Rising interest rates and inflationary pressures have put a hit on the stock of several Los Angeles County companies, including homebuilders, video game makers and restaurants.
Their share prices are in most cases being pinched by other factors as well, but the fear of rising inflation rates is clearly taking a toll.
Among the casualties:
The stock of local homebuilders recently bounced back from a jarring decline that began on May 11, but continue to tread water in anticipation of rising rates.
Shares of Los Angeles-based KB Home have shed 40 percent of their value since the start of 2006 and were trading at around $46 last week. Ryland Group Inc., also of Los Angeles, has seen its shares drop 42 percent so far this year and was trading at around $44 last week.
The stock of two local video game publishers, already facing pressure due to the growing cost of development and the transition to a new generation of consoles, has taken a tumble this year. Santa Monica-based Activision Inc.’s shares have fallen 17 percent this year and Agoura Hills-based THQ Inc. has experienced a 10 percent drop-off.
Two of the most popular local restaurant chains, California Pizza Kitchen Inc. in Los Angeles and Cheesecake Factory in Calabasas Hills, have seen their stocks falter. Both chains are mid-range eateries.
Cheesecake Factory shares are down more than 25 percent since the end of March, a drop that analysts attribute in part to soft sales and increased pressure on consumers due to higher gas prices.
Shares of California Pizza Kitchen have traded between $22 and $35 a share over the past year, though the company got a boost in May after reporting strong first-quarter profits and an 18 percent jump in revenue. The company’s same-store sales have held up better than other casual dining chains and many analysts believe CPK has a high-income customer base that has not been as vulnerable to higher gas prices.
CPK founders and co-chief executives Larry Flax and Rick Rosenfield were responsible for the company’s rebound after a rapid expansion. The company also may be feeling the pinch from higher food and energy prices.
“Casual diners that cater to a more moderate consumers are seeing an adjustment taking place,” said Peter Oakes, senior research analyst at Piper Jaffray & Co. He pointed out that high-end steakhouses Morton’s Restaurant Group Inc., based in Chicago and Ruth’s Chris Steak House Inc. based in Heathrow, Fla., are outperforming most casual dining chains.
That same theory translates to other market sectors, according to Mike Dokmanovich, executive vice president and head of middle market banking for Comerica Bank, a unit of Detroit-based Comerica Inc. He said consumers tend to steer clear of high-end retailers during a downturn.
“The luxury end of retail gets hit fast and, to some extent, basic goods on the low end get a pickup,” he said.
Spending fatigue
Though interest rates are still relatively low by historic standards, several analysts predict that consumers are at their limit on spending after serving as the catalyst for the nation’s four-year expansion. Some economists believe the dramatic sell-off of all the major stock market indices in the past few weeks is an indicator that consumer spending will halt in coming months and hit many local industries.
“I think it’s clear that the economy is going to have slower growth in the next couple of quarters, which is not a very good menu for equities,” said Don Straszheim, vice chairman at investment bank Roth Capital Partners, in Newport Beach.
Since May, the Dow Jones Industrial Average is down by 6 percent and the Nasdaq is off more than 9 percent, causing investors and executives to wonder which sectors serve as defensive bets in a climate of rising rates.
Consumer staples and healthcare are two sectors that are expected to outperform as the economy slows.
Several local health care stocks have held up well during the stock market’s recent drubbing. These include First Consulting Group Inc., based in Long Beach, Molina Healthcare Inc., also in Long Beach, and OTC Bulletin Board-traded HemaCare Corp., in Woodland Hills.
Scott Anderson, a senior economist at Wells Fargo & Co., said consumers are feeling pressure because of high energy prices and a cooling of the housing market. Combine that with the double-whammy of rising interest rates and falling stock prices and the wind could be knocked out of spending in the second quarter. Consumers account for two-thirds of U.S. economic activity.
“The Fed is making it more expensive to tap the equity in homes,” Anderson said, and that will affect consumers’ ability to buy cars and other big-ticket items. “All those interest-rate sensitive sectors will get hit hard housing, autos and appliance manufacturers. Retail is also pretty vulnerable.”
Peripheral effects
Consumers have been quick to move into cash and safe investments that are offering higher yields such as treasury bills, certificates of deposit and other short-term investment vehicles.
According to data from the Federal Reserve Board, consumers had $1.05 trillion invested in CDs at the start of last week, compared with $792 billion two years ago.
CDs are averaging 4.8 percent returns nationally for one-year terms and 4.4 percent for six-month terms, according to Bankrate.com, though some lenders are offering as high as 5 percent just for letting money do nothing without any risk.
Rodney Olea, senior vice president and director of fixed income at City National Asset Management, a unit of City National Corp., said investors are repositioning their portfolios.
“Repricing of risk in equity markets, housing and business investment will become more volatile,” he said.
One potential problem is that as stock markets decline, they may dampen companies’ appetites for mergers and acquisitions. Still, the value of announced mergers hit a record $1.65 trillion as of last week, according to Dealogic, a technology firm that collects data on capital markets.
Murray Rudin, a partner at private equity firm Riordan Lewis & Haden, said rising rates don’t have much impact on private equity or venture capital flows, but it will affect companies’ ability to borrow money and exit companies.
“The indirect issue is that if higher rates somehow drive the country into a recession, then you’re looking at a very different effect,” he said.
Higher interest rates will likely reduce the performance of highly leveraged companies that are backed by private equity. Falling stock prices also tend to reduce the potential for private equity and venture capital firms to exit companies, either through initial public offerings or outright sales.
At the same time, higher rates could have a dampening effect on company valuations, but those lower prices could in theory make a sale more attractive.
“The question is whether you want to underpay on the way in but get lower prices on the way out,” he said. “And you can’t have it both ways.”
