Connecting the Dots

By: Tony Sagami | Wed, Aug 24, 2005
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"Air coming out of these (real estate) balloons."
3 home furnishing retailers disappoint
Falling computer prices plague PC industry
Rising commodity prices skewer Toro

The bulls can't be happy about another day of falling stock prices, but they are probably feeling pretty good about how tame the damage has been.

Despite some disappointing home sales numbers, a rebound in the price of oil, and some discouraging retail reports, the Dow Jones was only down 50 points.

That's not bad for a market that was down 73 points at one point on a day when the news was largely negative.

That should change after we get past Labor Day. I continue to believe that selling will accelerate in September.

"Air coming out of these (real estate) balloons." According to the National Association of Realtors, existing home sales fell by 2.6% in July to an annualized pace of 7.16 million homes. The Wall Street crowd was expecting 7.29 million sales.

The NAR chief economist, David Lereah had a couple choice words about the data.

"We are starting to see some air coming out of these balloons."

Look, when the industry insiders start voicing words of caution, you just know that prices have got out of hand.

There were several critical data points that you can't ignore:

Inventories of homes for sale rose 2.6% in July to 2.751 million, a 4.6-month supply at the current sales pace. It's the largest inventory since May 1988.

==> The median price of a home rose to 14.1% in the last 12 months to $218,000. Lereah of the NAR called that a pace that "is not sustainable."

==> Condo flippers are about to get skinned. Sales of single-family homes fell 2.3% but sales of condos dropped 5%.

==> The hottest markets are showing the signs of strain. Sales were flat in the South, fell 3.3% in the Northeast, fell 1.8% in the Midwest, but dropped by and fell 7.5% in the West. Cities like San Diego, Los Angeles, Las Vegas, and San Francisco already appear to be falling.

You know what I think the most telling sign of all is? Most homebuilding stocks are down 15% to 20% from their peak.

And I bet it gets a lot worse.

3 home furnishing retailers disappoint. One of the luckiest beneficiaries of a hot real estate market are the companies that sell home furnishings to fill up those new homes. Judging from what Pier 1, Williams Sonoma, and La-Z-Boy had to say today, the real estate market isn't so hot.

==> Same-store sales fall 12-14% at Pier 1. Pier 1 slashed its Q3 forecast because of very weak customer traffic in August. How weak? Pier 1 expects to see same-store sales to drop by 13% to 15% in August. As a result, Pier 1 now expects to report a 12 to 14 cents Q3 loss -- much worse than the 6-cent loss the Wall Street crowd was counting on.

==> Sales fall short at Williams Sonoma. Williams Sonoma hit their Q2 profits numbers but reported worse-than-expected sales. Wall Street was expecting $783 million but Williams Sonoma only pulled in $776.

==> La-Z-Boy drops Q3 forecasts. La-Z-Boy took down its Q3 forecasts from 23 cents on $537 million of sales to 19 cents on $521 million of sales. What's the problem? According to CEO Kurt Darrow:

"While we have continued to make steady progress in the evolution of our business model, we remain concerned with several macroeconomic factors, including continued rising energy prices and interest rates, which could impact the industry's growth prospects and dampen consumer confidence."

That admission that $65 oil and rising interest rates are hurting consumers is probably shocking news to the Jack-and-the-beanstalk crowd. We, of course, know better. But what surprised me was the new that the employee discount pricing on cars is stealing sales from La-Z-Boy.

"Additionally, there has been fierce competition for consumers' discretionary income, with employee pricing offers from the automotive industry, which is contributing to weak retail furniture demand."

Look, it doesn't matter whether the culprit is $65 oil, rising interest rates, or incentive-heavy car deals. What matters is that consumer spending is slowing down.

Falling computer prices plague PC industry. A new study from the Gartner Group revealed two things: (1) PC unit sales are growing at a double-digit rate but (2) PC revenues are flat lining.

Gartner is predicting that worldwide PC shipments will grow by a very healthy 12.7% in 2005. Sounds great, right?

Not so fast. Gartner is also forecasting that worldwide PC revenues will grow by a paltry 0.5% while 2006 is even bleaker. Gartner expects total PC sales to actually fall by 0.4% in 2006.

The reason for the big difference between the two numbers -- unit sales and sales revenues -- is simple: computer prices are plunging. According to Gartner:

"The drop in mobile PC ASP (average selling price) has been particularly remarkable."

Desktop prices have plummeted. CompUSA, for example, is selling a HP Pavilion desktop with a monitor for $199.99 (after rebate) and Dell has been selling a $299 desktop systems. Laptops too, are falling in price. Acer, Dell and HP all offer laptops with Windows for $499.

This just reinforces the uninspiring forecasts that Dell and Gateway gave last week. Gateway cut its sales forecast because of "competitive pricing pressure" and Dell blamed its lukewarm results its over-aggressive pricing.

The world still needs computers but prices are dropping so fast that anybody in the PC food chain is finding its profit margins dropping just as fast. The PC business is quickly falling into a profitless prosperity trap.

You want to invest in companies with rising profit margins that benefit from economies of scale. Not in businesses where prices and margins are falling.

Rising commodity prices skewer Toro. Toro hit its Q2 profit numbers but cut its full-year 2005 forecast. For the full year, Toro expects to make $2.34 to $2.39 a share, the low end of which is below the $2.39 Wall Street was counting on.

What's the problem? According to CEO Michael Hoffman:

"We've encountered some substantial head winds in the areas of weather and commodity costs."

Specifically, Hoffman cited sharp increases in the cost of steel and oil-based resins as the culprits.

Since Toro makes yard products, you could use this as another dot to confirm a real estate slowdown. However, I think the most important points are that (a) inflation is worse than Wall Street thinks and (b) rising commodity prices are eating into corporate profits.

By the way, it was just last week that competitor John Deere reported worse-than-expected Q2 results and said it was slashing production for the rest of the year.


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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