Connecting The Dots

By: Tony Sagami | Thu, Jul 21, 2005
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IBM uses hocus pocus to make its numbers
Restructuring at HP and IP = job losses
Back-to-school sales poised to disappoint
Housing starts flatten out
Fun and games with inflation numbers

Buy now and listen later.

At least that is what the bulls did this morning after hearing IBM pat itself on the back for delivering such great Q2 results.

The Dow Jones shot out to a 90-point gain within minutes of opening.

The problem is that IBM's great results (more below) were the result of accounting smoke and mirrors and not an improvement in operating profits.

In fact, the bulls were so preoccupied with IBM that they ignored the announcements of massive layoffs at Hewlett Packard and International Paper (more below) and paid zero attention to the disappointing housing starts report.

After all, why let little things like facts get in the way of a good party?

The Dow Jones tacked on 71 points today, but the Nasdaq was up almost twice as much on a percentage basis.

Risk be damned, the bulls jumped on anything with a big beta today and made computer hardware, computer software, and internet stocks the biggest winners of the day.

No question, today was a good day for the bulls.

IBM uses hocus pocus to make its numbers. IBM reported $1.12 of Q2 profits last night, which is 9 cents better than the $1.03 Wall Street was expecting. Hallelujah!

Not so fast.

1. First of all, the $1.12 excludes 10 cents of costs related to stock options. If you include those 10 cents of true, real, hard compensation expenses, IBM would have missed forecasts by one penny.

There was a trio of one-time, non-operating costs that IBM used to manufacture 2 cents of extra profit.

==> $775 million (29 cents per share) gain from the proceeds of the settlement with Microsoft.

==> $1.1 billion (45 cents per share) gain from the proceeds from the sale of IBM's PC division to Lenovo Group in May.

==> A $1.7 billion charge (72 cents per share) to cover the cost of job cuts against earnings for the cost of 14,500 layoffs.

2. The combined result was 74 cents of one-time gains against 72 cents of one-time losses; 2 cents of non-operating income profit.

If you back out the 10 cents of stock options and 2 cents of non-recurring gains, IBM would have actually missed it number by 3 cents!

3. More than 50% of IBM's business is from its technology-services division. In Q2, services revenue increased by a mediocre 6% or an even less impressive 4% if you backed out currency fluctuations.

4. I told you to expect a chorus line of complaints about the rising dollar from corporate American. CFO Mark Loughridge warned that second-half revenue would be hurt if the dollar continues to strengthen against the euro.

Wall Street is really impressed with IBM. Not me.

Restructuring at HP and IP = job losses. Both Hewlett Packard and International Paper were in the cost cutting mood today.

Hewlett Packard announced that it would eliminate 14,500 jobs (10% of its workforce) and reduce retirement benefits by freezing pension payments and medical benefits.

International Paper is going to sell off several non-core divisions, sell some of it more desirable timberland, and close packaging plants. IP didn't quantify the number of jobs that would be lost...but the answer is "a lot."

Wall Street is treating these job cuts as financial strokes of genius. I doubt, however, that the HP and IP workers that get laid off will share that enthusiasm or be spending a lot of money at their local retailers.

Speaking of retailers.

Back-to-school sales poised to disappoint. Americans don't do a lot of shopping in the summer, but the spend a ton of money on back-to-school shopping.

Not so fast -- here's some bad news for American retailers.

According to retail research company America Research Group, the back-to-school shopping season is going to be very disappointing for retailers.

"Parents have much lower spending plans this year, with the average at $296.20 compared with $411.24 a year ago."

Families are planning on spending between $201-$300 at the low end and between $301-$400 at the top-end, much below the $401-$500 and $501-$600 reported in last year's survey.

53.3% of the respondents said they were trying to get their children to wear what they wore last year, compared with 36.8% last year.

Those aren't very encouraging numbers. Of course, a lot can happen between now and Labor Day, but I bet this survey's dismal forecast is just a manifestation of sky-high oil prices and rising interest rates.

Housing starts flatten out. The Commerce Department reported American contractors broke ground on 2.004 million new homes in June.

2.004 million homes sounds like a lot of homes, but it is (a) unchanged from May and (b) below the 2.007 million starts Wall Street was counting on.

There were two other pieces of evidence supporting the real estate slowdown argument.

==> Through June, new home construction in Kansas City is 9% lower than the first six months of 2004.

==> Last quarter, real estate prices in Southern California appreciated at the slowest growth rate in more than three years.

I'm not telling you that the real estate in your town is about to fall off a cliff. Every city if very different.

For example, my property in Austin, Texas is only slightly more valuable today than when I bought it 3 years ago. My property in western Montana, however, has gone just as berserk as San Diego or south Florida.

But the evidence of a peak is accumulating and caution, I believe, is the most appropriate strategy.

Fun and games with inflation numbers. John Crudele of the New York Post is one of my favorite reporters and I highly recommend his column. Today, he gave two examples of how badly the government inflation numbers are understating the true rate of inflation.

American Auto Association calculates that gasoline prices have risen 21.5% since this same time last year. But the government swears gas prices are only 6.9% higher over the year

That little trick alone saved the CPI from being 0.53% points higher

Despite all you've read, the government thinks housing is only 2.2% higher over the past year. Others, including the National Association of Realtors, calculate that housing is up at least 12.5%.

Of course, that's old news for readers of this column.

What you should ask yourself is if Alan Greenspan and his buddies are smart enough to know that the government inflation numbers are phony too?

I think they are, which is why the Fed continues to raise interest rates in the face of otherwise friendly inflation numbers. If that is true, the idiot bulls calling for the Fed to stop raising interest rates are going to be very, very disappointed.

Everybody and their brother understands the Fed will raise interest rates again at the August meeting. The bulls are very hopeful, however, that the tenth rate hike will be the last rate hike.

They will be disappointed. And so will the stock market.


 

Tony Sagami

Author: Tony Sagami

Tony Sagami
Harvest Advisors.

Tony Sagami

Tony Sagami is the owner and founder of Harvest Advisors, an investment research and money management company. Sagami has been managing money for more than 20 years and is one of the early pioneers in the application of technical and quantitative analysis to mutual funds and stocks.

Tony is a man that wears several hats. In addition to Harvest Advisors, he has launched several successful technology companies. Tony is the owner of Monocle Systems, a popular investment analytical software program that has been used by thousands of professional money managers and sophisticated individual investors. Tony is also co-owner of AdvisorSquare, one of the largest web design and hosting companies in the world.

Tony is a frequently quoted expert, appreciated for his frank and unconventional view. Tony has appeared in publications such as the Wall Street Jouranl, Barrons, Kiplingers, Smart Money, Business Week, New York Times, Washington Post, Investors Business Daily, Bloomberg, Financial Planning Times, Mutual Funds Magazine, Chicago Tribune, LA Times, and many others.

A graduate of the University of Washington, Tony enjoys coaching youth sports, serving his community as an active Rotarian, and exploring the all the beauty that Montana has to offer. Tony is a Paul Harris Fellow, an Eagle Scout, and married to his first-and-only wife and father of 4 wonderful kids.

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