(Barron's)
The Trader: Jobs Report Sends Dow To Six-Year High Equity
investors got everything they were hoping for last week: strong earnings results
and an employment report weak enough to keep the Federal Reserve from raising
rates after this week's meeting, but strong enough to ensure the economy grows
nicely. The news sent the Dow Jones Industrial Average to a six-year high
of 11,577.74 after a 138.88-point gain on Friday that capped a 1.9% rise on
the week. The index notched its third-highest close ever and now stands within
150 points of its all-time high of 11,722.98, hit in January 2000. Likewise,
the S&P 500 added 15.15 points on the week to close at 1325.76, and Nasdaq
tacked on 20 points for a 2342.57 close. Lots of excitement was created
by the Labor Department's report on Friday that employers added 138,000 jobs
to payrolls in April and the unemployment rate remained at 4.7%. The jobs added
were less than the 200,000 economists expected. "The market loved
the employment number because it believes the Fed doesn't have to be aggressive
going forward," says Peter Zuleba, a senior portfolio manager at Glenmede
Trust. The Fed is expected to raise the federal-funds rate one more time this
Wednesday to 5%, before pausing. The news helped interest-rate-sensitive sectors,
like financials, utilities and home builders, rally on Friday. The employment
news arrived at the end of a week filled with strong earnings reports. Through
Friday, 423 companies in the S&P 500 had reported earnings that were up
14% on average in the first quarter, according to Thomson Financial. That result
is better than the 12.6% expected on April 1. Of those reporting, 67% beat
expectations, 16% matched and 17% missed, which is better than the long-term
averages of 59%, 21% and 20%. For the full year, analysts hope earnings will
grow by 13.3%. The positive events of the week were more than enough to offset
the negatives: a declining dollar and high oil prices. The dollar fell to a
one-year low against the euro by Friday's close and is down 7% so far this
year. Crude oil managed to pop back over the $70 barrier on Friday. But the
market chose not to care. While the 8% year-to-date gain in the Dow and
the 6.2% return in both the S&P 500 and Nasdaq are certainly impressive,
they pale next to certain segments of the market. The Russell 2000, which hit
an all-time high on Friday, has made its investors 16% richer in just the past
four months, and the once stodgy Dow Jones Transportation Index -- also at
an all-time high on Friday -- has gained 18% year-to-date. Picking the
right stocks has been even more fruitful. Those lucky -- or wise -- enough
to have purchased Caterpillar (ticker: CAT) at the turn of the year have enjoyed
a 38% gain, while Boeing (BA) has returned 26% and Alcoa (AA) gained 18%. The
leaders list in the S&P 500 has a similar industrial feel: Allegheny Technologies
(ATI) has risen 108% since Jan. 1 and Nucor (NUE) is up 75%. Commodities
continue to shine, as well. Gold is up 32%. And silver, which has jumped 56%
this year, would return more than 150% on an annual basis if its gains continued
at the current pace. The sharp moves have many value investors who loved these
names three and four years ago when they were ignored by the masses saying
the market feels much like it did in 1999 before the technology market bubble
popped. Shares of both Microsoft (MSFT) and Google (GOOG) have underperformed
since the former kicked off the equivalent of an arms war in the world of Internet search.
Last week Microsoft shares fell 35 cents to 23.80, down from 27.25, where they
it stood before the company's earnings report in late April. Likewise, Google
shares, at 394.30, were down 23.64 on the week, or 5.7%, and have slid 46 points
since late April. But they remain above 360, where they stood when we penned
a skeptical piece earlier this year ("In the Drink," Feb. 13, 2006).
Last week, at a meeting with online advertisers, Microsoft said it will double research
and development spending on its MSN network to $1.1 billion in fiscal 2007,
up from $500 million in fiscal 2005. The tech giant also plans to increase capital
spending to $500 million in 2007 from $100 million in fiscal 2005. Microsoft
is surely hoping the surge in spending will boost its 13.2% market share in
search, which is well behind Google's 42.7% share. Both industry titans can
finance a battle for quite some time. Microsoft has a $33.5 billion cash hoard
and Google's is $8.4 billion. "Microsoft is willing to sacrifice short-term
profits to turn up the heat on Google. The big kahuna is coming into the [search]
market in a bit way," says Fred Hickey, editor of the High Tech Strategist
newsletter. "Google can't afford to lose any market share because its
stock is priced for perfection." In the short-term, all this spending
could continue hurting both stocks. Procter & Gamble (PG) handed investors
one of their few disappointments last week. While the company's earnings rose
7% to $2.21 billion, or 63 cents a share, beating estimates of 61 cents a share,
investors instead focused on net sales that rose to $17.25 billion, missing
analysts' target of $17.6 billion. The personal-care company also gave an earnings
range of 52 to 54 cents a share for its fiscal fourth quarter ending June 30,
below the 55 cents expected. The news ignited fears that Cincinnati-based
P&G's acquisition of Gillette would nick its performance. Gillette's razor
and blade sales rose only 1.2% in the quarter and sales in the Duracell/Braun
segments declined 0.7%. By week's end, P&G shares had fallen to 55.73,
down 2.48 on the week and 11% from their 52-week high of 62.50. Before
washing their hands of the company, investors should realize that inventory
reductions at Wal-Mart Stores (WMT) hurt total P&G sales by an estimated
1.5 percentage points, William Pecoriello of Morgan Stanley says. The razor
category faced tough comparisons in Western Europe, where M3 Power was introduced
last year. Sales also were dragged down by P&G inventory reductions in
the emerging markets. Meanwhile, investors overlooked some of the good news
in the earnings report. Procter & Gamble has been able to boost prices
to offset increases in commodity costs, and gross profit margin expanded by
1.1 percentage points. Also, the operating margin grew 1.7 points, thanks to
savings from the merger, volume leverage and some reduced spending on marketing.
The company should enjoy organic top-line growth of 5% to 7%, lower than
the 8% it has seen in the past three years but nothing to whine about, either.
P&G has said it plans to achieve $1.2 billion of cost savings from the
Gillette merger, and its internal forecasts are even higher at $1.5 billion,
says Bill Schmitz, an analyst at Deutsche Bank Securities. Meanwhile, the company's
market share is up in two-thirds of the categories in which it competes.
"The stock is the cheapest in the household group, with some of the fastest top-
and bottom-line growth," says Schmitz, who has a Buy recommendation and a 68
price target on the stock. The company's 10-year average multiple is 19.5, and
it currently trades for 17 times expectations of $3.27 a share in earnings for
the 2007 calendar year. Barron's thought the stock looked interesting last
summer ("A Beauty!" Aug. 22, 2005), with the shares trading at 54,
and our view hasn't changed. Friday's underwhelming jobs report, and resulting
hopes that the Federal Reserve would raise interest rates only once more in
the current cycle, sent home builders' shares soaring in the week's final session,
after four days of miserable news for the sector. Toll Brothers (TOL)
shares climbed more than 4% to 30.85 Friday, despite the company's report that
orders declined 32% in the fiscal second quarter, ended April 30, following
a 29% decline in first-quarter orders. The stock was down 4% on the week, however,
and has just about been halved since last summer's high. Shares of Hovnanian
Enterprises (HOV) followed a similar pattern. The stock climbed 4% Friday to
36.76, but was down 7.6% over the five days and is well off its high of 73.40
last summer. Early last week the home builder cut guidance for its second quarter,
ended April 30, to $1.40 to $1.50 a share, down from $1.55 to $1.80. Full-year
estimates also were reduced to $7.20 to $7.40 a share, from $8.05 to $8.40.
And, like Toll, Hovnanian's orders dropped -- by 20% in the second quarter.
In another sign of a potential slowdown, privately held ACC Capital Holdings, which
owns subprime-mortgage-lender Ameriquest, said it will cut 3,800 jobs and close
229 branches. The company said the move was in response to challenging conditions
in the market and the increasing number of people shopping online and over
the phone for mortgages instead of walking into branches. While the weakness
in the housing sector might have been lost on an ebullient stock market, which
instead focused on lagging economic indicators such as construction spending
(up 0.9% in March) and new-home sales (up 13.8% in March), we'd suggest studying
forward-looking indicators. These include mortgage applications, tracked by
the Mortgage Bankers Association, which rose last week by 11.3%, to 433.3,
but remain unsettlingly close to the previous week's level of 389.4. That's
the lowest reading since November 2003. The pending-home-sales index compiled
by the National Association of Realtors tells a similar tale. Based on home-sales
contracts signed, the index eased by 1.2% in March to 116.2, and is 10% below
its August peak.
Bulls hope the slowdown in housing mirrors what happened in 1995, when the increase
in prices lessened but prices never declined and a recession didn't ensue.
So, while Bruce Kasman, head of economic research at JPMorgan Chase, is calling
for total home sales to fall 15% this year and 5% next year, he doesn't expect
housing prices on average to fall. Prices in certain over-extended markets,
such as those on the coasts, are likely to see price declines, however. Housing
will drag economic growth down to 3% but not into a recession, he predicts,
because the Fed isn't yet restrictive. But the housing sector seems a bit
like the proverbial canary in the coal mine and could well be sending a signal
the broader market is ignoring. Douglas Cliggott, chief investment officer
at Race Point Asset Management, a hedge fund, notes that residential investment
stands at 6% of gross domestic product, much higher than the 4.5% level in
1995 and almost double the trough of 3.3% in '91. Housing's contribution to
GDP hasn't been this high since the 1950s, and is well above the 4.7% average
over the past 50 years. Any continued slowdown is sure to mean job losses,
not just among real- estate brokers but also in the mortgage-finance industry.
Then there are the ripple effects from a real-estate slowdown, whether they
be a decrease in advertising spent to hawk homes, or the reduction of legal
or title fees reaped at closings. Fewer dollars will be spent to fix homes
in preparation of a sale or in the wake of a purchase. So,
while a housing slowdown doesn't guarantee a recession, it certainly increases
the risk, says Cliggott. |
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