Jubak's Journal
Recent articles:
• A hero for speculators: Davy Crockett, 8/16/2005
• Don't trust us with Social Security accounts, 8/9/2005
• 5 energy bill winners, 8/8/2005
More...
| | Jubak's Journal
3 picks for the dog days of summer
Gloomy investors worry about housing, energy costs and global growth. Here are three companies that should sidestep the real culprit -- a squeeze on profits.
By Jim Jubak
What is it about August that turns investors so pessimistic? Maybe it's the heat and humidity that turns even sweet-tempered New York traders into cranky naysayers. Or maybe it's just the knowledge that stocks are facing the normally treacherous months of September and October.
Whatever the cause, the stock market is spending these late August dog days worrying that the housing market has started to crack, that consumer spending is starting to slow, that demand from China is starting to slacken and that higher energy prices are finally taking a bite out of the economy.
On most recent days that has added up to falling stock prices on fear that the economy as a whole is about to slump.
I think stocks -- most stocks -- do face a problem for the rest of 2005. But the real problem, despite the markets' August pessimism, is not slower general economic growth. Growth, in fact, looks fine to me. The U.S. economy is likely to turn in third-quarter growth of 4% to 5% and is about to get some help from Germany and Japan in pulling the global economy. And wealthier consumers in the United States continue to spend at an impressive pace.
No, the problem is the profit squeeze that will keep most stocks treading water for the rest of 2005. I've got a thought or two -- and three picks -- for working around that problem. But before you can implement that strategy, I think you need to understand the real problem.
Related news and commentary on MSN Money
Let's take a closer look at what's been worrying the stock market about the economy in August.
The housing market stalls -- or does it?
On Aug. 23, the National Association of Realtors reported a 2.6% drop in sales of existing homes. That followed news from the Mortgage Bankers Association of a 2.2% decline in mortgage applications for purchase. Sure looked like evidence that the housing boom was in danger of stalling.
And then came the report on Aug. 24 from the U.S. Commerce Department that sales of new single-family homes had increased in July by 2% to a seasonally adjusted annual rate of 1.41 million. Economists had projected that sales would fall by 3.1% in July. The inventory of new homes on the market fell to a four-month supply in July from a 4.1 month supply in June.
The truth is that you can't really find any trend -- either up or down -- in these numbers because the changes reported are all within the margin of error in the data survey. Investors can't know if they're seeing the beginning of a trend, or simply a random change that results from how the data was collected that month. All we can reasonably conclude is that housing sales remain at historically strong levels and that, for the moment, the boom remains intact.
Historically, it has taken mortgage rates at 7% or above to put an end to a housing boom. We're a long way from that level. The average rate on a 30-year fixed mortgage was just 5.7% in July, up from 5.58% in June but below the 6.06% rate of July 2004.
Consumers are cutting back on spending -- or are they?
On Aug. 16 Wal-Mart Stores (WMT, news, msgs) beat Wall Street earnings estimates for the company's second quarter but warned that higher gas prices are hurting its core, lower-income customers. The company cut its projected earnings-growth rate. A few days later, on Aug. 24, Wal-Mart competitor Dollar Tree Stores (DLTR, news, msgs) said it, too, believed higher gas prices were reducing its customers' shopping trips. Dollar Tree Stores told Wall Street to expect third quarter earnings of 28 cents to 31 cents per share, below the Wall Street consensus estimate of 31 cents. Sure sounds like the consumer is cutting back.
Or maybe it's just the lower-income consumer with less discretionary income who is feeling the full effect of higher energy prices. On Aug. 24, Coach (COH, news, msgs), a retailer serving what I'd call the high end of the middle market, told Wall Street that sales for the September quarter were running ahead of expectations. The company projected earnings per share of "at least" 25 cents a share, a penny above the Wall Street consensus estimate.
The truth is that higher energy prices continue to play out in very unequal ways across the economy. Higher prices at the gas pump are hurting some consumers while others are absorbing the increases without significant changes in behavior. Some companies are muddling though by finding ways to cut energy consumption or by passing higher costs along to customers. Others, such as the airlines, are being savaged by higher fuel costs. At some point, higher energy prices may send the economy as a whole into a slump, but it doesn't look like we're at that point yet.
Bottlenecks in China are slowing global growth -- or are they?
No doubt about it, China's economy is paying the price for recent unbalanced growth. For example, Chinese demand for steel increased at an annual rate of 10% in the last half of 2004 and the first quarter of 2005. China's steel supply, however, has been growing at a rate of about 20% annually, as Chinese banks provided a flood of easy capital to current and would-be steelmakers. That's led to a round of price cuts, including a recent 15% price reduction by Baosteel, China's largest steelmaker.
And you can see signs that the relentless, China-driven pressure on commodity prices might be easing. Copper inventories on the London Metal Exchange have climbed to a nine-month high, for example.
But, as always, any data about China should regarded with extreme skepticism. No one knows the real level of steel demand in China. Rising copper inventories, some metal traders believe, have less to do with falling demand from China -- they say it has been stable -- than with falling demand from U.S. homebuilders who have cut their use of the metal because of the high cost.
It's increasingly likely that global economic growth will be less dependent on China (and on the United States) over the next year than it was over the last 12 months. And that's because there's increasing evidence that both the Japanese and German economies are entering periods of real growth.
The latest quarterly figures from Japan show a third straight quarter of economic growth. True, the most recent growth rate comes out to just an annualized 1.1%, but that's still a big pick-up from the mid-2004 slump. And it comes with encouraging jumps in exports, up 2.8% from the March quarter, and in domestic private consumption, up 0.7% from the March quarter.
The good news from Germany is much more rudimentary, and any recovery there could still be undone by the coming election. But German labor costs are now below those in France and Italy, thanks to creative cost-cutting by some of the country's biggest exporters. Last year, the country regained its title as the world's biggest exporter. Growth in Germany is projected to drop to just 1% in 2005, but to pick up to 1.6% in 2006. Even that uptick would be welcome, and there's a good chance that growth could come in stronger than current projections.
|
