By Joseph Hogue, CFA
The wait is over for a formalization of the 130 billion-euro aid package for Greece to avoid a default in March. Bloomberg reported today that the Greek government has found the extra cuts to bring spending down to $427 million and will be given the $173 billion aid package needed to avoid default. Though the euro was initially up over the news, it quickly pared gains over the realization that the country's problems may be far from over.
Optimism has been fairly high over the last couple of weeks that Greece will eventually win the support to avoid a March default. This optimism has been masking the fact that austerity measures alone will not pull the region out of crisis and there is not sufficient growth on the horizon to accomplish the task.
Of just as much importance to this week's markets is China's second cut of bank reserve ratio requirements in three months. In a move that may add an estimated $63 billion into the financial system, bank reserve ratios will be decreased by 50 basis points (0.5%) on the 24th of February. Talks of a 'hard landing' to the Asian economy have largely declined though the nation still faces considerable risk from an escalation of the European crisis.
Economic data out of the United States moderated a bit last week as retail sales came in under expectations and industrial production was flat over the month. Manufacturing is generally considered strong though as much of the disappointment in industrial production was due to weakness in utilities.
The danger comes from the light retail sales and lack of consumer participation in much of the recent strong economic data. Even as other parts of the economy, i.e. manufacturing and employment, have shown positive trends consumers have failed to increase spending at a commensurate rate. Up until now, the lack of increased spending has not been a problem as companies have managed to increase margins over the last couple of years and drive profits on cost cutting measures. Higher margins could come under pressure as companies become about as lean as possible but are unable to support high expectations through revenue increases.
There has also been talk of problems with seasonality in many of the releases over the last few months. One, historically temperate weather conditions have supported housing-related releases as builders and homebuyers have not been shut out by freezing weather. There is the risk that, without a fundamental change in the housing market, the strong building and sales over the winter may cannibalize activity in March and April.
Secondly, many have expressed doubts that the seasonal adjustment factors used in many reports are correctly showing activity. The historic drop-off in activity between November and March of 2008 caused models to build in an artificial weakness into data releases. As raw data comes in, the models adjust the estimate upwards to account for this seasonal weakness when in fact it was a business cycle weakness. When the upward adjustment comes off of estimates in March and April, the estimates may be much lower than trending data would suggest.
Without the support from positive earnings surprises, lighter economic data may lead to some profit-taking in late-February through March.
Still the U.S. economy looks on track to keep its wait-and-see growth rate of 2.0% for the year and there are sectors that will grow above-trend. Business equipment was again a stand out in the industrial production data as companies buy technology and industrial equipment to eke out remaining gains to productivity. International Business Machines (IBM) should continue to do well in this environment. The company beat expectations by $0.09 on January 19th to report fourth quarter earnings of $4.71 and full-year earnings of $13.49, a 16.5% increase over the prior four quarters.
Warm Weather a Problem for Apparel
According to the National Climate Data Center, January was the fourth warmest on record and continued the temperate winter seen in November and December. Warmer weather may translate to lower than expected sales for retailers like Columbia Sportswear (COLM). The outdoor apparel company reported strong fourth quarter results but analysts are only expecting $0.08 per share for the first quarter, a drop of 78% from the same period last year. The stock has been basically flat over the last six months but still trades for around 16.4 times trailing earnings.
Other apparel companies' shares may come under pressure as cold-weather inventory sits on shelves. VF Corporation (VF), maker of the popular North Face brand, reported fourth quarter estimates in-line with expectations on February 16th. The company's product line is more diversified than Columbia and analysts are expecting an increase in earnings of about 5.0% for the first quarter. The shares are one of the more expensive in the space, trading for 18.5 times trailing earnings and could come under pressure if consumers fail to increase spending or weather-related issues depress sales.
Economic Week Ahead
Housing-related stocks may again get a boost as momentum and warm weather boost existing sales on Wednesday and new sales on Friday. Existing sales have increased four out of the last five months and are up 3.6% over last year. December sales came in at 4.61 million with expectations for January to be slightly higher at 4.65 million. Still, much of the activity is in the distressed market and prices have not yet halted their downward trajectory. Home improvement retailers continue to be the investment of choice as the distressed purchases require a significant amount of work and homebuyers still on the sidelines must spend to upkeep their own homes.
Home Depot (HD) will report earnings before the market opens on the 21st and is expected to show $0.42 per share net income, an increase of 16.6% over the same period last year. The $72 billion home improvement retailer trades at a lofty 20.0 times trailing earnings but should continue to see strong sales through the next couple of years.
New home sales on Friday are expected to show an uptick as well to 315,000 from December's 307,000 report. Despite a weak 2011, builder confidence has increased for five consecutive months and is now the highest in five years.
Initial jobless claims on Thursday should show another week of momentum in the labor market. Claims have come in under the 400k threshold for 13 of the last 15 weeks and were the lowest since March of 2008 last week. Structural issues may persist over the remainder of the year, but there is little doubt that employment has begun its slow climb upwards for the cycle.
Shares of Monster Worldwide (MWW) had been doing well versus the general market until an unfavorable earnings report sent the stock down about 20% on January 26th. The shares are trading down around lows not seen since March 2009 but still sell for about 18.3 times trailing earnings. Though competition is increasing from other sites, the rebound in the job market combined with lowered expectations may help to support the shares through the rest of the year.
Tuesday could present a strong day for the markets if the Eurozone PMI numbers can manage to remain above the 50.0 index number used to signal growth. Some pressure on the European financial markets has eased recently with sovereign bond yields decreasing slightly and news of a Greek deal. While fourth quarter GDP was negative for everyone but France, the services index managed to post a reading of 50.4 last month. Another reading above 50.0 could give renewed momentum behind the recovery efforts.