Connecting the Dots

By: Tony Sagami | Fri, Aug 19, 2005
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Plethora of retail warnings Part III
Home prices "extremely overvalued" in 53 cities
Whoopie. Leading indicators up 0.1% in July
Google insiders bail out. Should you?

There wasn't a whole lot of action today. The Dow Jones was able to drag itself out of negative territory and end up with a 4-point gain, but it was largely a day of directionless pushing and shoving.

Long-term interest rates fell significantly today on an avalanche of warnings from retailers (more below).

Internet, software, hardware, and semiconductors were some of the weakest sectors while banks and drug stocks were some of the few winners today.

I thought it was interesting that the Hong Kong Hang Seng index got clocked for a 332-point loss to 15,090 last night. I'd pay close attention to that market for more weakness.

I'm not ready to proclaim the arrival of a bear market...but I'm getting close.

Plethora of retail warnings Part III. This week has been full of retailers -- the most notable of which was Wal-Mart -- that have told Wall Street to tone down their overly optimistic Q3 and Q4 expectations.

The parade of retailers that are taking down their Q3 forecasts is getting long. Here are the latest of what is becoming a very, very long line of pessimistic retailers.

Hot Topic not so hot. Hot Topic turned in weaker second-quarter earnings and significantly chopped its Q3 and Q4 forecasts. Not only did Hot Topic miss its Q2 number by a penny, it warned that it would only make 15 to 18 cents in Q3 and 30 to 38 cents in Q4. Those numbers are below the 27 and 38 cents respectively that Wall Street was counting on.

Harry Potter doesn't save Barnes & Noble. Despite the release of the blockbuster Harry Potter book, Barnes & Noble fell short of its revenue forecasts. Q3 looks even worse as Barnes & Noble warns that it expects to lose 1 to 4 cents, which is well below the 2 cent profit Wall Street was expecting.

A shortage of well-dressed children. Children's Place, a chain of upscale child clothing and toy stores, is also suffering from the Q3 blues. Children's Place reduced its Q3 profit forecast from $1.03 to 86-91 cents instead.

Limited sales at Limited Brands. Limited Brands delivered an inline Q2, but expects a very weak Q3. How weak? Limited now expects to suffer negative same-store sales in August and expects to lose 1 cent per shares in Q3. Wall Street was hoping for 6 cents of profit. For full-year 2005, Limited is now forecasting $1.36 to $1.38 of profits, below the $1.40 Wall Street target.

Flat same-store sales at New York & Co. New York & Company is an upscale retailer of casual and business wear. Like Limited Brands, NWY hit its Q2 numbers but isn't very optimistic about the next quarter. Wall Street is expecting 25 cents per share of profits. Wrong! NWY says it will only make 15 to 18 cents instead. The reason is simple: same-store sales are expected to be flat in Q3 compared to a 7.0% gain during the same period last year.

Clothes aren't the only weak area. Home furnishings retailer Bombay Company reported a worse-than-expected Q2 loss and warned that it won't turn a profit for the full year. For the year, Bombay now expects a 6 to 12 cents loss instead of a 2 to 8 cents profit. Historically, a robust real estate market is accompanied by a robust home furnishings and furniture market. Gee, do you think the real estate rocket could be running out of fuel? Think about it.

Even video game sales are weak. Video game retailer GameStop warned that it expects its Q3 same-store sales to fall by 8% to 10%. Q3 profits will be in the 18 to 20 cent range instead of the 21 cents Wall Street expectgs. And for the full year, it will earn $1.30 to $1.40 instead of the $1.42 Wall Street is counting on.

Claire's complains about high gas prices. My 11-year old daughter -- who often thinks she's 16 -- loves to shop at Claire's Stores...but there are apparently not enough young girls like her. Claire's told Wall Street that it would fall short of Q3 expectations. Instead of 31 cents, Claire's now expects to make 27 to 30 cents instead.

The CEO of Claire Stores perfectly summarized the problem facing all retailers.

"We were also concerned about the impact on customer behavior of shifting levels of consumer confidence as well as steadily increasing fuel prices."

If that sounds suspiciously similar to the complaints you heard from Wal-Mart on have a good memory.

About the only people who don't think that energy prices are a problem is the Jack-and-the-beanstalk crowd on Wall Street.

You should ask yourself a simple question. Who should you believe? The Wall Street MBAs that have never run a business in their life or the people that actually run America's businesses?

The answer from the people that run America's largest retail stores is clear: the economy is slowing down.

Home prices "extremely overvalued" in 53 cities. According to a study by National City Corporation, single-family home prices are "extremely overvalued" in 53 U.S. cities.

The definition of overvalued is a market that is 30% (or more) above where National City estimates it should be based on historic price data, area income, mortgage rates and population density (a proxy for land scarcity).

Worse yet, those 53 cities make up nearly a third of the overall U.S. housing market.

According to the study, the most overvalued and highest risk markets are in California, south Florida, Boston, Long Island, Nassau and Suffolk counties in NY, and Ocean City, N.J.

Whoopie. Leading indicators up 0.1% in July. One of the recurring themes of this column has been our characterization of the economy as okay-but-not great.

The Commerce Department must agree with us because its Leading Economic Indicator index for the month of July went up by a measly 0.1%, well below the 0.3% gain the rose-colored glasses crowd was expecting.

Over the last six months, the LEI are up 1.1%, which is "consistent with the economy continuing to expand moderately in the near term."

These aren't horrible numbers. These are recession numbers. What they are simply okay-but-not-great numbers that show a moderately growing economy.

The challenge for the stock market is that the Wall Street crowd isn't expecting "okay." The Wall Street crowd is expecting gangbuster growth and when they realize they are wrong, the stock prices will have to fall in order to be in alignment with reality.

It is the disconnect between so-so reality and milk-and-honey dreams that makes the stock market so richly overvalued.

Google insiders bail out. Should you? Google announced that is was going to sell up to 14.8 million of its shares, which at current prices would raise around $4 billion.

Interestingly, Google went public almost exactly one year ago. At that time, the Google IPO was for 19.6 million shares at $85.

Here is what bothers me. As of June 30, Google had about $2.95 billion in cash. What I want to know is what the heck is Google going to do with that roughly $7 billion!

I suspect they are going to use it to finance the purchase of some other over-priced piece of dot-com crap such as

The smartest Google could do is sit on that cash and buy their own stock back after it loses 50% of its value. I say that because that is exactly the type of haircut -- at a minimum -- that I believe Google will eventually suffer.

The smartest thing you could do, if you own Google, is to copy what Google management is doing: selling!


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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