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Five Things You Need to Know: If the Economy Is So Bad, Why Are Stocks Going Up?

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Underlying demand for stocks trumps overarching economic malaise... for now.

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Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. If the Economy Is So Bad, Why Are Stocks Going Up?

It's a classic investment conundrum: The economy looks terrible, so why are stocks going up? The reality, difficult as it may be to grasp, is that the economy and the stock market are two different things. That's why it is important to consider long-term economic issues within the context of short-term movements in supply and demand.

There continues to be underlying demand for stocks as illustrated by the long-term bullish percent indicators we follow being positive and in reasonable field position.

Below is where we stand with the point and figure bullish percent indicators for equities, based on Investors Intelligence data.

This simply tells us demand is in control of the stock market. That's great for the short-term. But if you listen closely to what companies are saying, there's little reason to be encouraged longer-term by what's happening in the broader economy. So what does this discrepancy mean?

We believe it means we are simply in a counter-trend rally driven by a reversion of excessive negative sentiment. Put more simply, people are relieved the entire economic system did not collapse on the back of the (ongoing) debt bubble. However, once this condition of relative relief is, well, relieved, we face a darker reality in the second half of the year.


2. A Darker Reality

Consider PF Chang's (PFCB). Yesterday on the company's earnings conference call we head the following nuggets:

President Robert Vivian:
- "Many traditional household expenses are as high as we have ever seen them. We continue to believe we have not seen the bottom of this cycle, and that it will be with us into next year."
- "Even though our commodity contracts provide stabilization for the balance of this year, we do have concerns looking into 2009."

  • The company raised total menu prices 2.5% last quarter.
  • On the bright side the company noted sequential improvement in comps spread across the 36 states where comp stores are operating. BUT, their traffic remains negative, and, as Vivian said, "as long as this continues to be the case, we'll be swimming upstream."
  • In the Q&A, Vivian reiterated how important traffic is to the company, saying "the biggest factor effecting our ability to deliver... results is how many guests venture through our doors each day."
  • Moreover, Exec. VP Russell G. Owens noted that the company has a high percentage of restaurants in subprime-effected areas. In those areas is the company seeing a bottoming of the impact? No. According to Owens, "As a general rule it's gotten worse in the first quarter than the fourth quarter, and we have
    seen during the quarter [it] continue to worsen in those markets."
  • PFCB is projecting 200-250 basis points of margin improvement. The question was asked, "How?" Well, largely through labor costs, and maybe 50-80 basis points in cost of sales. This is an ongoing theme we're hearing: margin improvement or margin contraction improvement for some companies, through labor cost cutting. That has a very important and direct impact on consumer spending and the economy.


3. Dude, Where's My Job?

Virtually everywhere we turned yesterday, especially in the consumer discretionary category, the talk was of cost savings. And if companies weren't outlining specific labor cost reduction strategies, they were busy alluding to them in Wall Street code; i.e., "right-sizing," "enhancing productivity," "cross-training," "consolidations." Below is a survey of what we're hearing:

Dover (DOV): "We did a lot of spending to shutdown plants, lay off people. I think the head
count of that company is probably down well over 200 people. There will probably be additional actions to right-size the company." - Ronald Hoffman, President and Chief Executive Officer.

Schering-Plough (SGP): "[O]ur quarterly results reflect the impact of our rigorous focus on cost controls such as the hiring freeze we imposed from March of last year." - Fred Hassan, Chairman and Chief Executive Officer.

"[W]e are looking for savings and productivity improvements across the company. We're currently targeting the biggest chunk of our savings to come from SG&A. In looking at the individual lines, we see about half from SG&A and the remainder split pretty evenly between R&D and manufacturing." - Robert J. Bertolini, SGP Executive Vice President and Chief Financial Officer.

Smurfit-Stone Container Corp. (SSCC): "We reduced head count by an additional 230 positions in this quarter for a total of almost 5,600 since 2005. We closed an additional box plant for a total of 29. We remain on target to reach our 525 savings target in 2008 through additional savings from our capital program, plant closures and head count reductions." - Steven J. Klinger, President and Chief Operating Officer, Smurfit-Stone.

Norfolk Southern (NSC): "The employee counts have come down a little bit. We're
watching that very carefully. As we've discussed before, we have a significant attrition issue facing us over the next few years due to the demographics of our workforce and we have been hiring aggressively, as you know, for a while. But we have some very good models which take traffic levels into account. And as we've seen traffic soften, we've really started to moderate on our hiring and work that into our plans." - Charles Moorman, President and Chief Executive Officer.

Host Hotels & Resorts (HST) - "On the cost front we are reexamining the light labor models at each hotel, looking to avoid filling positions and emphasizing cross-training to add further efficiencies. We are carefully reviewing our food and beverage service platforms to identify opportunities to cut costs, to adjusting hours of operation or staffing levels. In some instances, in concert with our operators, we are mandating across the board expense cuts." - W. Edward Walter, President and Chief Executive Officer.

Monaco Coach (MNC): "We will continue to lower our production run rates, reduce our SG&A and our overhead costs and more quickly facilitate other consolidations within our company. While these steps are painful for many of our great employees, they are necessary to ensure the long-range stability and strength of our company. - Kay Toolson, Chairman and Chief Executive Officer.


4. New Home Sales Plummet Despite Price Cuts

Sales of new homes fell to the lowest level in nearly 17 years, according to the Commerce Department. Sales of new one-family houses in March were at a seasonally adjusted annual rate of 526,000, 8.5% below February's revised rate, and 36.6% lower year-over-year.

Even more ominous, sales plummeted despite a sharp deceleration in price. The median price for a single-family home fell 13.3% year-over-year.

And inventories also increased, moving to 11 months' supply from 10.2 months' in February.


5. NASCAR Fans Taking a Pit Stop

An interesting article in USA Today takes a look at how slowing consumer spending and high gas prices are impacting NASCAR. TV ratings are up 2% so far this year, but attendance at the tracks has declined or remained flat.

As a result, some tracks are attempting to offset increased costs for fans by lowering ticket prices. Lowe's (LOW) Motor Speedway in North Carolina is promoting its $39 tickets for the 165,000-seat Coca-Cola 600 on May 25 as part of affordable packages, the newspaper reported.

NASCAR attendance is an interesting indicator. According to the article, 53% of NASCAR fans earn less than $50,000 annually and 31% less than $30,000.

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No positions in stocks mentioned.

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