Dow Jones Reprints: This copy is for your personal, non-commerical use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool on any article or visit www.djreprints.com
When a 500-point weekly loss in the Dow leaves investors wondering why the market had such a muted response to the headlines being inflicted on us from Washington, it's clear that the politicians' shouting match has gotten even more overheated and unenlightened than usual.
Sure the market slid close to 4%, and measures of expected market volatility and downside hedging demand reached levels not seen since March. But, given all the drama over the federal debt ceiling in Congress, the equity-index retreat was so orderly and the action in Treasury bonds so sedate, that investors were more likely to ask why the market dogs weren't barking louder.
When it comes to Treasuries, the answer is pretty straightforward. Sure, the U.S. is under threat of a credit-agency downgrade, and at least several dozen nihilists in Congress seem to want to take the government to within a few pen strokes of default, just to get a point across. But, in terms of the big picture that shows what really matters to creditors, the week's drama wasn't so alarming. If nothing gets done, the supply of Treasuries is capped, economic growth is hampered and risk aversion rises. Sounds pretty bullish for bonds.
Now, for sure, banks and large companies are marshalling cash and securing their short-term liquidity as precautions. As Morgan Stanley interest-rate strategist Jim Caron says, this amounts to "an unintended tightening" of monetary conditions, "which is exactly what the economy does not need now."
Stocks are acting as more of a thermometer of investor emotions, although even at that traders have been as likely to focus on UPS earnings as on whichever committee chairman is moistening a Capitol Hill microphone with a restatement of his party line. It's not the politics or the ultimate outcome of the fiscal debate that matters most to equity investors, but the effect of all this wrangling and potential curtailed spending on growth.
One thing stocks have in their favor, which will help cushion any emotion-driven selloff that might arise in the absence of progress in D.C., is that the market wasn't pricing in much at all in the way of long-term corporate earnings growth even before the political standoff took the fore. Depending on the assumptions used, stock prices recently were embedding 10-year future profit growth in the low single digits or less.
And Deutsche Bank strategist Binky Chadha points out that the economic trend most salient to corporate performance–real gross domestic product excluding government and housing activity–has grown at a 4.6% rate for the past two years, and even last quarter was up 1.8% versus the 1.3% headline GDP figure. In short, stocks have become an orphaned asset class, subjected to relatively low expectations.
MANAGERS AT BOTH Home Depot (ticker: HD) and Lowe's (LOW) are busy stocking up on leaf blowers and hurricane window guards, the typical late-summer routine. Both companies, of course, are tethered to stabilizing (if not rebounding) home values and the ability of consumers to spend on house projects.
Yet at the moment, the market is treating these similar companies quite differently, affording Home Depot shares a historically wide premium over Lowe's that doesn't seem justified by the fundamentals.
Home Depot is about 40% larger than Lowe's, based on revenue, but sports nearly twice Lowe's market value. Home Depot trades at a bit more than 15 times earnings for the current year, a two-multiple-point premium to Lowe's, which fetches 13.2 times 2011's profit. Both are expanding their bottom lines 13%. The stocks' dividend yields are also close, 2.85% for the Atlanta-based industry leader to 2.6% for the Mooresville, N.C., No. 2 player. The valuation differential hasn't been this wide since around 2003, notes Brad Ginesin, hedge-fund manager at Polar Capital, who has a long Lowe's/short Home Depot pair trade on.
Home Depot, for sure, has greater exposure to non-U.S. home-improvement revenue, which might account for some of the valuation spread. Still, both companies have been good stewards of capital in a tough operating environment. Lowe's, in this regard, might have the edge, with a $2.4 billion share-buyback plan in place, fully funded by free cash flow, that amounts to 7% of the company's market value. Robert W. Baird analyst Peter Benedict notes that Lowe's is on track to generate enough cash to repurchase half of its market capitalization over the next five years.
One need not be enthusiastic about the financial fortunes of the average weekend hammer swinger to conclude that Lowe's shares are a good bet, especially relative to its main competitor.
E-mail: michael.santoli@barrons.com
This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com
Yahoo! Buzz
MySpace
Digg
del.icio.us
NewsVine
StumbleUpon
Mixx
David M. Demshur sold 200,000 shares after an all-time high stock price.
Though impressive quarterly results lifted the online travel agency's stock, shares may have little room for upside.
Apple, HTC and Samsung will reap the majority of the benefit.
The consumer-products giant has limited margin-expansion potential.
Citigroup, PNC, Wells Fargo, Fifth Third and BB&T have catalysts.
Shares of the industrial conglomerate, Dover, give investors a play on hot businesses ranging from oil drilling to the iPhone.
Europe's banks line up to own up to the Greek-bond impairments on their books—and this is just the beginning.
The supplier of wafer-fab equipment saw gross margin slip.
Though second-quarter earnings fell short of estimates, the energy giant should power higher.
Abercrombie & Fitch's discounting will hurt American Eagle's margins.
The energy explorer is seeing megaprojects coming to fruition.
Companies that want to grow their sales in this economy had better be able to steal customers from rivals. (At SmartMoney.com.)
We must confess that for all our skepticism about the breed, we underestimated the politicians' avidity for folly.
The online retailer is unique: The stock rises when the company reports weaker earnings. How that's possible and why the shares can fly still higher.
Brokers' stock picks had a nice run following the financial crisis. This year has been a great deal tougher. So who's worth listening to these days?
Despite the debt-ceiling stalemate and the looming threat of a downgrade, investors still sought the refuge of U.S. government bonds.
A messy legal battle pitting bond-fund star Jeffrey Gundlach against his former employer TCW went to trial last week. What's at stake, and why certain claims seem to favor Gundlach.
Stocks tumbled on fears of a credit-rating downgrade for Uncle Sam and news of weak GDP growth. But IPOs soared, and the outlook for the market might be brighter than many think.
Robert Alan Feldman of Morgan Stanley discusses Japan's troubles with deflation and an aging population, and other problems; he also sees lessons for the U.S. and Europe.
WisdomTree's new fund blends these inflation-protected securities with commodities to try to outpace the CPI.
FedEx founder and CEO Fred Smith first learned about leadership as a young Marine officer in Vietnam. He used those same principles to build FedEx into a $28 billion company.
Workday is betting on its software as a service, or SaaS, model to boost it past its progenitor, PeopleSoft. The cloud is all.
Why MFS New Discovery portfolio manager Tom Wetherald likes Citi Trends, Universal Forest Products, NVR and SciQuest. And how he rode Zipcar.
Read Full Article »