Housing malaise eats into Lowe's net Lowe's Cos. said Monday that its second-quarter profit fell 7.9%, hurt by the housing market downturn, which cut into demand for cabinets, countertops and other big-ticket purchases.  Results, however, exceeded analysts' estimates, thanks to strength in seasonal sales as homeowners restored lawns and outdoor landscaping after last year's drought in much of the country. The No. 2 home-improvement retailer also benefited from the U.S. government's stimulus checks, which aided its comparable sales by as much as 1.5 percentage points, more than it projected. It also gained unit market share at its fastest pace in eight quarters as many independent operators closed shops, Chief Executive Robert Niblock said on a conference call with analysts.Despite better-than-expected results, Lowe's third-quarter profit forecast missed analysts' estimates as the retailer expected a continued challenging housing market into 2009, especially in regions such as California, Florida and the Gulf Coast. It also said it is evaluating the number of stores it plans to open for next year in light of the current sales environment. It said it will announce the final number next month. Sales rose 2.4% to $14.5 billion as the company opened in more locations. Same-store sales, or sales at stores open at least a year, dropped 5.3%.

• Lowe's beats 2Q estimates, despite profit drop

 Along with a lowered outlook you'd think that would hardly be a reason to bid up the stock. As usual what we think is going on is that the lack of grasp on the nature, timing, structure and lags in the business cycle completely escape everyone in general. For example the new meme is that while the world is headed in the tank the US is potentially headed back up. BtW - that differential explains the dollar bounce along with interest rate gaps...watch out. But other than that one line nobody gave the most important retail statistic much attention.

Let us offer up another stat that will be completely ignored - no coverage whatsoever. Real weekly wages were updated by the BLS after the CPI release. Guess what...they were down -3.1%. In fact for the last six months the figures are: -1.4, -.8, -.9, -.7, -1.1,-2.5 and -3.1% ! Remember our "Tipping Point" discussion - well it certainly looks like it's here IOHO. We're going to spend the rest of this post digging thru some big picture economic data to try and read ourselves into a more realistic, data-grounded context. Hopefully in such a way that you can reach your own conclusions. 

GDP vs Consumption

Let's start with a comparison of GDP and Consumption (PCE) back to 1980. Take a gander at this little chart which shows the YOY% change in the two. If there's any doubt about this being cyclic speak now. We'll draw your attention to the teeny little tail where both, but especially consumption, have dropped below the trendline. Now ask yourselves - what recent data you've seen, or read here, would indicate that's going to turn around ? We think the more relevant question is what will the downturn look like - '01, '91 or earlier ?

Recession vs Growth Recession

You might recall that the Fed's current published forecast calls for growth thru 2010 of less than 2% - in fact they're counting on it to reduce inflationary pressures. When the economy grows at less than its' full employment potential think of that as a "growth recession". More importantly translate that out of geekspeak and into pain indicators. That means lost jobs, lowered spending, bad earnings pressures, you name it. Just to put that in context we ran back to 1960 or so and ranked downturns as Recessions (<0%), Week Growth Recessions (0-1%) and Growth Recessions (1-2%). And ended up with this fascinating chart. Note: if you believe our measures we almost experienced a growth recession at the end of '06 but were saved by the oil price drop and saw one again this last couple of quarters. But we are, in fact, now in a growth recession !!

If you'd really like to dig a little more into what's going on we put together some more economic cycle charts running back to 1960 where possible so you can see how the economy (GDP), Consumption and Investment relate and what links to what in the lag structure. We also - and this is especially important - look at the key drivers of future consumption demand. Which are growth in employment and real wages. Like we said at the start that news is getting worse fast. See what it means and keep reading (and of course click to enlarge the charts). 

BtW - the most interesting and potentially useful chart on Wages, Employment and future demand is the last one :) ! 

Here's a composite chart that takes GDP, Consumption and Employment back to 1960. If that doesn't look like your perfect theoretical business cycle then we give up. We think it's beautiful - though scary. Notice that, in general, Consumption tends to trigger an economic downturn though not always. And go down proportionately as far - which it did not do because of the Housing ATM. The piper is playing and we avoided a major downturn with his music after the Tech Bubble. But now he's coming to get paid. When you look at Employment though you can see he already collected part of his fees. Employment dropped relatively farther during our "mild" '01 downturn than in previous ones and never recovered as well. And we wonder why people have been "whining" for the last few years - makes sense now doesn't it ?

Investment

If Consumption is the engine of the economy the accelerator that speeds it up or slows it down is Investment. And for almost every period and cycle since the end of WW2 there's been a regular and predictable relationship between the economy and Investment. Unfortunately that afore-mentioned Housing ATM was part and parcel of a Housing Bubble unlike anything we've seen. In fact anything I've heard about forever. And we're in the process of an unprecedented bust that'll stretch out for at least another couple of years. So, congratulations. We're all the proud parents of two back-to-back bubbles that are going to burst with unfortunate consequences. Notice that Investment follows along quite nicely with GDP thru this whole period - except for the last few quarters when it's pulling down and away much more rapidly than you'd expect. When we breakdown investment into its' Capex and Real Estate components you can see why. RI is tanking big time. But here's the real rub - that we know about. If the Economy tips over what happens to Capex ? And Tech Spending ? And.....tech company revenues, profits, earnings and stock prices ? Now there's an interesting question. 

Wages, Employment & Consumption

The critical question is what's going to happen to consumption ? Will the engine get starved of fuel ? Well, judging by the changes in real wages it's already beginning to be. If employment tips over, as one would expect, you can count on it. Take a look at this composite which shows the key indicator - W+E vs Consumption on the bottom and the pieces (Real Wages, Employment) on top, since 1960. W+E looks to be dropping like a rock - or more importantly like it has in other previous, serious downturns. When you look just at Wages that's the primary current reason. Though we will point out that YoY Employment went negative with the last month's payroll data. And bear in mind the Birth-Death adjustment is still adding in more "virtual" jobs than the actual data. When some real data gets collected and the model's parameters get refreshed we're all likely to be in for some very unpleasant surprises.

 But just for fun let's quote you two different headlines on Industrial Production - both reporting on the same data and both given entirely opposite impressions.

Industrial Output Growth Slows U.S. industrial production slowed in July, pulled back by a drop in output at utilities as the weather turned fairer. Industrial production increased 0.2%, following a revised 0.4% climb in June, the Federal Reserve said Friday. Previously, June output was seen rising 0.5%.

Industrial output up 0.2 percent in July Industrial output rose in July at a slightly better pace than expected as a further rebound in the auto industry offset a big plunge in output at the nation's utilities.

 Fortunately, or not, we consider the MSM reporting to be improving but still not quite there yet. Sadly for our market positions the markets got it right the first half of the day but schizophrenia returned in the second, as they recovered. But if Mr. Market is listening let us correct your mis-apprehensions. They are indeed out to get you and here's the proof.

As always  if you'll click on a chart  you'll get an enlarged version in a seperate window.

Retail Sales

 The headlines have it that Retail sales dropped after an upward revision for last month, not mentioning the downward revision for May :). More interestingly our preferred YoY change was 2.9%, 5.8% x-Autos. Which sounds good until you look at the chart and realize it's downtrending. MUCH more important though is real retail sales which was -1.9%, negative for the eight month in a row and at an increasing rate. Let's zoom in and get a little more granular so you can see the more recent data.

Real Retail Zoom-In

I'm afraid the headlines and MSM reporting still hasn't absorbed the power of YoY reporting or of looking at the inflation-adjusted data but at least they're improving a little. When you get more granular, as in this chart, you can that we turned negative in Dec07. In other words when energy prices started going crazy people did the rational thing. CalculatedRisk's continued emphasis, supported by minor analysts like Marty Feldstein, that we most likely enterred a recession in then is looking better and better. 

 Real Sales Energy-Adjusted

Thought if you just looked at retail sales x-Autos you'd think things weren't really that bad. As a big picture sidebar observation we urge you to recall our comments from a while back that the GDP numbers and component breakdowns tell us that indeed we crossed, or are crossing the tipping point into a more serious downturn. (Tipping Points, Blindsides, Ouches: Tough Times Getting Tougher) An observation obviously NOT absorbed into the markets as yet. Where you can see this is by netting out gas station sales - a statistic you can get nowhere else since it's a painful manipulation of the data, at least so far.

 When you do that it turns out real retail sales turned negative in Oct07 ! And of course that's the same month when real (estimated) gasoline sales jumped and have kept climbing. In other words real retail sales has been negative for 10 months. And the rate of decrease is increasing. Tipping points indeed. And nobody is factoring that into their pricing, valuations or business planning that we can tell. There are some very unpleasant surprises lurking in the wood work for a lot of people as the normal cyclic lags start to work themselves into view.

Just put another big picture point on it what we've seen is the air going out of the leveraged financial bubble over the last three quarters. In other words the consequences of the credit bubble bursting and destroying the Housing market and sucking out the "vital bodily fluids" from the markets. What we have not seen is the consequences of a downturn in the business cycle. But IOHO we're about to. (News Alert: Vicious Credit, Economy, Market Cycle Spotted, Markets Drivers 2 (Buyouts): the Carry to Cash Economy, Market Drivers: Liquidity, Liquidity(Buyouts) and Buyouts (Buybacks)

"The air is coming out of the balloon pretty quickly here," said Brian Bethune, a senior economist with Global Insight, a Lexington, Mass., forecasting firm. "Consumers are just throwing in the towel." Retail sales in July were weaker than expected at many chain stores, suggesting the May and June sales boost from the stimulus checks is quickly fading. Talbots Inc., Kohl's Corp. and Gap Inc. were among those retailers reporting double-digit sales declines last month. Discounters, including Wal-Mart Stores Inc. and Costco Wholesale Corp., fared better, but Wal-Mart U.S. President Eduardo Castro-Wright warned that spending could slow: "With the end of the stimulus checks, we know consumers are spending more cautiously," he said. Consumer spending is poised to weaken just as foreign growth -- a vital offset to sluggish domestic demand -- also shows signs of slowing. Surging export growth, coupled with falling demand for imports, added 2.4 percentage points to second-quarter growth in U.S. gross domestic product -- marking the largest contribution in nearly three decades. Without that contribution, GDP would have slipped 0.5%. WSJ Vidclip Review

·          Economic Slump in U.S. to Worsen as Consumers Get `Squeezed' After Rebates [Kaufman Says U.S. Economy `About to Approach Recession']

·          Economic Slide to Extend Into 2009: Blue Chip, Economy Seen Slowing More Sharply: Philly Fed

U.S. Retail Sales Drop as Record Gasoline, Credit Squeeze Hurt Auto Sales Sales at U.S. retailers dropped in July for the first time in five months as record gasoline prices and tighter credit reduced automobile purchases. The 0.1 percent drop followed a 0.3 percent gain the prior month that was larger than previously reported, the Commerce Department said today in Washington. Sales excluding automobiles rose 0.4 percent, less than anticipated. The sales drop came even as the Treasury distributed tax rebates as part of the government's fiscal stimulus plan. Consumer spending, which accounts for more than two-thirds of the economy, is likely to keep fading, hurt by rising unemployment, falling property values and elevated fuel costs. Retail sales excluding gasoline fell 0.2 percent, the Commerce Department said. Spending, which has grown every quarter since 1992, may stall in the last three months of this year after growing at a 0.6 percent annual pace from July to September, according to the median estimate of economists surveyed by Bloomberg from Aug. 1 to Aug. 8. Figures from Commerce on July 31 showed spending grew at a 1.5 percent pace in the second quarter. The world's largest economy will expand at an average 0.7 percent annual pace from July through December, half the gain in the first six months of the year, according to economists surveyed.

1.       Economists Expect 2008's Second Half To Be Worse Than First The U.S. economy is poised for an unpleasant finish to 2008, amid a consumer-spending slowdown and a weakening global economy. The emerging pattern is the reverse of what most forecasts showed at the beginning of the year.

2.       OECD Forecasts Sharper Slowdown for G-7 The world's leading developed economies are set to slow more sharply in the months ahead, according to the OECD's indicators of future activity.

3.       Predicting What's Next Gets Harder Investors often expect the stock market to behave like a crystal ball. Lately it has made a better rearview mirror. For decades, turns in the stock market typically led earnings by roughly six months. But during the past decade or so, stocks have moved roughly in tandem with, and occasionally lagged, the trajectory of profits…

4.       Is the Market Still a Future Indicator? At this point, you would have thought the Efficient Market Hypothesis would have died a quite death. The most fascinating aspect of this is the opportunity for anyone in the market to identify inefficiencies. Discover where the market has a non random error -- we've called it Variant Perception over the years -- and you have a potentially enormous money making opportunity.

 Those headlines pretty well capture the arguments we've been making for some time, are based on similar analysis and point to a lot of other folks seeing the tipping point being crossed. And as Barry Ritholz points out in his post on the Deficient Market Hypothesis "you have an ....opportunity" ....if you make the right choices of course :) ! Speaking of which the next central question is what happens when the analysts figure out that their earnings outlooks need to go in the trash ? And the markets absorb those revisions ? How long will all that take to percolate ? Somewhere in there may lie some of Barry's opportunities.

We'll leave you to skim thru the readings which beef up these arguments but will note that the blue-highlighted titles are URL's - in other words you can click thru to get to the underlying story or post if you like. Now let's jump into parsing out the profit analysis

 Corporate Profits: First Pass

Let's start with a fairly simple look by using the St. Louis Fed's FREDII data graphing tool to look back at YoY changes in corporate profits to 1980. Part of the point here is that you aren't reliant on the MSM but courtesy of the Fed can take some pretty deep dives yourself.  It may take a bit to learn the tool and data sources, and maybe a bit more to learn what the data's telling you, but generating current analysis eventually takes a few minutes. Also btw just clicking on any graphic or chart will bring up an enlarged version for closer examination.

Take a careful look here and there are several things to notice. First off the timing, patterns and business cycle relationships are exactly what one would expect. The economy drives profits, no if, ands or buts. With some aberrations  that are important.  The blue line is  "real company"  after-tax profits on the right scale and it's volatile. But that scale wouldn't be so distorted except for the huge jump since '00. Before that those profits were cycling around a trend, which turned down in the '90s. Notice also that the drop in this decade is steep, now near-zero and below and appears headed lower.

Corporate Profits: Pass II

Let's take another pass at the data courtesy of Northern Trust's econ department and zoom in a bit, albeit with slightly different data on profits coupled with some inflation data.

 First off notice that QtQ profits have been negative and dropping since Q406. Wonder where those buybacks and earnings reports are coming from ? You should. We do know it certainly didn't go into hiring or capex. And therefore won't either !

What about margins ? Well when the ratio between the good CPI and the finished consumer goods PPI is dropping like a rock that tells us there's no pricing power whatsoever. It also tells us that profits have been under enormous and growing pressures for some time. And when it accelerates those pressures worsen. Now what do you think about future profit prospects ? Worse and worse we hope ! :)

Corporate Profits: Pass III 

Now let's take final pass at the big picture so you can get the full "slowly-boiling-frog" environment. The rather busy chart below shows corporate profits from 1979 from the national accounts. The UL shows the absolute number stacked up and if it looks like the Finance industry has been wallowing at the trough you'd be right. The UR shows profits as a % of GDP. We see three major structural trends that will govern things in the future. First off profits for non-financial companies were steady until this decade when they started liquidating their futures. Second, it looks like Financial companies went thru a major structural jump-shift and grabbed off more of GDP and, in the LR chart which shows % share of total profits, that's confirmed. And we now know what that was based on and how solid it was. Hm.....not promising. Remember the broken business models and wonder how that'll play out. And third, it looks like foreign profits (Rest-of-World or ROW) showed a steady rise until later in this decade when they took a big jump. That's born out in the LL chart which shows YoY% chanages, which btw, are both steady and pretty much mirror the business cycle. Note that very recently ROW profits are showing a non-cyclic jump. Brave new world indeed.

U.S. Economic & Interest Rate Outlook: Base Case vs Checkmate (NT): On a year-over-year basis, U.S. nonfinancial corporation profits generated from domestic operations have been contracting since the fourth quarter of 2006 (see Chart 19). With our forecast of contracting real GDP growth in the second half of this year followed by a muted recovery in 2009, unit sales growth for nonfinancial corporations is likely to be weak. Because of soft final demand, we believe that profit margins also will be squeezed as businesses find it difficult to pass on their higher commodity prices to consumers. This has been the case so far as the ratio of the Consumer Price Index (CPI) for goods to the Producer Price Index (PPI) for finished consumer goods has been falling (see Chart 20).

• Misery Index: 10 CEOs in the hot seat

And the Winner, er, Loser Is... Portfolio.com readers speak: Who is the least trustworthy C.E.O. on Wall Street? John Thain has been thumped recently for having apparently reversed course on some initially reassuring comments he made about Merrill Lynch's capital position. But he's hardly alone in having been overly optimistic amid the mortgage meltdown, as Portfolio.com writer Megan Barnett recently documented. That raised the question of which financial-services C.E.O. is saddled with the widest credibility gap these days. So we asked our readers to vote. By that measure Thain came out fairly well, perhaps because Merrill is still in business and Thain still has his job. Readers said the least trustworthy executive is Alan Schwartz, who was unfortunate enough to be in the corner office at Bear Stearns when the C.D.O.'s hit the fan there in March. Close behind: Martin Sullivan, formerly chief executive of American International Group, who famously calculated the chances of AIG posting a loss as "close to zero" -- a few months before AIG posted losses of $13 billion. Thain came in sixth place of our nine nominees, a few basis points behind Dick Fuld at Lehman Brothers.

Big Differences In Earnings and Analysts' Estimates What's the value of analyst estimates? Look at the enormous differences between actual earnings and analyst estimates for a couple of recent companies: GM (NYSE: gm) loss: $11.21 Estimate loss:: $2.62 Merrill (NYSE: mer) loss: $4.97 Estimate loss: $1.91 These aren't the only ones: there are dozens of other examples in financials, autos, airlines and home builders where we have seen misses not of a few pennies, but of orders of magnitude. The problems: 1) poor visibility: these industries are seeing business deteriorate on almost a daily basis 2) poor communication and data sharing: many companies provide little if any guidance and share a little information as possible, leaving analysts to either develop their own sources or remain at the mercy of the company 3) poor quality of analysts: the best analysts have left the sell side and now work for the buy side. The remaining sellside analysts, as a group, are of lesser quality.

Shipping Costs Start to Crimp Globalization The world economy has become so integrated that shoppers find relatively few T-shirts and sneakers in Wal-Mart and Target carrying a “Made in the U.S.A.” label. But globalization may be losing some of the inexorable economic power it had for much of the past quarter-century, even as it faces fresh challenges as a political ideology. Cheap oil, the lubricant of quick, inexpensive transportation links across the world, may not return anytime soon, upsetting the logic of diffuse global supply chains that treat geography as a footnote in the pursuit of lower wages. Rising concern about global warming, the reaction against lost jobs in rich countries, worries about food safety and security, and the collapse of world trade talks in Geneva last week also signal that political and environmental concerns may make the calculus of globalization far more complex.

Commodity costs crimp Kodak turnaround Surging commodity prices are complicating Kodak’s (EK) recovery plan. The Rochester, N.Y., photo company posted a second-quarter profit that missed Wall Street’s estimates, as profit margins narrowed under the pressure of year-over-year increases in silver, aluminum, petroleum-based and other raw material costs. Kodak also said it expects its full-year profit to come in at the low end of its earlier forecast, and reduced its 2008 cash generation target.

Players

Las Vegas's Gambling Slump Shows How Starbucks Expansion Bubble Lost Air The Starbucks index is pointing down in Las Vegas. The Nevada city's gambling-driven growth in the 1990s proved irresistible to Starbucks Corp., the world's largest coffee-shop chain. Las Vegas, which had no Starbucks outlets before 1995, has about 155 now, according to the store locator on the company's Web site. Starbucks, stung by a slowdown in sales as strapped consumers shy away from $4 lattes, is staging the biggest retreat in its 37-year history, closing 600 of 11,168 U.S. company-owned and licensed stores. Las Vegas is taking the biggest hit, losing 16 of the once-trendy cafes, including in North Las Vegas, or 10 percent of its total. Los Angeles will lose just two of about 56 and New York City 10 of more than 200. The closings ordered by Chief Executive Officer Howard Schultz, 55, will cost as many as 12,000 jobs in the U.S. The company had 172,000 jobs as of last September. Rising gasoline and food prices, increased unemployment and the housing slump have shackled Starbucks. The company said in April that U.S. sales in stores open at least 13 months, a standard retail industry measure of performance, declined for the third straight quarter. Starbucks swings to loss on store closure costs

Why Starbucks lost its mojo Pundits and analysts blamed stock prices, the mortgage crisis, competition from McDonald's and Dunkin Donuts, along with real estate blunders, like putting stores on opposite corners of the same intersection. But they had it mostly wrong. This economic logic was too narrow and not culturally informed enough to explain Starbucks' fall. The company thrived throughout the past 15 years by giving middle-class Americans exactly what they thought they wanted – and this wasn't really about coffee. It was about creating a product that allowed doctors and lawyers, IT specialists and travel writers, and then their imitators, to portray themselves as they wanted to be seen. That's how products work in the world we live in. We buy things to announce something about ourselves. For the most part, the products that sell the best are the ones that communicate most effectively. That's what Starbucks did with their coffee. Really, then, they sold not coffee but elevated status. Just by buying the coffee and speaking the company's made-up lingua franca, you became a cup-carrying member of the upper class. And that made Starbucks, overpriced as it was, an affordable form of statusmaking.

Whole Foods Looks for a Fresh Image in Lean Times Whole Foods Market is on a mission to revise its gold-plated image as consumers pull back on discretionary spending in a troubled economy. The company was once a Wall Street darling, but its sales growth was cooling even before the economy turned. Since peaking at the beginning of 2006, its stock has dropped more than 70 percent. Now, in a sign of the times, the company is offering deeper discounts, adding lower-priced store brands and emphasizing value in its advertising. It is even inviting customers to show up for budget- focused store tours like those led by Mr. Hebb, a Whole Foods employee. But the budget claims are no easy sell at a store that long ago earned the nickname Whole Paycheck. Told of the company’s budget pitch by a reporter, some Whole Foods customers said they had not noticed cheaper prices; a few laughed.

Walter Robb, the company’s co-president, acknowledged that Whole Foods was fighting strong consumer perceptions about the chain’s prices, and he added that some of that was deserved. But he said the company had made a strong effort to challenge its competitors on price. Whole Foods’ makeover comes amid a tumultuous time in the grocery industry, as customers struggling to pay for higher-priced fuel and food are trading down to lesser products and discount-oriented stores. A July survey by TNS Retail Forward, of Columbus, Ohio, found that 20 percent of shoppers have changed where they buy groceries and household essentials because of the economy. The biggest beneficiaries have been dollar stores and discount grocers like Aldi and Save-a-Lot, which offer a limited selection at extreme discounts.

Wal-Mart Stores Inc.'s run as this year's best-performing Dow Jones Industrial Average company may end after the world's largest retailer said sales growth will slow this month. Wal-Mart declined 6.3 percent yesterday, the steepest drop since 2002, after it said sales in stores open at least a year may rise as little as 1 percent, which would be the smallest gain in five months. The company said most shoppers had spent the U.S. tax rebates that spurred sales. Wal-Mart had climbed 28 percent this year before yesterday, compared with the 30-company Dow's 14 percent drop. After yesterday's decline, Bentonville, Arkansas-based Wal-Mart had a gain of 20 percent, just ahead of International Business Machines Corp.'s 19 percent increase. Spending of tax rebate checks, part of the government's attempt to rejuvenate the economy, helped produce Wal-Mart's biggest same-store sales gains of the year in May, with a 3.9 percent increase, and June, with a 5.8 percent jump. The company lured shoppers battered by soaring gasoline and food costs with $4 prescriptions and discounts on groceries and flat-screen televisions as steep as 30 percent. Total sales in the first half of the fiscal year that started Feb. 1 climbed 9.6 percent. Total sales in July increased 9.4 percent. ``We are seeing the end of a catalyst,'' Lauri Brunner, a Minneapolis-based analyst for Thrivent Asset Management, said yesterday in a Bloomberg Radio interview. Thrivent manages $73.2 billion in assets, with 1.5 million Wal-Mart shares through June.