5 Caution Signs In The Market

Morningstar markets editor Jeremy Glaser is seeing some yellow flags in earnings, commodities, and retail sales.

Jason Stipp: I am Jason Stipp from Morningstar, and welcome to the Friday Five.

After some surprise market news this week and not a small bit of volatility, the Friday Five is asking, “Is it time for caution?”

Here with me to offer some details is Morningstar markets editor, Jeremy Glaser.

Jeremy, thanks for joining me.

Jeremy Glaser: Glad to be here, Jason.

Stipp: So what do you have for the Friday Five this week?

Glaser: We’re going to take a look at caution at retailers, at Opentable, at General Motors, commodities, and finally at Boston Beer.

Stipp: So a lot of retailer reported same-store sales on Thursday. They looked pretty good. Where is the caution there?

Glaser: The sales did look good. Overall, a lot of retailers, big ones like Target and Costco had really good quarters. A lot of that was driven by Easter. Easter spending being in this particular month. But certainly we heard a lot of caution from executives in terms of raising guidance, and in terms of trying to temper investor expectations for the coming months.

They think that rising gas prices are keeping people from going to the mall or taking up a lot of extra consumer disposable income, and that unemployment is still a problem, and really could be a drag on earning sales.

So even though they had a pretty good report, generally speaking there was lot of caution about what things could look like in the future.

Stipp: One area where we do hope that consumers will continue to spend is in the restaurant arena. Opentable is a company that helps them make reservation for restaurants. They reported this week. Any signs of caution there?

Glaser: I think we do have some reservations about picking up Opentable stock. This is a hot IPO, and it really soared after it came out of the gate. People are excited about the tech boom. People are excited about the innovative model, but our analyst R. J. Hottovy has really considered the stock to be pretty overvalued, and their earnings release this week did nothing to dispel that notion.

They had a lot of trouble with keeping costs under control. They spent a lot of money on technology, a lot of money on headcount, a lot of acquisition-related expenses. That really kept profitability down, and this is a business that should be extremely profitable, if you think about it. Their general levels of cost of goods sold should be relatively small, but certainly they have had trouble executing on that.

They are still a young company. Things will probably improve over time after they make these investments. Hopefully, they will pay off. They will be able to reap them later. But for the time being, the valuation is just too rich, and we think investors should be cautious about the stock.

Stipp: GM reported on Thursday. It’s a big name a lot of folks were looking for. We expect that there is still a lot of pent-up demand in autos. Did the results play out as we would have liked to have seen?

Glaser: We’ve been excited about General Motors since it has come out of its bankruptcy reorganization. You are absolutely right that there is probably a lot of pent-up demand for auto sales. They just had shrunk to such a low level that there are lots of people who now have to go and replace cars that just aren’t roadworthy anymore, cars they just don’t want anymore.

And GM could be a prime beneficiary of that. They’ve shed a lot of legacy brands and legacy costs that really burdened them before, but we saw this quarter that they are still having to spend a lot of money on incentives and promotions in order to get that volume through the door.

Most of the improvement in earnings came from higher volume instead of higher price, and management has said before they don’t think that these incentives are creating a big drag, but our analyst Dave Whiston certainly thinks that that actually could be the case, and that he is expressing some caution. Investors should really look carefully at these promotions to make sure that profitability and that earnings don’t shrink too much. I think we’re still relatively optimistic on the company over the long-term, but we are seeing some very early signs of caution there.

Stipp: In the commodities market, we’ve seen a real roller-coaster ride. I think oil was down at one point about 10% on Thursday. Silver really swooned this week. What’s going on with commodities and how much caution should you have if you were interested in investing in that area?

Glaser: I think, you need to have a lot of caution to have an iron stomach before you really get into the commodity market and into commodity trading.

Unlike a stock or even a bond, where you can say, “OK, here are the clear levers, and here is how they’re going to move”–things like earnings, things like how people are going to view those future earnings–commodities don’t pay off that kind of income. They’re worth in a lot of cases what someone else is going to buy them for or work what the industrial use could be for some other commodities. And certainly it’s difficult to predict that.

With the recovery in the United States seeming to slow down a little bit, but with emerging markets remaining strong, with uncertainty in the Middle East and across the globe ebbing and flowing it seems like on an almost weekly basis, it’s really challenging to come up with exactly where these commodity prices are going.

They’d risen so much, it isn’t terribly shocking that we’re seeing some pullbacks in some of those key commodities markets. I personally don’t know exactly where any of them are going to go anytime in the future, but I think before investors go in, they need to do it with their eyes wide open and understand they’re going to need to take some caution and be prepared for quite a bit of risk as they enter into those markets.

Stipp: So, lastly Jeremy, after a rough week in the market, some folks might want to kick back with a beer and relax. We heard from a couple of beermakers this week. Should investors raise a glass and say cheers?

Glaser: I don’t think it’s time for all investors in breweries to start getting excited and raising the glass quite yet. Boston Beer, the maker of Sam Adams, looks a little bit frothy right now. Certainly craft beer has been a very rapidly expanding category in the United States; we’ve seen a lot of entrants from players like Anheuser-Busch InBev or from Molson Coors, and those have really been competing against Sam Adams pretty effectively. And Sam Adams has had to really expand their advertising spend and really expand their marketing in order to keep their market share up to keep that volume coming out of the brewery. They’ve been successful so far, but it’s been expensive, and it’s really hurting profitability.

We think when you look at the stock a few years down the road, if you think that we’re going to have compressed profitability over that time, the stock really doesn’t look like a great value. We think people would be better off looking at some other breweries–Molson Coors in particular looks the most undervalued right now.

Certainly for consumers, it’s great to have a lot more choices, but for investors they should be careful of not just buying the company that makes the beer they like, but buying the one that’s going to be the most profitable over time.

Stipp: Well, Jeremy, I’m glad that you’re not throwing caution to the wind. Thanks for the report today.

Glaser: You’re quite welcome, Jason.

Stipp: For Morningstar, I’m Jason Stipp. Thanks for watching.