Earnings Bring Housing Sector Into Focus

Home-improvement retail chain Lowe’s (LOW) is usually a good barometer for the state of the housing market. And judging by the company’s latest earnings report, the recovery could be stalling. Lowe’s this morning reported second-quarter earnings of 51 cents a share on sales of $13.8 billion. Profits fell 19% from a year ago, well below expectations. And investors are punishing the stock, which is down sharply in pre-market trading.

Analysts weren’t expecting a blowout quarter, but the numbers could quickly curb enthusiasm for housing stocks. Lowe’s issued guidance for the third quarter that was below expectations, saying it expects earnings between 21 and 25 cents per share, compared with a 27 cents forecast by Wall Street analysts. The company has been opening stores, adding 21 in the first quarter, and had plans for another 18 in the second quarter. But it may now take a bit longer for those stores to turn a profit. And the company now says it will slow its expansion.

Home Depot (HD) reports later this week and if it issues a similar forecast, analysts could see it as a sign that housing is still troubled. Brokerage firm FBR Capital Markets downgraded Lowe’s recently from "outperform" to "market perform," largely on valuation concerns. Expect more downgrades if Home Depot doesn’t report improving numbers.

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Housing will be in the spotlight later today, when the National Assocation of Homebuilders Index comes out at 1 p.m. The index provides a glimpse of housing demand and sentiment among builders. And it’s risen in four of the past five months, suggesting housing has bottomed out.

The big question: whether builders are starting to see cracks in the market. Builders broke ground on new homes in July at the fastest pace in eight months, according to a Bloomberg survey. Housing starts rose 2.7% last month to an annual rate of 598,000. And even the luxury market may be stabilizing. Toll Brothers (TOL), the largest U.S. luxury homebuilder, reported last week third-quarter revenue that exceeded analysts’ estimates, with new home contracts rising over the year-earlier quarter for the first time since 2005.

Still, housing stocks may already be priced for perfection (at least in this economy). The S&P’s homebuilder index is up 31% since the beginning of July, compared with a 9.2% increase for the market. And analysts say one or two more earnings misses could be enough to topple this wobbly sector.

They don’t call it the dismal science for nothing. Japan’s economy grew at an annual 3.7% in the first quarter, the government said Monday, marking the end of its worst recession since World War II. But economists were looking for 3.9% growth, and Japan’s Nikkei stock index promptly sold off, ending the day down 3.1%.

Japan is the latest major economy to emerge from recession, following France and Germany last week, but the markets are starting to show skepticism. Analysts said Japan benefitted from a massive government stimulus package (sound familiar?) and strong export growth (up 6.3%). But the effects of the stimulus may soon wear off and economists saw dark clouds in the silver lining: business investment, about 15% of the economy, fell 4.3% in the quarter, the government said. Unemployment is expected to hit a record 5.9% next year. And consumer spending—never particularly robust in Japan—is forecast to be weak as workers muddle along with lower wages. Indeed, Japan’s central bank now says GDP is likely to grow at a slow 1% rate—suggesting the country won’t be a global growth engine soon.

Of course, none of this bodes well for U.S. stocks. The markets were already getting frothy, with the S&P 500 up nearly 50% from its March lows. True, many companies have issued earnings reports that beat Wall Street forecasts. But earnings season is almost over, and analysts say the markets will want to see evidence that economic growth is sustainable. If Japan is any guide, though, the stock party could come to a quick end if the results don’t top expectations.

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