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The Problem With Modern Monetary Theory

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Modern monetary theory has been…

Market Sentiment At Its Lowest In 10 Months

Market Sentiment At Its Lowest In 10 Months

Stocks sold off last week…

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Pillars of Support: Consumers and Short Stocks


With the third quarter winding down, several companies with off calendar year-ends announced earnings this week along with companies updating their guidance for the current quarter.

Rohm and Hass exemplified what I discussed last week. When it upgraded it guidance this week the specialty materials company noted, "We continue to see some improvement in the macro-economic environment. However, the industrial sector remains weak, and this lack of a broad-based economic recovery is affecting our revenue growth."

Last week, a few newspapers announced that advertising revenue fell during the latest quarter. Ironically, this came at the same time as media consultants increased their forecasts for advertising spending. On Wednesday, Viacom announced that "while the economic recovery has translated into robust national advertising sales growth, the pace of the recovery in local advertising markets going into the fourth quarter is not as rapid as had been anticipated."

The anemic health of the commercial construction sector caused A.O. Smith to dramatically lower guidance for the third quarter. Instead of earning around $0.44 per share this quarter, it will only earn about $0.19 per share.

Steelcase, one of the leading office furniture makers, offered some hope to those looking for a turnaround in business spending. While the company reported revenues that were down 8%, it did say, "we are seeing some signs that business capital spending is finally beginning to recover in the United States." This compares to last year's remarks that were very down trodden; "Our outlook is consistent with recent economic reports suggesting that North American business capital spending stalled in August, as corporate bankruptcies, accounting issues and a falling stock market reduced business confidence. Leading indicators in our business, such as order rates and bid activity point to a likely double dip that will begin with our third quarter shipments and continue into the fourth quarter." So the company does call it like it sees it.

Travelers are starting to hit the road again. Smith Travel Research reported that August RevPAR (revenue per available room) increased 1.9% year-over-year. This was on top of a 2.7% increase in July. Most of the gain was from an increase in occupancy (1.2 percentage points) rather than pricing (0.1%). Upper upscale continued to be the weakest sector with RevPAR actually decreasing 0.4% from last year. Occupancy rates were higher at the high-end as well, up 0.5 points, but the ADR (average daily rate) fell 1.1%.

This week, Verizon announced its earnings would fall short of previously forecasts. The largest local phone company said lower demand from business customers along with increased labor costs were the primary factors.

Bed Bath & Beyond reported earnings that were two cents ahead of Wall Street's estimates. Obviously the hot housing market played a significant role in the retailer's 5.9% increase in same store sales. The company is maintaining its aggressive expansion with plans to open 80 - 90 stores this year. This would bring its total store count to about 590 stores. The company mentioned that it believes it "can operate at least 950 Bed, Bath & Beyond stores in the U.S." At current growth rates, this is only four more years of growth before the company has to create another retailing concept, or start acquiring other companies to help generate revenue growth. The company is already starting to acquire small retailers. As store growth starts to diminish, it is likely that it will start acquiring larger and larger companies. Best Buy noted that its acquisition of Musicland was because it would "continue its revenue growth beyond fiscal 2005, when the Company expects to complete its Best Buy store expansion in the United States."

Over the next five years, several of these high-flying, high-growth retailers that will run out of growing room. Home Depot is one retailer that is already experiencing this problem. The valuation multiples the market awards these stocks will most likely diminish. Retailers rarely trade at high multiples when most of their sales growth is derived from same store sales.

The rally that started in March has been broad-based with almost all the indexes hitting highs last Thursday on a closing basis. The index of high short interest stocks also closed at a high on Thursday. At this point it was up 40.3% year-to-date and up 62.0% from the March lows. Over the past four days the heavily shorted stocks dropped 2.9%, which is the same as the S&P 500 and about 50 basis points less than the NASDAQ. The Russell SmallCap index has fared even better. It actually made its closing high a day later, 9/19, and is only down 2.4% from its high. Short sellers will start feeling more optimistic once the "short stocks" start underperforming the market.

I first discussed the current short squeeze in my column May 7, 2003, column. At that point short stocks were up 25% off the lows set in March. I also included a table of 12 stocks that at the time were examples of how much these stocks had already rallied.

  Price Change Short Interest as % of Float
Ticker Company Name 3/11-5/7 5/7-9/24 May September
AMZN Amazon.Com Inc 34% 61.6% 18% 15%
ACF AmeriCredit Corp 314% 59.3% 20% 17%
AMR AMR Corp 328% 73.9% 34% 28%
CPN Calpine Corp 77% 11.2% 23% 21%
DAL Delta Air Lines Inc 119% -2.9% 19% 16%
ERES eResearch Tech. 26% 138.6% 62% 34%
EXPE Expedia Inc 94% Acquired 21% Acquired
JNPR Juniper Networks 49% 28.6% 15% 15%
NFLX Netflix Inc 52% 60.8% 50% 49%
OVTI Omnivision Tech. 49% 77.2% 55% 35%
SLAB Silicon Lab. 12% 68.6% 31% 21%
XMSR XM Satellite 166% 43.2% 48% 51%

I was hoping the short interest had diminished more than it has on these stocks. There are likely several hedge funds that have been short these kinds of stocks while long cyclical or other economically sensitive stocks. Funds that have put on this strategy are clearly not doing well. It is likely that these short stocks will outperform as managers give up on the shorts in hopes of salvaging the year.

The market is at an inflection point. Third quarter earnings, and more importantly fourth quarter guidance will most likely be the resolving factor. At this point the earnings picture remains positive, but mixed. Fourth quarter earnings estimates are even more aggressive than third quarter estimates, but with the credit flood gates wide-open it is hard to bet against. Perhaps, more important is the bond markets determination to push interest rates lower at any hint of financial stress. This in turns lowers borrowing costs throughout the economy, which sets in motion the American consumer. At some point the market will start questioning the fact that Fed funds are stuck at 1% when GDP is growing 3%, 4%, or even 5%.

I will be out of the office next week, so I will not be writing a commentary. The next Mid-Week Analysis will be on October 8.

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