MarketView for June 16

Summary 

Stock prices were lower again on Tuesday as residual concerns regarding the economy and Best Buy's disappointing revenue outlook sent Wall Street into a tizzy once again. A rebound in May housing starts pointed to some stabilization in that sector, but another government report showed industrial production had a steeper-than-expected slide last month.

Industrial production fell 1.1 percent in May, while capacity utilization, a measure of slack in the U.S. economy, slumped to its lowest level on records dating back to 1967.

Best Buy, the country’s largest domestic consumer electronics retailer, posted weaker-than-expected sales in its first quarter, while pointing out that earnings for the rest of the year would be worse than forecast. Its shares closed down 7.3 percent to $35.84.

The S&P 500 is still up 34.8 percent from March's 12-year closing low and declines have been shallow and short-lived.

Consumer discretionary and resource stocks were among the day's worst losers. After adding to the market’s momentum earlier in the day, materials and energy shares fell as the dollar strengthened. Chevron closed down 1.7 percent at $69.88.

Single-family housing starts were up 7.5 percent in May, the largest gain since January 2006.

A smaller-than-expected rise in May's overall Producer Price Index suggested inflation pressures were muted. At the same time, shares of large industrial manufacturers, whose fortunes are closely tied to a growing economy, were off for the day, with 3M Co closed down 1.5 percent at $58.41.

Inflation Falls and Housing Starts Rise Sharply

Housing starts and permits rose sharply for the month of May, as the statistics came off of record lows, while wholesale prices were muted despite higher gasoline costs, indicating the economy was moving closer to the end of a deep recession.

According to a report by the Commerce Department on Tuesday, housing starts rose 17.2 percent, the biggest rise in three months, to an annual rate of 532,000 units. This was as ground-breaking activity for multifamily homes surged 61.7 percent after diving 49.4 percent in April.

Even more encouraging for the housing sector, which is at the center of the longest U.S. output decline since the Great Depression, starts of single family homes rose 7.5 percent, the largest gain since January 2006?

Ground breaking activity for single family homes has now chalked up higher reading for three consecutive months, an indication that housing investment could be less of a drag on the economy in the quarters ahead, if the trend continues.

A separate report from the Labor Department indicated that prices paid at the farm and factory gate increased by 0.2 percent versus a 0.3 percent April rise. Prices compared with a year ago notched their steepest falls since 1949, which should help to ease market fears that inflation could soon be stalking the economy after the recent spike in longer-dated government bond yields.

Government bond prices rallied after the Federal Reserve bought a bigger-than-expected amount of Treasury debt as part of a wider program to help keep interest rates down. Meanwhile, housing market data, including new and existing home sales have shown signs of bottoming in the slide, but the surge in mortgages rates following a spike in Treasury debt yields could hamper the sector's recovery.

Benchmark government bond yields jumped to an eight-month high last week on concerns the government's effort to pull the economy out of a 18-month old recession would push the country's budget deficit to unsustainable levels and undermine the value of its assets and ignite inflation.

While new housing starts rose on a monthly basis in May, they dived 45.2 percent compared to the same period a year ago, the Commerce Department said. New building permits rose 4.0 percent, the largest gain since June 2008, to 518,000 units in May, the Commerce Department reported.

The slower pace of increase in May producer prices was a relief for investors who of late have been preoccupied with inflation in the wake of the surge in government bond yields. When compared with the same period last year, producer prices fell 5.0 percent for the largest decline since August 1949, the Labor Department said.

Core producer prices, which exclude food and energy costs, dropped 0.1 percent in May compared with a forecast for a 0.1 percent rise, and after a 0.1 percent increase in April. This was the largest decline in monthly core producer prices since October 2006, when they fell 0.5 percent. In contrast with May 2008, core producer prices rose 3.0 percent. Gasoline prices rose 13.9 percent.

Another report from the Federal Reserve also suggested any worries about inflation as a result of aggressive programs by the U.S. central bank to boost the economy may be overblown.

Industrial production fell 1.1 percent in May, dragged down by declining vehicle output following auto plant shutdowns by mostly Chrysler, currently in bankruptcy to help it reorganize, and continued inventory cut backs by manufacturers. Production fell 0.7 percent in April. Capacity utilization, a measure of slack in the economy dipped to a record low 68.3 percent.

Best Buy Exceeds Expectations

Best Buy posted lower first-quarter earnings and weaker-than-expected sales on Tuesday and implied earnings for the rest of the year would be worse than forecast, dragging its shares down more than 7 percent.

The consumer electronics retailer said it gained market share after main rival Circuit City closed its doors. Still, fewer customers visited its U.S. stores in the quarter as consumers continue to cut back on discretionary purchases.

"I think consumers are careful. They're being very, very careful," President and CEO-designate Brian Dunn said in an interview.

Best Buy saw demand rise when Circuit City shut down but has also faced increased pressure from Wal-Mart Stores Inc and others adding laptop computers, flat-screen televisions and other products to their stores.

The company's lower profit still exceeded expectations and the news was good with respect to improvements in gross margin and market share gains. The sales weakness was a concern, especially since most of the quarter fell after Circuit City's liquidation sales. Nonetheless, Best Buy estimated that as of April 30 its domestic market share grew by nearly 2 percentage points from a year ago. However, sales of gaming items, digital cameras, appliances and movies fell, however.

According to Best Buy it earned $153 million, or 36 cents per share, in the fiscal first quarter ended on May 30, down from $179 million, or 43 cents per share, a year earlier. If you exclude restructuring charges, Best Buy said adjusted earnings fell to 42 cents per share from 43 cents per share.

Despite interest in new products such as Palm's Pre phone, Apple Inc's latest iPhones and the debut of Microsoft’s Windows 7 later this year, Best Buy maintained the expectations it issued in March.

The company still expects to earn $2.50 to $2.90 per share this year, with same-store sales flat to down 5 percent and total revenue of $46.5 billion to $48.5 billion.

First-quarter gross profit rose to 25.3 percent of revenue from 23.7 percent, aided by the inclusion of Best Buy Europe and a 70-basis-point increase in gross profit in the U.S. business, where Best Buy had better control over promotions and lower freight and logistics costs. Sales at stores open at least 14 months declined the most during May, which faced a tough comparison to a year earlier, when consumers spent government stimulus checks.