Risk/Return: Wall Street Drama Queens, Lululemon, Olive Garden, Mosaic

Risk/Return: Wall Street Drama Queens, Lululemon, Olive Garden, Mosaic


Q3: How bad was it?
That strange noise you heard around midnight Friday night was the sound of hundreds of thousands of traders and investors sighing with relief as the books closed on the third quarter of 2011. Now it’s time to brace for the real news: how corporate revenues and earnings fared during that period.

If you believe the analysts, they did well: the consensus estimate is that S&P 500 companies will report a 13.1% jump in profits in Q3 and are on track for 14.1% gains in the fourth quarter and 9.7% better earnings next year. But apparently not too many investors share that confidence: The stock market just posted its worst performance since the dreadful winter of 2008-2009.

So who’s right, the market or the analysts? The market, several pundits declare forcefully. “Estimates are too high across the board,” says Tom McDowell, chief investment officer of Rice Hall James, a San Diego-based money management firm. Certainly, Ingersoll Rand didn’t do much to boost the bulls. Its stock plunged 12% Friday after reporting that sales slumped in the third quarter; Ingersoll Rand will still turn a profit, but it will be closer to $2.70 to $2.80 a share rather than the previous forecast of $2.90 to $3.10.

Jack Ablin, chief investment officer at Harris, is betting that third-quarter earnings will grow only 10% and that fourth-quarter earnings will show no growth at all. Investors are “deeply skeptical” about upbeat earnings forecasts, says Ablin, and simply shrug them off. Current stock market valuations price in a 20% decline, rather than the 9.7% advance analysts are looking for. “Zero percent profit growth would be greeted with relief,” he argues.

The Street’s volatility addicts
If billions of dollars weren’t at stake, it might be tempting to describe traders and investors drama queens, given their propensity to react violently to every tidbit of market news. But let’s settle for dubbing them volatility addicts. “If we don’t move instantly, we know we’ll be trampled,” says one hedge fund trader. The Chicago Board Options Exchange Volatility Index shows just how dramatic an impact that act first, think later approach has had on the markets: in the third quarter, the VIX doubled to hit 42.96, the biggest gain in its 20-year history.

In their own defense, volatility addicts point to unpredictable markets and the even more unpredictable global economy. Take last week: Thursday’s report of a dip in jobless claims made folks upbeat, but the Commerce Department reported Friday that personal incomes fell in August for the first time in two years. Traders promptly pummeled the market, sending the Dow Jones Industrial Average down 240 points.

Volatility is likely to rise to fever pitch ahead of Friday morning’s release of arguably the single most important piece of economic data these days: the monthly job creation numbers. Economists expect that 60,000 new jobs were created last month, not enough to push the unemployment rate below 9.1%. The slightest variation on that figure, and markets will swing sharply higher or lower.

Lululemon: Yoga gear that defies gravity
Americans may have seen their personal incomes flatline but that doesn’t seem to have affected their ability or willingness to fork over $100 for a pair of yoga pants from Lululemon Athletica. Skeptics may grouse that the rate at which same store sales are growing is slower than it used to be – but it’s hard to quarrel with results, when the 20% same-store sales growth is higher even than the company estimated. And Lululemon is one company that doesn’t seem to need to worry about its earnings: those came in 76% above year-ago levels when the company reported fiscal second-quarter results last week. Of course, this is defying all the conventional wisdom that says in uncertain economic environments, consumers scale back their spending to basics. Perhaps yoga gear is a 21st century basic, alongside organic vegetables and Prozac? Or maybe it’s because Lululemon yoga pants make your butt look good.

Indigestion at Olive Garden may subside
Another entry in the “things really shouldn’t be happening this way” sweepstakes comes from Darden Restaurants. History tells us that when folks feel low on cash but still want a night out, they head to restaurants like Olive Garden or Red Lobster (both owned by Darden) rather than Chez Whatever; they might have to settle for paper placemats rather than linen tablecloths, but they get table service and real cutlery. But investors seem reluctant to believe the company’s bullish forecasts that revenue will hit at least $10.5 billion by 2016, up from $7.5 billion in the fiscal year that ended in May. Perhaps that’s because for now, patrons seem to be bypassing Olive Garden in favor of the likes of McDonald’s, now offering marginally healthier fare (yum – Angus beef burgers!) at lower prices than Darden’s sit-down chains. (And you don’t need to tip your minimum-wage cashier.)

Darden’s profits are sliding – down 6% in its fiscal first quarter – and so is its stock price, down 10.7% last week, mostly after the earnings news hit the tape. Still, analyst Lynne Collier of Sterne Agee predicts that as long as that pesky employment data is not deteriorating, Darden could snap back. “They’re dealing with their company-specific issues,” she says. The demographics also favor the company. “I’m a working mom with three children,” says Collier. “Where else am I going to take them if I don’t like McDonald’s? I don’t have time to cook every night.”

Mosaic: Why it should bounce back
Mosaic got a bumpy welcome into the S&P 500 index last week. The fertilizer company reported a big jump in earnings but still disappointed analysts who hadn’t factored in a rise in costs. Still, look for the stock to recover quickly from this setback: fertilizer is one commodity that’s still in hot demand as the pressure grows in markets like China and India to boost agricultural output on a declining supply of arable land. That’s worth bearing in mind when Monsanto reports its earnings Wednesday: analysts are uniformly bullish, recommending an overweight position in the stock. The company told a Credit Suisse conference last month that it expects to collect higher prices for its new hybrid seeds as crop prices seem likely to stay high. Perhaps it’s time to compensate for those higher food prices by looking for profits from agricultural stocks?

Where the bourses are boiling
Jamaica, Mongolia, the United States, Zambia, Mauritius, Venezuela, Sri Lanka: which of these doesn’t belong in this mix? If you guessed the United States, you’re right, but probably not for the reason you expected. The other six countries have stock markets that are actually posting positive returns this year, reports Bank of America’s chief global equity strategist, Michael Hartnett. And yes, those are the only six stock markets globally to have managed this feat – the other 88 are swimming in red ink. No wonder frontier markets investing is becoming more mainstream.