The Day Ahead: Spain on the Brain

 | Apr 19, 2012 | 8:33 AM EDT
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From the middle of last week the prospect of a full-fledged blowup at today's Spain debt auction has hung around like a nosy parent does on their child's FaceBook and Twitter pages. Corporate revenue and earnings beats be-gone, for a Spanish debt auction could confirm what we already know: a country with a eurozone high 23% unemployment rate will be fiscally troubled for a while to come. Of course, we don't know what the repercussions will be if Spain does require a bailout from its financially healthier neighbors; hence, the touch-and-go nature of the market. Characterizing trading as touch and go simply means that quality starts to the year, broadly speaking, are not being enshrined in valuations as they should. The mindset is this: Why downshift a risk-free rate assumption if a business garnering 30% of its annual revenues from Europe, but has commenced on the right foot this year, if a Spain debt auction goes bust and triggers domino effects? (I hate adding all these theatrics for you, but it's how the collective masses think.) Or, that is the very boring mental mechanics behind how my industry colleagues go about their business.

With that in mind, I think we are able to agree that when an event in the stock market is over hyped it will usually not live up to its billing, and some other event often swoops in from left field and steals the spotlight. Such a viewpoint could be applied to Apple's (AAPL) supposedly bleaker profit margin outlook from a device that is not on the market (and may never be); the event that could fly onto the radar screen is another mega earnings report from Apple that lends credence to Goldman Sachs' (GS) pre-earnings bullishness. However, that is a debate reserved for a different forum, for the timing being the surprise event of the day could be jobless claims.

It was only a week ago that jobless claims interestingly climbed by 13,000 as if to succinctly confirm the less than stellar March employment report. The data was explained away as seasonally driven, so there is little wiggle room to today's headline. A poor reading stands to raise another caution flag on the bullish expectation of employment gains reaccelerating and in the process, create an oddity before the Fed's pow-wow next week. The oddity would be a weakening trend of employment growth that seems to align with policy member views (namely Bernanke) and that doesn't spur further extraordinary easing (seeing as the weakening trend is not weak enough). Even that scenario would warrant a reconsideration of buying into the encouraging signs that have emerged from first quarter earnings season, and steady as she go forward-looking commentary.

Sidebar: Having gone straight down since peaking at 464,000 for the week-ended April 29, 2011, claims and the associated improvement in non-farm employment have surely been igniters of the post debt ceiling rally. Hearing trucker Werner (WERN) state that it's having difficulty finding skilled workers due to extended unemployment benefits and a lack of qualified truck driving school candidates , as well as "productivity gains" logged by companies in the first quarter, one really has to make a hard assessment on whether bullish forecasts on employment are warranted for this year. A "fiscal cliff" in 2013, and political risk in the fourth quarter, are considerations, too. Pull up a chart of payroll services firm ADP (ADP), it goes a long way in discrediting economist estimates (provided you are pro efficient markets person).

Word of the Day: Oddity

A large part of earnings season is finding common threads in the various reports. I noted yesterday that a rhythm to this earnings reporting period has been found, mostly in higher-than-expected global volumes, surprising pricing power, and productivity fueled margin expansion. There are also oddities in market land, which could develop into actual trends or prove to be nothing more than temporary phenomenon.

  • Saks (SKS) has a 27% short position, Tiffany (TIF) is 35% off its July 2011 52-week high, and American Express (AXP) logged a solid quarter of card member spending.
  • Analysts continue to pound the table on Lowe's (LOW) and Home Depot (HD), with a touch more bullishness being thrown to the former. These actions are happening with the names near 52-week highs. Housing starts and the NAHB Housing Market Index were disappointments this week. Who is right and who is wrong? My inclination is to use the analyst calls as contrarian indicators and remove some profits in each name if applicable. I have to get this off my chest. According to Thomson Reuters, Piper Jaffray has had a neutral rating on Home Depot since July 2009, and dating back to Nov. 14, 2011 on Lowe's. A neutral rating! I have watched this research inactivity for years, and find it in no way shape and form being in the spirit of research (which is to add value to the wealth building aspirations of clients through bold calls supported by granular, yet impactful, data). It's examples such as this why I believe equity research has much in common with Best Buy's (BBY) model (which is at risk of becoming obsolete).
  • Apparently consumers do not care about gas prices being above $4 a gallon, or so says the consensus. But the market says, "Hello! Wal-Mart (WMT) shares continue to climb." This is despite a weak profit margin outlook in my estimation, and in turn a function of the long held view of the stock as a countercyclical play: When gas prices go up, consumer spending goes down and people spend more at Wal-Mart).
  • Yum! Brands (YUM) killed it again with its sales in China, but unfortunately the segment's operating profit margin compressed 150 basis points (bps). Wage inflation of 17% was a key deterrent of greater revenue flow through. The China wage inflation problem fits well with Wal-Mart's margin outlook being weak (higher costs to receive supplies plus global investment in everyday low prices).

Be on the lookout for:

  • Snap-On's (SNA) earnings conference call today and any negative commentary on peripheral Europe (management has been negative, but I will be in search of a darker tone change) after Stanley Black & Decker's (SWK) "slower Europe" comment in its 8-k.
  • Decent bounces (qualified as hard snaps on a good bit of volume) for Terex (TEX) and Caterpillar (CAT). Tells on China's landing? At the very least, indicative of the European Union's (EU) better-than-expected February industrial production report.


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