MarketView for May 17

 

Summary 

 

The Dow Jones industrial average and the S&P 500 indexes fell for a third day on Tuesday after disappointing figures from Wal-Mart and Hewlett-Packard, although a late rebound suggested investors may be looking for a short-term bounce. Both the S&P 500 and Nasdaq dipped below their 50-day moving averages, but those levels appeared to bring in buying interest.

 

Recent weakness in sectors tied to economic growth and the sharp decline in commodities have spurred talk of a prolonged pullback. Short-term traders see an opportunity, judging by late gains in certain energy names and financials' strong performance on Tuesday.

 

Lately investor concern has centered around lackluster economic figures. Wal-Mart Stores Inc reported that same-store sales have now fallen for two years. Wal-Mart's stock fell 0.9 percent to $55.54.

 

HP, the world's largest technology company watched as its share price fell 7.3 percent to $36.91 after the company reduced its forecast due to problems stemming from Japan's earthquake and soft PC sales. In addition, both housing data and industrial production slowed, adding to evidence that the economy is hitting a soft patch. Meanwhile, trading action was volatile as stocks fluctuated with currency and commodity prices.

 

Tech stocks fell as investors sold recent winners due to unease about pockets of weakness in the economy. The PHLX semiconductor index .fell 1.2 percent.

 

Some analysts have pointed to oversold conditions in the stock market's cyclical areas such as energy, materials and industrials, which they say are primed for a short-term bounce. However, caution dominated much of the day's trading with the S&P's industrial sector index down 1.3 percent, pressured by Caterpillar, which fell 3.8 percent to $102.08. At the same time, financial stocks were higher by and large.

 

Housing starts and permits for future home construction fell in April, pointing to prolonged weakness in the housing sector while the Federal Reserve reported factory output slumped in April as an automobile parts shortage hurt production. Weyerhaeuser lost 2.9 percent to $21.50.

 

Commodity-related stocks also lagged as the dollar rose on concerns about a Greek debt restructuring. A stronger dollar reduces the appeal of dollar-priced commodities, which become relatively more expensive. Worry over European sovereign debt is giving investors a reason to make a flight to safety to the dollar.

 

Shares of defensive companies continued to outperform. The S&P utilities sector's index rose 0.7 percent, with help from a 3 percent gain in the shares of American Electric Power to $38.85.

 

Economy Still Has A Ways to Go

 

Factory output slipped for the first time in 10 months in April as a shortage of parts from Japan crimped activity and home building slumped, showing the economy got off to a weak start in the second quarter. Signs of lackluster economic activity were also evident in declining sales at Wal-Mart Stores, which said its customers were still living from paycheck to paycheck. Home Depot also reported a drop in sales while Hewlett-Packard cut its 2011 profit forecast.

 

Nonetheless, I am cautiously optimistic the economy will regain speed this quarter. Nonetheless, economic growth slowed to a 1.8 percent annual pace in the January-March period, leaving some analysts to doubt that growth will pick back up to an annualized rate of 3.0 percent.

 

Manufacturing output fell 0.4 percent, breaking nine straight months of gains, as supply disruptions from Japan's earthquake hit auto production, the Federal Reserve said. Overall industrial production was flat, with gains in mining and utilities offsetting the drop in factory output. Excluding cars and parts, manufacturing output rose a sluggish 0.2 percent.

 

A separate report from the Commerce Department showed groundbreaking for new housing dropped 10.6 percent to an annual rate of 523,000 units as a glut of homes on the market discouraged new projects. Though March's housing starts were revised up substantially, it was not enough to soften the blow from last month's drop. Tornadoes that lashed parts of the country last month were partly to blame for the drop. Starts in the tornado-ravaged South slumped to a two-year low.

 

Hopes are high that gasoline prices will fall and the nascent labor market recovery will strengthen enough to boost consumer spending and therefore economic growth. However, Wal-Mart said its domestic sales fell in the February-to-April quarter, adding it continued to see a paycheck cycle, where people stock up around payday and then spend less as money runs out.

 

Manufacturing has been leading the recovery and it is expected to bounce back as auto supply disruptions fade. Housing, however, is a different matter. Construction is being crowded out by an oversupply of homes and in particular foreclosed properties that sell well below their value.

 

In March, the spread between the prices of new and previously owned houses was about $54,200, indicating used homes are selling well below the cost of construction. A spread of between $20,000 and $30,000 is generally viewed as ideal.

 

A report on Monday showed that while builders expected a modest improvement in sales during spring, they anticipate market conditions to weaken in the next six months. There are likely between 8 million and 9 million homes on the market, including the so-called shadow inventory -- foreclosed properties and those that are about to be repossessed by banks.

 

The weight on the economy will be limited, however, since residential construction only accounts for about 2.2 percent of gross domestic product. In addition, with the labor market showing signs of life, a slight improvement as the year progresses is possible. A similar outlook was shared by Home Depot, which raised its profit forecast for the year despite a slow start to the spring selling season.

 

Groundbreaking last month was depressed by a 24.1 percent tumble in the volatile multi-family homes sector, where starts for buildings with five or more units dropped 28.3 percent. Single-family home construction fell 5.1 percent. Permits for future home construction dropped 4.0 percent to a 551,000-unit pace last month. They were held down by an 8.8 percent drop in the multi-family segment. Permits to build single-family homes slipped 1.8 percent.

 

Hewlett-Packard Disappoints

 

Hewlett-Packard reduced its 2011 profit forecast as it prepares to spend heavily to revamp a troubled division that provides everything from computer maintenance to high-level tech consulting, sending its shares down more than 7 percent. Chief Executive Leo Apotheker, who took the helm in September, blamed the division's "missed opportunities" under his predecessor Mark Hurd and vowed on Tuesday to revamp the division to focus on consulting, cloud computing and higher-margin businesses, moving away from less-profitable endeavors like maintenance.

 

HP also trimmed its sales forecast for the second straight quarter, sending its shares to their lowest level since June 2009, wiping out about $7 billion in market value. The latest revision, the second since Apotheker took over seven months ago, raised questions about the former SAP CEO's ability to spark growth at the technology behemoth.

 

Several Wall Street investment houses, including Credit Suisse and Barclays, responded to the results by lowering their recommendations or price targets on the stock.

 

The expansion in services comes as the global PC industry is under siege from the growing popularity of mobile devices such as Apple's iPad. Investors will get more insight on the weakening demand for PCs in Dell’s quarterly report.

 

HP's sales of PCs and other devices slid 5 percent in the second quarter to $9.4 billion. Consumer PC sales in particular dived 20 percent -- greater than the company anticipated. The sluggish industry-wide consumer PC market plus the lingering supply impact of Japan's earthquake are expected to hurt the world's largest technology company's profits for the rest of the year.

 

Apotheker indirectly blamed the services unit's problems on Hurd, who left the company in August amid allegations of sexual harassment. HP acquired the division when it bought Electronic Data Systems in 2008 -- a major initiative spearheaded by Hurd -- adding services ranging from help-desk support for PCs to advising corporations on rebuilding data centers to take advantage of new "cloud computing" technologies.

 

Cloud computing refers to the use of Web-based servers to deliver services to large businesses and organizations. Apotheker said that business failed to expand quickly enough into more profitable services such as consulting, where it vies with IBM and Oracle.

 

In a signal that HP intends a serious expansion of the services division, Apotheker stripped the group's previous manager of responsibility and put the arm under the direct control of HP veteran Ann Livermore -- who heads up the enterprise division -- until a new chief can be found. He also plans to hire more people to shore up consulting.

 

Apotheker wants to boost earnings by pushing into sectors such as cloud computing, which for HP involves helping companies to revamp their data centers. Investors are looking for signs of progress on that strategy.

 

The spending on services may have to be offset by tight cost control elsewhere. It comes as HP grapples with newfound competition in the server market from Cisco and Oracle, lukewarm consumer spending on PCs, and the expansion into cloud computing.

 

"We will manage our costs very prudently ..., including our salary costs," Apotheker said. "We want to create enough resources to expand our business." The company is not planning any job cuts but will watch its headcount, he added.

 

HP cut its outlook for full-year profit, excluding items, to "at least $5.00 per share" from a previous $5.20 to $5.28. It also cut its full year revenue outlook to $129 billion to $130 billion from a previous $130 billion to $131.5 billion.

 

Revenue in the fiscal second quarter ended April 30 rose to $31.63 billion, up 3 percent from the previous year and slightly above the average estimate of $31.52 billion. Strength in the quarter was driven by its commercial and enterprise divisions as businesses continued to spend on technology. The company reported net income of $2.3 billion, or $1.05 a share, up from $2.2 billion, or 91 cents a share, a year earlier. Excluding items, HP earned $1.24 a share.