MarketView for August 13

 

 

Summary  

 

Stocks rose on Thursday as better-than-expected earnings by Walmart helped offset disappointing government numbers on retail sales and jobs. The shares closed up 2.7 percent at $51.88 following its second-quarter earnings and its outlook for the full year.

 

The rest of the retail sector was lukewarm, however, after the Commerce Department reported retail sales fell 0.1 percent in July. Wall Street had been expecting to see an increase in retail sales from the government's "cash for clunkers" program that offers taxpayers money for trading in gas guzzlers for more fuel efficient new cars.

 

Also on the negative side, the government said the number of workers filing initial applications for unemployment benefits rose by 4,000 to a seasonally adjusted 558,000.

 

Financial stocks were among the bright spots, a day after hedge fund manager John Paulson, who had made a fortune betting against financial companies after foreseeing the credit crisis, disclosed that he had bought large stakes in several banks, including spending a million dollars on Bank of America stock. Bank of America ended the day up 6.7 percent to close at $17.00.

 

After the closing bell, shares of Nordstrom fell 0.9 percent to $29.50 after the upscale department chain reported a steep decline in quarterly earnings. Shares of AutoDesk added 0.8 percent after the bell on the company’s quarterly earnings that beat expectations.

 

The shares of various homebuilders were lower on a string of downgrades, with D.R. Horton down 3.7 percent to $12.95 after Citigroup cut its rating. KB Home fell 2.5 percent to $17.83 after a downgrade by Raymond James.

 

Cut Economic News Some Slack

 

There was much ado made of the economic data released on Thursday, with the bottom line being that it did not meet hopes and expectations. Cut the data and the government a bit of slack. If the data was a disappointment it was because you were expecting too much.

Yes, it is true that retail sales were slightly on the negative side as consumers spent a bit less in July, while at the same time there was an increase in claims for jobless benefits last week. However, we are just now exiting from the granddaddy of recessions. Do not look for miracles. All things considered the data was not bad and could have been much worse.

A Commerce Department report on Thursday showed total retail sales down 0.1 percent in July after increasing 0.8 percent in June. Excluding motor vehicles and parts, sales fell 0.6 percent in July after rising 0.5 percent the prior month. If you were expecting the so called ���cash for clunkers” program to carry the day, it was an unrealistic expectation.

 

The decline in July retail sales was affected by a 2.1 percent drop in sales at gasoline stations. That stemmed from a retreat in gasoline prices during the month after a 6.3 percent surge in June. Excluding gasoline, retail sales nudged up 0.1 percent. Sales were weak in nearly all areas of discretionary spending.

 

Nonetheless, the retail sales data cast a shadow over an anticipated rebound in consumer spending in the current quarter. Spending, which accounts for more than two-thirds of U.S. economic activity, has been pressured by high unemployment.

 

There was also a report from the Labor Department indicating that first-time applications for state unemployment insurance benefits rose 4,000 to a seasonally adjusted 558,000 last week. Although weekly data is relatively unreliable due to tremendous fluctuations from week to week, this reading was essentially an unchanged one from the previous week. Despite signs the recession is winding down, companies are slow to hire, though the pace of layoffs has dropped markedly.

 

On a more positive note, the Labor Department also reported that the number of people collecting long-term unemployment benefits fell by 141,000 claims to 6.20 million claims for the week ended August 1, the lowest since mid-April.

 

Another report from the Commerce Department showed U.S. business inventories fell 1.1 percent in June after a 1.2 percent decline in May. Business sales rose 0.9 percent in June, advancing for the first time since July last year, after being flat in May.

 

The inventory data confirmed the record drop in inventories in the second quarter and could mean gross domestic product during that period will be revised to show a decline slightly greater than the 1.0 percent annual rate reported last month.

 

Walmart Exceeds Estimates

 

Walmart released better-than-expected quarterly earnings on Thursday as more stringent inventory controls offset falling sales. At the same time, the company forecast full-year earnings that exceeded Street estimates, sending its shares up 1.7 percent.

 

The world's biggest retailer, which now describes itself as "Walmart", said the hold-down on inventory helped it protect margins and avoid costly markdowns as cautious shoppers stuck to buying necessities like food.

 

Net income fell slightly to $3.44 billion from $3.45 billion but earnings per share rose to 88 cents from 87 cents, as the company had fewer outstanding shares in the latest quarter. Total sales fell 1.4 percent to $100.08 billion, pressured by a stronger U.S. dollar, which cut the dollar-value of sales made outside the United States. Sales rose 2.7 percent to $104.28 billion on a constant currency basis.

 

"Short term, we believe the economy will continue to be challenging," said CEO Mike Duke on a recorded call. "We are accelerating our focus on reducing expenses and improving productivity in all of our operations."

 

Walmart reported that sales at domestic stores open at least a year fell 1.2 percent. In May, the company said it would stop posting sales on a monthly basis, leaving analysts to guess how it fared in the quarter compared with last year when it was helped by rising food and fuel prices and consumers spending tax rebate checks.

 

Vice Chairman Eduardo Castro-Wright said on a recorded call that the company had underestimated how much of a boost it got from shoppers spending tax rebate cash in its stores a year ago. He also said sales were hurt by falling food prices.

 

Chief Financial Officer Tom Schoewe said that consumers were under significant pressure, preferring to pay for purchases with cash or debit cards instead credit. Walmart is also seeing a bump in sales at the start of the month when consumers receive government aid such as food stamps, he said.

 

Sales at Walmart's domestic stores rose 0.3 percent in the second quarter to $64.21 billion, while they fell 3.2 percent to $11.91 billion in Sam's Club warehouse locations. In the company's international division, sales fell 5.1 percent to $23.97 billion, but on a constant currency basis international sales increased 11.5 percent to $28.16 billion.

 

For the back-to-school shopping season, which is now underway, Castro-Wright said he believes Walmart is gaining "significant share", and it was pleased with the initial response to its back-to-school merchandise. As to the outlook for Christmas, Schoewe said he was hopeful the season would be better than a year ago.

 

For the current third quarter, Walmart indicated that it expects earnings per share from continuing operations of 78 cents to 82 cents. The average Reuters estimate was 80 cents a share. For the 13 weeks ended October 30, the company forecast domestic same-store sales to be flat to up 2 percent, with same-store sales at its Sam's Club to be flat, plus or minus 1 percent. For the year, it forecast earnings from continuing operations of $3.50 to $3.60 a share.

 

Even Warren Buffett Goofs Occasionally

 

If you thought the mighty on Wall Street never make mistakes, read on. Warren Buffett's Berkshire Hathaway underestimated the risks of falling stock prices to its billions of dollars of derivatives bets, yet still believes it is valuing the contracts fairly.

 

Berkshire revealed its error in a June 26 letter to the SEC, one of several pieces of correspondence with the regulator about the company's annual report, and made public on Thursday. Berkshire also agreed to SEC demands for more explanation on $1.8 billion of write downs on stock investments, and $2.7 billion of auction-rate and other municipal debt holdings. On June 29, the SEC said it completed its review without further comment.

 

The correspondence shows Berkshire, which has close to 80 businesses and ended June with more than $136 billion of stocks, bonds and cash, is struggling to comply with SEC requirements to disclose enough about its finances. This issue had surfaced in June 2008, when the regulator demanded "a more robust disclosure" of how the insurance and investment company values its derivatives. Buffett did provide some additional disclosure, in what he called "excruciating detail," in his annual shareholder letter in February.

 

The derivatives contracts are tied to four equity indexes in the United States, Europe and Japan, and are a big reason Berkshire's earnings fell for six straight quarters. That string ended in the April-to-June period as stocks rebounded.

 

In the June 26 letter, Berkshire's Chief Financial Officer Marc Hamburg told the SEC that last year's 30 percent to 45 percent declines in the equity indexes "are in excess of our volatility inputs." He nevertheless said Berkshire's expectations for stock market volatility are "reasonable" given the long-term nature of the contracts, which expire between 2018 and 2028. Berkshire ended June with $8.23 billion of paper losses and $37.48 billion of potential liabilities on the contracts.

 

Buffett expects the contracts to be profitable and can invest upfront premiums as he wishes. This is one reason the world's second-richest person believes the contracts are unlike derivatives that are "financial weapons of mass destruction."

 

The $1.8 billion of "other-than-temporary impair losses" in 2008 related mainly to 12 equity securities that "generally" lost 40 percent to 90 percent of what Berkshire had paid for them, Hamburg wrote on May 22. Berkshire did not write down six other securities that fell 20 percent to 40 percent, he said.

 

Hamburg also wrote that Berkshire had reduced its stake in auction-rate and similar municipal debt to $2.7 billion at year end from $6.5 billion six months earlier, but that the credit crisis slowed the runoff in the fourth quarter.

 

The auction-rate market seized up in February 2008 and has not recovered. Berkshire has said it does not plan to sell its auction-rate holdings at below face value and can hold them until they are auctioned off or redeemed.