Stocks Tumble, But Hope Holds Its Ground

THE STOCK MARKET'S RALLY OFF ITS JULY 15 LOW SPUTTERED, yet Wall Street heaved a small sigh of relief.

For a start, last week's pause was just benign enough to keep the recent bounce alive, even if the bullish momentum had begun to flag. The biggest setback came Thursday when the Dow Jones Industrial Average skidded 283 points after the release of data showing sales of existing homes had plunged in June toward a decade low. Yet the blow was blunted by uninspired volume; 6.05 billion of New York Stock Exchange shares traded, compared with volume topping 7 billion when stocks turned around.

Financial stocks that had just pulled off a 31% six-day surge began to falter, absorbing a 6.7% drubbing that accounted for nearly half of the Standard & Poor's 500's Thursday decline. But a pullback like this "is not unusual following a rebound off a climactic low," notes Miller Tabak's chief technical market analyst, Philip Roth.

Most crucially, crude oil continued to burn off its recent speculative fumes and fell 4.8% to $123 a barrel. This third straight weekly slide left crude 15% off its recent peak and snapped a pernicious rise that had threatened consumers and weighed down stocks. These breaks in oil's uptrend and stocks' downtrend could still carry "enough momentum to rally the S&P 500 into the 1320-1340 range," argues Bespoke Investment Group.

The Dow ended the week down 126, or 1.1%, to 11,371, while the S&P 500 relinquished 3, or 0.2%, to 1258. The 500-stock benchmark had bounced nearly 5% from its mid-July intraday low of 1200 but remains 20% off its October peak. Technology and small stocks fared better: The Nasdaq Composite Index rallied for a second straight week after its six-week losing streak and added 28, or 1.2%, to 2311. The Russell 2000 index rose 17, or 2.5%, to 710.

Stocks' ginger footing leaves much to worry about. The mid-July bounce was spurred by a rule change some traders dismiss as a "government-orchestrated short squeeze," and it robbed stocks of the chance to reach a natural trough. Home prices continued to decline, banks aren't lending, global economic growth has slowed and job cuts are rising. But an uptick in big-ticket items ordered, and a wee 0.6% ebb in new-home sales in June offered some reprieve, as did a minor lift in consumer confidence as rebate checks are spent.

Might oil fall further to give stocks a boost? Refiners' earnings reports this week will offer a preview. Results are expected to be terrible, squeezed as refiners were by pricey crude and waning domestic gasoline demand. But the stocks' trajectory serves up a hint of how long and how far the market expects crude oil to retreat.

Meanwhile, companies continued to prime investors for the worst, and warnings from American Express (ticker: AXP) to Costco (COST) showed the rot sparing no segment of the income spectrum. Clog-maker Crocs (CROX), which traded as high as 75 last October and which Barron's has consistently warned against, plunged below 5 after it slashed estimates.

But how much of the profit outlook is already priced into stocks? According to Bespoke, the 64% of companies that have beaten estimates so far have rallied 3.2% immediately after, while the 26% missing the mark have slid 4.9%. Overall, the average stock has clung to a slim 0.6% gain -- the paralysis a measure of how far the market has already fallen and its inability to advance.
ANYONE WHO DOUBTS EXPECTATIONS are heightened still need only look at Chipotle Mexican Grill (CMG). The Mexican-food restaurant chain reported a 23% rise in net income that nonetheless missed estimates by a penny, and the stock was pummeled.

The drubbing left the one-time high-flyer -- flagged here in October as over- priced -- down nearly 56% this year. At about 66, shares now fetch just over 20 times forward earnings, down from a jalapeño-hot 53 times last fall. One analyst after another surrendered and downgraded the stock last week, worried about compressed margins and slowing growth as menu-price increases failed to offset the surging cost of ingredients. It doesn't help that the jalapeno has joined another key ingredient -- tomatoes -- on the salmonella-scare list.

Sometime soon, a better risk-reward profile will nudge Chipotle onto the Buy list. After all, sales and profits are still growing, and the company plans to open more restaurants this year than it did last. But one senses the selling could get worse before the bears exact their toll and things get better.

Yum Brands (YUM), too, recently saw second-quarter revenue rise 12% and net income improve 4%, but alas, commodity costs pushed expenses up 14%. While the operator of KFC and Taco Bell beat estimates (thanks to a lower tax bill), its weakening margins worried investors enough to knock shares down to 34, off 16% since May.

Considering the unprecedented pressure on consumers, its same-store sales look commendable, and 14% growth in China and plans to open 450 restaurants there helps Yum capitalize on the overseas consumer boom and the Third World's sad but growing hankering for American fast food. In 10 years, Yum reckons 70% of its growth will come from overseas, which makes this pullback a buying opportunity -- especially if the rabid rise in commodity costs begin to ease.

FIVE YEARS AGO, Lehman Brothers (LEH) bought Neuberger Berman to diversify its revenue stream beyond its fixed- income roots. But will they still be together to celebrate the deal's anniversary in October? A question making the rounds is whether Lehman will have to sell its asset- management unit to buttress its balance sheet. The Wall Street firm raised some $12 billion in equity capital recently, but a still-foundering housing market renders future mark-to-market losses likely.

Lehman's asset management unit could generate $2.07 billion in 2008 revenue and earn nearly $750 million in pre-tax income, estimates Keefe Bruyette Woods analyst Lauren Smith. A price tag of 11 to 12.5 times pretax income would value the entire asset management business -- of which Neuberger Berman is an integral piece -- be-tween $8 billion and $9 billion.


Rally Interrupted: The Dow's bounce off its mid-July low ran out of steam as companies braced for slower growth. The benchmark is 20% off its October peak.
Such a sale would let Lehman raise capital without diluting shareholders. But Neuberger, with its clutch of wealthy clients and burgeoning assets under management, helped prop up the firm. Even as revenue from debt underwriting and fixed income grew in recent years, Lehman was able to expand the portion of its revenue drawn from the stock markets and from overseas.

That has helped Lehman's credit ratings, while closing its valuation chasm with its peers -- advantages the firm must hold dear in these jittery times. Not for nothing that Merrill Lynch (MER) recently opted to sell its stake in Bloomberg rather than relinquish its holding in BlackRock (BLK). In the long term, Smith thinks Lehman may be better off keeping asset management intact and selling a minority piece to private equity investors -- assuming it has a choice.