Day Ahead: Bottoms Up?

 | Jul 05, 2012 | 7:38 AM EDT
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For most of the July 4 holiday I was trying to put a finger on what the market has been whispering to me on a daily basis. While cooking a slab of beef on the barbie there was a slight epiphany that maybe, just maybe, the market has begun to price in a mid-year reacceleration in U.S. growth, less severe Eurozone economic readings from any country not named Germany and a pleasant surprise on China in that its rate of expansion confounds the increasing number of worry warts.

Then, amidst the chucking of rather dangerously lit mortars into a friend's metal garbage can, a deeper thought presented itself that perhaps the market isn't even concerned with six months removed from today, it's content to climb the non-technically-existent wall of worry until it decides to focus on fundamentals.

But it was the final flurry of thoughts upon driving home smelling like burnt fuses of products sourced from China that were the most inspirational.

Deranged market: The market has become completely unmoored from fundamental realities. Yes, the European lovie-dovie news has stuck longer than many, including me, believed. But does that banding together only in the verbal sense truly alter the material sources of weakness in corporate financials caused by a previous six months of international high stakes drama? Bottoms-up analysis fans will be ripping their hair out this earnings season because individual companies doing things correctly (which is what bottoms up analysis is about, finding winners in a sector and forgetting the macro) will have a macro influence in the numbers that is impossible to measure. Pure bottoms-up people have to respect the macro to a certain extent, they have to.  For example, Nike (NKE) is usually a bottoms-up analyst's dream, given a leading-edge product suite and strong market positions globally. But those ingrained positives are being undercut by a management team reluctant to share what portions of China are slowing (tier one, two, three) and the precise reasons for dread in certain European markets.

Color me a skeptic on this rally. The market is doing its best to find its identity, continuing to embrace one package of news (eurozone not splitting, for now, and China being supported by rate cuts) but not yet willing to acknowledge the fundamental negatives that stand to rip its face off. That said, even a strategic skeptic such as myself would be a dope not to recognize that a newsflow rally could be sustained near-term after months of hell-in-a-handbasket headlines.  People are still mostly positioned short the market and a win/win trading environment has formed. Europe downtrending and below-consensus data supported by promises of governments to work together, any downside surprise to China is met with talk of rate cuts and any more ISM type reports in the U.S., including the looming jobs tally just brings the Fed in for a tighter hug. It's as if the market has built in mental crutches to anything negative that may materialize. Scary stuff, but playable stuff (I will attack with the truckers, like Swift (SFY), or oilfield services, like Ensco (ESV), which have perked up of late, have intriguing valuation and a good yield).

Boooo on Costco

Should you own Costco (COST), having jumped on the near-term rally, use today's June same-store sales report to lighten the load. For those interested bystanders, cool your jets. Here is why I am not digging Costco's numbers:

  1. Total sales by category likely to undercut bull thesis that Costco's earnings have significant upside potential as inflation retreats. The thinking has been on Costco that its profit margins would benefit as it holds prices a little longer with costs of merchandise moderating.
  2. The overall trends in the business tell me the membership fee increase has impacted Costco.
  3. Core sales, which exclude gas and currency and adjusting for calendar variances, were weak and indicative of pressured market share (BJ's Wholesale doing a great job with new member acquisitions).
  4. U.S. comp in June was cycling an easy two-year stacked comparison. In English, the year-ago performance was soft, meaning this month had to be better due solely from a numbers standpoint/inflation, etc.
  5. July 4 calendar shift or not, member traffic was dissapointing, a rarity for Costco. With the decline in gas prices, members may be filling up less at Costco and foregoing the extra park-and-shop moment.

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