have stepped up their own tough talk on inflation, likely paving the way for the 17th consecutive interest-rate hike. On June 5, Federal Reserve Chairman Ben Bernanke said the recent uptick in a closely watched inflation measure was "unwelcome" (see BusinessWeek.com, 6/6/06, "The Chill in Bernanke's Words"). In afternoon trading June 8, futures markets reportedly assessed a 76% chance that the Fed will raise rates 25 basis points at its next meeting, to be held June 28-29.

In recent years, an environment of low interest rates and easy liquidity has emboldened investors to place riskier bets, boosting volatile asset classes like commodities and emerging markets. But as rates increase, market players fear that liquidity will dry up, analysts say. "The central banks are taking the punch bowl away," explains Jack Ablin, chief investment officer at Harris Private Bank (BMO ).

Even deflation-wary Japan has gotten in on the tightening act. In March, the Bank of Japan officially ended its so-called quantitative easing policy, which injected excess reserves into the nation's banking system (see BusinessWeek.com, 5/12/06, "Easing Out of Quantitative Easing").

PRICING RISK.  Japan's accommodating monetary policy allowed for "carry trade," a strategy where hedge funds and other investors would borrow cheap yen and use it to buy assets around the world. "The jitters in the marketplace actually started at the end of February, when you started to hear the Japanese talk about the ending of quantitative easing," says Quincy Krosby, chief investment strategist at The Hartford (HIG ).

Of course, tighter monetary policy isn't the sole factor behind the recent stock-market downturn. In a June 8 press conference broadcast via the Web, European Central Bank president Jean-Claude Trichet said ongoing market volatility reflects a renewed appreciation of investment risks.

"There was a certain level of underpricing of risks in the global financial market," Trichet said, observing that other central bankers share this view. "If this pricing of risk goes a little bit up, it would be perhaps going in a direction of better pricing of risks."

BAD COMBO.  Risk aversion has helped drive stocks downward as investors move to less-volatile issues, analysts say. "It's not a pricing reassessment," Harris' Ablin says. "It's a risk rebalance." Indeed, riskier asset classes have tended to see bigger declines (see BusinessWeek.com, 6/8/06, "No May Flowers for Investors").

Also on June 8, short-term Treasury yields rose above their long-term counterparts for the first time since March. An inverted yield curve, as this phenomenon is known, has traditionally been viewed as a signal of an upcoming recession. The Treasury market seems to be worried that Fed tightening "plus the combination of the weakness we see in housing and consumer sentiment is going to cause weakness in the economy this year and next year," says Brian Gendreau, investment strategist at ING Investment Management (ING ).

Of course, the markets could be wrong. One factor that could forestall a potential extended downturn is a strong second-quarter earnings season, analysts say. S&P analysts project that second-quarter earnings will increase 8% from the same period a year earlier, ending 16 consecutive quarters of double-digit percentage gains (see BusinessWeek.com, 5/5/06, "Second-Quarter Preview").

OIL WATCH.  "I don't think we're at the end of the bull run," says Jean-Michel Six, chief European economist at S&P. "Earnings growth might not be as strong as it was in 2005, but it's still going to be decent. The corporate sector's health is certainly a mitigating factor."

A sustained decline in energy prices could also potentially support equities, analysts say. On June 8, July West Texas Intermediate crude oil futures closed down 47 cents at $70.35 a barrel, after falling as low as $69.10 after the death of Abu Musab al-Zarqawi, the al-Qaeda leader in Iraq.

"The issues in Iraq and Iran will be there and probably put a floor under crude oil prices, but to have oil trade back under $70 would be a helpful development for stocks," says Michael Wallace, global market strategist at Action Economics.

Some say investor sentiment has to worsen before the market bottoms out. "One thing that would be really helpful to get this out of the way would be if sentiment were to get really bad," says Linda Duessel, equity market strategist at Federated Investors (FII ). "Without poor sentiment, it's hard to think that we have a sustainable low."

BOLSTERING CRED.  Meanwhile, Duessel and others argue that the inflation threat -- ostensibly the reason central banks are hiking rates -- may be overblown. Fed economists actually lowered their inflation forecast at the May 10 meeting, points out David Rosenberg, North American economist at Merrill Lynch (MER ).

"The Fed is barking about inflation, but it is noticeably absent in their forward-looking models," Rosenberg wrote in a June 7 research report. "This is 100% about bolstering a perceived loss of credibility" (see BusinessWeek.com, 6/7/06, "No More Hints and Whispers").

Until the interest-rate saga plays out, investors will continue to wrestle with uncertainty, analysts say. And that's one thing markets like even less than higher interest rates.

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