Message from the Fed

When the roster of Fed speakers in a single day stretches past five, you know you are in for a real treat of undecided commentary.  That was the case Tuesday when eight members of the Federal Reserve Board took to podiums around the country to speak in an official capacity. 

The Lineup

Two members - Fed Governor Warsh and Philadelphia Fed President Plosser - served as moderators of panel discussions while five other members - Fed Chairman Bernanke, Cleveland Fed President Pianalto, San Francisco Fed President Yellen, Kansas City Fed President Hoenig and Dallas Fed President Fisher - delivered actual speeches that touched on the topics of liquidity measures, monetary policy and the economic outlook (Chicago Fed President Evans was due to speak Tuesday night).

A Familiar Tune

By and large, most of the remarks in these speeches weren't seen as breaking any new ground.  There was the requisite concern about inflation pressures, the reminder that the housing market remained a key risk in terms of the growth outlook, the thinking that the stimulus plan should help boost growth in the second half, and an acknowledgment that conditions in the financial markets are still far from normal.

The latter was heard in Fed Chairman Bernanke's speech, which focused on liquidity measures. 

Anyone who works in the financial markets would tell you that Bernanke's observation wasn't a mind-blowing one.  Credit spreads, while improved, still reflect conditions that are less than ideal. 

Spreading the News

One such measure known as the TED spread, which is the difference between the 3-month Treasury bill and 3-month LIBOR, stood at 85 basis points.  In a more normal environment that spread is in the neighborhood of 10 to 50 basis points.  However, it would be remiss not to add that the 85 basis point spread is a marked improvement from the 204 basis point spread seen shortly after the Bear Stearns bailout in March.

The understanding that the spread has contracted in the way that it has speaks to the calming influence of the Fed's efforts to boost liquidity through a series of innovative policy actions that include the Term Auction Facility, the Term Securities Lending Facility and the Primary Dealer Credit Facility.

In his speech Bernanke noted that the Fed stands ready to boost the size of its auctions if warranted by financial developments.  Based on the Fed's actions thus far, there was no surprise in that admission.

Remembering the Past

Bernanke's remarks provided a sobering reminder that it would be a mistake to grow complacent on the credit market situation due simply to recent improvements in credit spreads. 

Remember, we are in an environment where the worst of the market's fears have been tempered, yet as seen in the TED spread, we're not back to normal.

Bernanke wanted to make this point clear, as well as the point that it will most likely take more supervision and regulation of financial institutions to tackle the problem of moral hazard that always arises when the Fed is acting outside the scope of normal operations.

The stepped up supervision and regulation would presumably reduce the likelihood of the Fed being in the position of having to implement emergency measures to guard against a systemic risk.  It is a virtuous idea, but come to think of it, wasn't that supposed to be the ideal in the wake of Long-Term Capital Management?

There will undoubtedly be more supervision and regulation of financial institutions following the credit mess of 2007 and 2008.  However, when conditions return to normal, and eventually tip to better than normal, you can bet there will be increased calls for reduced regulation in an effort to maximize profit potential. 

Those calls will likely be heeded, and just as we'll see a thriving subprime mortgage business again some day, we'll also see the Fed wrangling again with a systemic risk. History and human nature all but assure it.

--Patrick J. O'Hare, Briefing.com

Wal-Mart Earnings Report

Wal-Mart (WMT 56.88, -1.14) reported its fiscal first quarter results Tuesday and provided guidance for the current quarter.  Its stock is down, with media reports attributing the weakness to disappointment Wal-Mart's guidance leaves more room for a downside surprise relative to the consensus estimate than a positive one.

While the reports ring true to a certain extent, they over-emphasize the point, failing to take into account that (a) Wal-Mart's stock has been on an impressive run of late and (b) the company has a history of providing conservative guidance.

In terms of the first quarter, Wal-Mart reported a 6.9% increase in net income to $3.022 billion, or $0.76 per diluted share, on a 10.2% jump in net sales to $94.1 billion.  The earnings per share figure was at the high end of upwardly revised guidance communicated in April.  Specifically, Wal-Mart said at that time that it expected first quarter earnings to range from $0.74 to $0.76 per share, up from initial guidance of $0.70 to $0.74 per share.

Incidentally, the initial guidance of $0.70 to $0.74 provided in February after its year-end report also left more room for a disappointment relative to the consensus estimate at the time of $0.74.

This time around Wal-Mart is projecting fiscal second quarter earnings to range from $0.78 to $0.81 per share.  The current First Call consensus estimate is $0.81.  Separately, the retailer is projecting U.S. same-store sales for the quarter to be flat to up 2%.

Wal-Mart reiterated its view that it is difficult to asses how the stimulus payments will impact its U.S. sales. 

With Wal-Mart providing free check-cashing services and focused on being recognized as the low-price leader, we'll go out on a limb for the company and say the impact will be a positive one.  Moreover, we suspect it will ultimately be cited as a catalyst by Wal-Mart for raising its guidance before the end of the quarter.

Either way, we can't help but be pleased with Wal-Mart's performance of late.  It is executing remarkably well, which is exactly what one would expect to see from this retailer in an environment where consumers have curtailed discretionary spending on account of higher food and energy costs and falling home prices.

The latter point notwithstanding, the April Retail Sales report indicated that discretionary spending hasn't stopped altogether.  Sales at electronics and appliance stores were up 1.4% from March and were up month-to-month in other highly discretionary categories such as clothing stores (+0.7%), sporting goods, hobby, book and music stores (+0.4%) and food services and drinking places (+0.9%).

Capitalizing on its staple grocery and drug businesses, Wal-Mart is picking up market share in this challenging economic environment.  However, it isn't giving away the store to do so.  Its gross margin in the first quarter was up 20 basis points from the year-ago period to 24.6% while its operating margin slipped just 10 basis points to 5.6%.

Inventories have been very well-managed, which is allowing Wal-Mart to dictate its price promotions as opposed to being in a position where it has no choice but to mark down prices aggressively to move merchandise.

The market has shown a renewed appreciation for Wal-Mart's approach to its business as evidenced by the 19% year-to-date return for its stock.  In the two months leading up to this latest earnings report, shares of Wal-Mart had risen 15% alone.

Given the outperformance, it is understandable that investors might view Wal-Mart's latest report as an opportunity to take some profits.  

At 16.5x estimated earnings, Wal-Mart isn't as cheap as it used to be, yet its commendable execution and competitive advantage in the current economic environment are key factors that favor holding the stock.

--Patrick J. O'Hare, Briefing.com