Archive for 2006

• Now It’s Medtronic’s Turn
  Eddy Elfenbein, August 3rd, 2006 at 11:35 am

  Shares of Medtronic (MDT) are getting slammed today. The company said that sales for the first quarter came in below expectations. Analysts were looking for sales of $2.98 billion while the company said that sales were $2.9 billion.
  Medtronic also said that earnings will range from 53 cents to 55 cents a share. The Street was looking for 57 cents a share.
  In May, the company raised 2007 estimates to $2.40 to $2.48 a share.
  Earnings are due on August 22.

• My Problem with the Mankiw Method
  Eddy Elfenbein, August 3rd, 2006 at 6:31 am

  As a rule of thumb, I try not to get in the habit of pointing out oversights made by Harvard professors. Having said that, I have a minor quibble with Professor Greg Mankiw.
  In the interest of full disclosure, Professor Mankiw is the Robert M. Beren Professor of Economics at Harvard, and he’s also the former chairman of the President’s Council of Economic Advisors.
  Me? I often blog while wearing bunny slippers.
  Anywho, Dr. Mankiw developed the “Mankiw Method,” which is a simple back-of-the-envelope equation for determining the appropriate target for the Fed funds rate:

  Federal funds rate = 8.5 + 1.4 (Core inflation – Unemployment)

  The Mankiw Method certainly has its benefits. It’s easy to follow, and in my opinion, it would have done a better job than the Fed over the past few years.
  There is, however, one major problem with the Mankiw Method. According to the equation, inflation’s impact on interest rates is greater than 1.0. I feel this is a big mistake. What it means is that for every 1% increase in inflation, interest rates rise by 1.4%. Consequently, as inflation increases, real interest rates also rise independent of unemployment.
  As long as inflation is low, the equation works well. But once inflation starts creeping up, then we start seeing problems. In February 1991, unemployment stood at 6.6% and core inflation reached 5.6%. According to the Mankiw Method, real interest rates should be 1.5%. In July 2004, unemployment was at 5.5% and core inflation was running at 1.8%. Again, the Mankiw Method would recommend a real rate of 1.5%.
  To restate my earlier sentence, for everyone 1% increase in inflation, real rates rise by 0.4%. This seems like extra punishment for an economy just for inflation.
  The blog, Political Calculations, also has some issues with the Mankiw Method, which the professor addresses.

• The Fed’s Next Move
  Eddy Elfenbein, August 2nd, 2006 at 4:39 pm

  I wanted to help shed some light on the Fed debate Wall Street has been having. The futures market indicates that Wall Street thinks there’s a 30% chance of a rate hike coming next Tuesday. Personally, I’m surprised so many people feel that way. It seems obvious to me that the Fed will raise rates, or at least, they ought to raise rates.
  Let’s take a step back and look at what’s happening. Everybody always wants to know what indicator the Fed is watching. Some people think the Fed should watch gold. Others think it’s employment and wages. Still others think it should monetary aggregates.
  I think the best variable to watch is real interest rates. By real, I mean the after-inflation return of short-term Treasury bills. Here’s a graph of the real return of 90-day T-Bills going back more than 50 years (12-month rolling period):
  
  Granted, this isn’t a perfect measurement. Monetarists will say that it’s not a cause but an effect of inflation. The biggest problem is that you never know what future inflation will look like. You only find out the real return after the fact. Still, I think it’s the best way to look at the Fed’s policies.
  For example, you can see that rates were too low during much of the 1970s. Real rates were negative for nearly eight straight years. In other words, you got paid to borrow money. That’s the problem with inflation. If it isn’t stopped early, it can spiral out of control.
  In my opinion, the Fed lowered rates far too much after 9/11. You can see that real rates were negative for over three years. That’s less than the recession of 15 years ago, which was much worse than the fairly shallow recession earlier this decade. I think we’re seeing the effects of the Fed’s easy money in today’s (still modest) inflation.
  Ideally, real rates should be at 0% during a recession, and around 3% during an expansion. The most recent report on core CPI showed that inflation increased 2.64% over the last twelve months (that’s through June). I should also point out that the T-Bill rate is about 30 basis points below the Fed funds rate.
  I’d like to see the Fed take rates up another 25 basis points, before pausing. I don’t think pausing now would be a huge error, but it’s better done sooner rather than later.
  There’s another fact to keep in mind: There’s a lot of new blood at the FOMC. Two governors joined the Fed earlier this year. Plus, there are two other vacancies (Frederic Mishkin has been confirmed by the Senate but he won’t be sworn in until after Labor Day).
  This means that there will be only ten voting members at the FOMC meeting. Since the Fed presidents take turns each year (the New York Fed President is a permanent member), this means that a minority of votes on Tuesday will be cast by people who never agreed to the start of the Fed’s rate hikes two years ago.
  We often forget that the FOMC is in fact a committee, but I wouldn’t be surprised to see some dissension next week.

• Too Much for Whole Foods
  Eddy Elfenbein, August 2nd, 2006 at 11:59 am

  Last December I wrote that Whole Foods Market (WFMI) was overpriced and probably due for a fall. At the time, the stock was at $76 a share (post-split). What happened? Of course, it rallied $78.
  But on Wall Street, the true value of a stock will eventually come through. You just need to be patient. Yesterday, Whole Foods’ stock dropped nearly 12%. The stock is now at $51 a share. That’s a pretty nasty fall.
  The company actually reported decent earnings but sales came in below expectations. It’s a good company, but the shares still look pricey.

• Expeditors International Is Getting Slammed
  Eddy Elfenbein, August 1st, 2006 at 2:55 pm

  The transportation stocks have been getting punished hard lately. Today’s victim is our very own Expeditors International (EXPD).
  The company reported earnings today of 25 cents a share, which was just a penny below expectations. The stock is currently down $6 a share, or over 13%. Frankly, the stocks strong rally during the first half of the year pushed it into overpriced territory, so some selling was due.

• Happy August
  Eddy Elfenbein, August 1st, 2006 at 9:24 am

  Ticker Sense notes that two-thirds of the total return of this bull market has come on the first day of the month:

  It’s that time of the month again – the first of the month. During this bull market, the cumulative return of the S&P 500 on the first trading day of each month is 27.04%. This blows away the cumulative return of the rest of the month which is just 13.44%. This means that 67% of the gains since the market lows of October 2002 have come on the first trading day of the month. The last two months have been especially profitable, with June 1st going up 2.05% and July 3rd going up 0.79%.

• GDP Revisions
  Eddy Elfenbein, August 1st, 2006 at 9:01 am

  Here’s something that hasn’t got a lot of attention. Along with last week’s GDP report, the government revised all the GDP numbers going back to 2003.
  Here’s what the new GDP figures look like compared with the old ones:
  
  Here’s what the old and new quarterly growth numbers look like:
  
  It turns out that the government had overstated economic growth from 2003 to 2005, and slightly understated growth for the last few quarters. This wasn’t a small revision either. Last month’s report of first quarter GDP was $11.316 trillion (these are annualized numbers and adjusted for inflation). The new number is $11.404 trillion. That’s a reduction of nearly 0.8% or almost $90 billion. Even a small reduction is a huge amount when dealing with the U.S. economy.
  While the initial GDP report of 2.5% has received a lot of attention, keep in mind that this number will be revised twice more, at the end of August and again at the end of September. These can be large adjustments too. The initial report of first-quarter GDP was 4.8% and it was later raised to 5.6% (and lowered again from 5.64% to 5.58%).
  It could turn out that all the concerns of the “weak” second quarter was much ado about nothing. We place a lot of importance on what the Federal Reserve does, but it’s always good to remember that the Fed never has a clear vision of what’s truly happening. The Fed is trying to drive on a highway by only using a a rear-view mirror. And it’s a blurry mirror at that.

• Donaldson Raises Dividend
  Eddy Elfenbein, August 1st, 2006 at 8:31 am

  There are two small items from last week that I wanted to mention. The first is that Donaldson (DCI) raised its dividend from eight to nine cents a share. Although the dividend yield is still very low (about 1.1%), what impresses me is how regularly Donaldson has increased it. The dividend has doubled in the last three years and tripled in the last seven. For the long-term, the company has increased its dividend by an average of 14% a year. That should put the low yield into some perspective.
  I also wanted to touch on Respironics’ (RESP) earnings. The company earned 43 cents a share which was very good. That beat expectations by four cents a share. This was also the end of RESP’s fiscal year so in FY 06, Respironics made $1.47 a share. For next year, the company sees earnings coming in between $1.72 a share and $1.77 a share (or 17% to 20% growth). The Street had pegged earnings at $1.63 a share. The stock didn’t react much from the announcement.

• The Midday Market
  Eddy Elfenbein, July 31st, 2006 at 11:28 am

  The markets are mixed so far. Energy stocks are up a bit, and financials have pulled back. The yield on the 90-day T-Bill has crossed over the 5-year yield which I don’t think had happened before.
  Expeditors International (EXPD) is set to report earnings tomorrow. After having a great first half, the stock has been very volatile recently.

• Economy Grew By 2.5% in Q2
  Eddy Elfenbein, July 28th, 2006 at 9:15 am

  The govenment just reported that GDP grew by 2.5% for the second quarter, which is less than half the rate of the first quarter:

  The second-quarter’s performance — which reflected the bite of high energy prices and rising interest rates on people and businesses as well as a cooling in the once red-hot housing market — was weaker than the 3 percent pace analysts were forecasting.
  The 2.5 percent pace was the slowest since a 1.8 percent growth rate in final quarter of 2005, when the economy was suffering fallout from the devastating Gulf Coast hurricanes.
  Even though the economy cooled in the second quarter, inflation heated up.
  An inflation gauge closely watched by the Federal Reserve showed that core prices — excluding food and energy — jumped by 2.9 percent in the second quarter — far outside the Fed’s comfort zone. That was up from a 2.1 percent increase in the first quarter and marked the highest inflation reading since the third quarter of 1994, when core inflation rose by 3.2 percent.
  The inflation reading was taken before the latest run-up in energy prices. Oil prices hit a record closing high of $77.03 a barrel on July 14. Gasoline prices also have marched higher, topping $3 a gallon in many areas.