by Shawn Narancich, CFA
Vice President of Research
The Mice Will Play While the Cats Are Away A late summer melt-up for stocks continued this week as more benign economic data globally, and supportive domestic retail earnings, kept stocks firmly bid. If it feels too good to be true, it may be. With key European policymakers on summer vacation and trading volumes low, investors are suspicious about the gains stocks have achieved recently. While evidence indicates that hedge funds have increased their exposure to this asset class, mutual fund data continues to show neutral-to-negative equity fund flows and substantial flows into bonds. Will retail investors’ distrust of stocks prove prescient? September may prove pivotal, as Europe’s sovereign debt troubles are far from solved. Will an upcoming ECB meeting, the German high court ruling on the constitutionality of the European Stability Mechanism fund, and yet another European finance ministers’ meeting harbor the potential to deal equities a setback? For now, stocks stand within shouting distance of year-to-date highs, and were bolstered this week by positive reads on both U.S. industrial production and better than expected retail sales that rose for the first time in four months. As stocks have risen, the marginal investment dollar has exited Treasuries, which booked another week of losses.
Ringing up Gains at the Cash Register Adding incentive for investors to add equity exposure was a heavy week of retail earnings reports that painted more plusses than minuses. After struggling for what seemed like an eternity to reverse its sluggish sales, Wal-Mart has parlayed inventory investment and sharper consumable pricing to book what has now been four consecutive quarters of positive same-store sales. The stock failed to pass muster with investors, however, as 20 percent year-to-date gains already appear to have discounted a 2 percent same stores outlook and moderately lower margins. The takeaway for Wal-Mart and its chief rival Target continues to be sharper pricing and one-stop shopping for lower income audiences stressed by high unemployment and $3.85/gallon gas. And just when investors had nearly thrown in the proverbial towel on 1990’s favorite The Gap, this retailer is now putting up impressive numbers at its namesake chain, Banana Republic, and discounter Old Navy. New management and better apparel styles appear to be doing the trick -- after nearly doubling so far this year, the stock added another 5 percent this week on a 7 percent gain in same-store sales and higher margins that drove a 40 percent boost to earnings.
A New Era Investors not content to leave their feasting to retailers also bid up the stock of Cisco on news the technology networking company will return more of its cash flow to investors. The stock’s 9 percent surge this week had less to do with ho-hum earnings and everything to do with a head-turning 75 percent dividend increase. In an arguably belated acknowledgement that its heady growth of the technology boom years is a thing of the past, Cisco’s management is recognizing, like so many other blue chip companies, that returning excess cash flow to shareholders is the best option in a slow growth, low interest rate environment where investors are hungry for yield.
Our Takeaways from the Week
- The Summer Doldrums have been kind to equity investors…so far
- Encouraging earnings reports from retailers unofficially marked the conclusion of second quarter earnings season