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Will Second Quarter Earnings Matter?

Economists have gotten more optimistic over the past month. Bloomberg reported that in its latest poll economists expect GDP growth of 3.5% this quarter and 3.4% in the final quarter of the year. Both of these estimates are 10 basis points higher than the survey conducted a month ago. Economists also expect the Federal Reserve to boost interest rates to 4.0% by the end of the year compared to 3.75 previously. While expectations for short-term rates increased, economists lowered their prediction for long-term interest rates. Ten-year Treasury yields are expected to rise to 4.5% at the end of the year compared to 4.6% in the previous survey. This is likely explained by lower inflation expectations. Economists expect consumer prices to increase 2.7%, down slightly from 2.8% last month. These results are similar to the latest survey from the Blue Chip Economic Indicators. The one difference was that in the Blue Chip survey, economists expect inflation to be 3.0% this year. Economists are also mixed on the outlook for oil prices. Forty-one per cent of the economists expect oil to reach $90 per barrel before $30. The remaining 59% expect oil to hit $30 per barrel first.

Nonfarm payrolls increased by 146,000 in June. This was lower than the 200,000 increase economists forecasted. Making up about half the difference was the revision of May's employment report showing that 104,000 jobs were created rather than 78,000 as initially reported. The unemployment rate dropped to 5.0% from 5.1% in May. Additionally, the average duration of unemployment dropped to 17.1 weeks from 18.8 last month. This was the shortest length since August 2002 and was as high at 20.2 weeks in February 2004.

Retail sales have been erratic this year with poor weather being blamed, especially in May. Analysts were expecting retail sales to be the strong, the International Council of Shopping Centers (ICSC) forecasted same store sale would increase 4.5% in June. In fact, same store sales jumped 5.2%, which was the strongest year-over-year growth since May 2004. Strength was broad based. Seventy-percent of the retailers tracked by First Call either met or surpassed analysts' estimates for same store sales in June.

According to CSFB's Comparable-Store Sales Index, general merchandisers increased sales by 5.4% led by 9% increases at Target and Costco. Department stores experienced their best month since March 2004. Department stores grew sales by 5.6%. Kohl's led the pack, up 14.4%. Neiman Marcus and Nordstrom posted solid 9.2% and 8.1% gains respectively. Overall the specialty apparel retailers increased sales by 5.0%. Abercrombie & Fitch increased same store sales by 38% in June, which was the seventh consecutive month of double-digit gains. American Eagle Outfitters and Bebe were two other retailers that had impressive results. American Eagle grew sales by 28.0% and Bebe by 31.4%. The two notable laggards were AnnTaylor and Hot Topic, both of which have had more negative same store sales than gains over the past year.

Alcoa was the first company in the Dow Jones Industrial Average to report second quarter earnings. The world's largest aluminum producer said that second quarter earnings were $0.46 per share excluding some items. This was a penny better than analysts' estimates, but a penny lower than last year. Revenue increased by 8%. Prices and volume were stronger for alumina, but prices were weaker in its primary metals business. Alumina prices rose 4% while primary metals prices fell 3%. The company said that current prices are substantially lower than the average price in the second quarter. The company is aggressively managing costs and plans to eliminate 6% of its workforce over the next year.

Gannett reported second quarter results that just met analysts' forecasts and were 5% higher than last year. Traditional media companies have been under pressure over the past couple of years. Advertising dollars have been shifting away from the traditional outlets such as television and newspaper to the internet. Additionally, costs are rising much faster than revenues. Gannett reported that newsprint costs were up 7.2% driven by a 10% increase in price and mitigated by a 2.5% decline in volume. The one bright spot has been local advertising. While national adverting has been weak for several quarters, local has grown. Overall ad revenue increased 2.5% during the second quarter. Consumer electronics, health, financial and telecommunications were strong, while department stores, furniture, entertainment, restaurants, and home improvement trailed last year's results. Employment advertising was especially strong. Overall employment classified revenue increased 17%. Over half of its newspapers had employment revenue ahead of last June, with about 38% of its markets having double-digit gains. The strength was split geographically. The West and South had double-digit gains, while the central part of the country and the East lagged last year's results. Reflecting the weaker national market, ad revenue at USA Today was down 1% and was very choppy during the quarter; down 4% in April, up 8% in May and down 8% in June. Management said that advertisers are waiting until the last minute before purchasing advertising space and that makes it very difficult to manage the business. Television advertising is performing even worse. Broadcast revenues declined almost 8% compared to last year due to the heavy political ad spending last year. On the conference call the company said that the political spending usually crowds out the traditional advertisers during the campaign and that they come back after the election. So far that has not happened.

Apple Computer reported second quarter earnings of $0.37 per share compared to $0.08 per share last year. Second quarter earnings were seven cents higher than analysts' estimates and was the seventh consecutive quarter of surpassing expectations. Sales increased 75% driven by iPod sales, which were up 616%. Macintosh sales increased 35%.

Earnings season has just started. Analysts and investors are anticipating companies reporting better earnings and favorable guidance. While earnings estimates have declined for the second quarter over the past three months, estimates for the third and fourth quarters have gotten better. Everyone has already concluded that the economy suffered and got through a "soft patch." Instead of focusing on second quarter results, investors will be much more interested in the outlook for the second half of the year. Two other important items to watch for will be if raw materials and other costs have moderated and what companies have pricing power. Speaking of pricing power, M.D.C. Holdings, one of the ten largest homebuilders by market capitalization, just announced that earnings per share jumped 20% in the second quarter on a 20% increase in revenue. The number of closings increased 14% and average price increased 5%.

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