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ERROR: type should be string, got "https://www.wsj.com/articles/SB50001424052970204451004575433560241472100\nBonds v. Stocks: Who's Right About Recession?\nUpdated Aug. 21, 2010 12:01 am ET / Original Aug. 21, 2010 6:51 am ET\nTWO ROADS DIVERGE in the markets: The Treasuries camp is expecting another recession, while the stock market, even after a 4.5% retreat over the past two weeks, seems to be enjoying its summer vacation. Who is right, and what's the punishment for being wrong?\nTreasury buyers drove the benchmark yield on 10-year notes down to a 17-month low, below 2.6% midweek, while two-year notes are yielding less than 0.5%—worse than they did during the credit crisis, and a record low. Depressed yields may not reflect dire economic prospects, but the warped reality of a central bank hell-bent on keeping borrowing costs down, some bulls have argued. But isn't our central bank so hell-bent because the economy looks dire?\nOn the other hand, stocks are just 12% off their 2010 peaks—while hardly exorbitant, they're 58% above their credit-crisis lows. Shouldn't we be quaking in our Gucci loafers?\nA mild recession could thump the Standard & Poor's 500 down to between 850 and 950, estimates Myles Zyblock, RBC Capital Markets' chief institutional strategist. That's 11% to 21% below today's perch near 1072.\nBut if we manage to avoid a recession, Treasuries could sell off hard. Fretful, yield-seeking investors have already poured $400 billion into bond mutual funds over the past 12 months, the biggest influx in 25 years, and even subpar economic growth of less than 2% \"could prove immensely challenging for bonds,\" Zyblock says. Taking into account monetary policy, inflation and growth forecasts, he pegs the fair value of the 10-year Treasury yield at 3.46%, but reckons it could overshoot to 4.35% \"in a contagious selloff.\"\nWith all eyes on economic cues, weekly unemployment claims climbed for a third straight week to 500,000, the worst since last November, while the Conference Board's leading economic indicators continued to decelerate, ticking up just 0.1% in July after declining 0.3% in June. Clearly, the economy is slowing anew after its government-goosed spurt. But the corporate bond market seems relatively unperturbed, and moderate stock prices, already-indifferent investors, and almost decimated levels of housing activity and capital spending should limit any carnage still to come.\nAnd unlike Japan, where the government took years to prop up banks and write down losses, and where wages shrank persistently and home prices in some cities fell nearly 80%, the threat of deflation here isn't yet acute. Our economy is barely expanding, but at least job-market barometers like hours worked and wages aren't shrinking. If that happens–watch out.\nRobert Buckland, Citigroup's London-based global strategist, counted 10 prior divergences over the past 11 years between global bond yields and stock prices–with stocks ultimately proven right on six occasions, bonds twice and two instances without clear-cut winners. The firm thinks a sustained global recovery could eventually drive yields higher, with the German 10-year yield rising 0.6 of a percentage point by year end while its U.S. counterpart rises 0.75 percentage points.\nIntel's (ticker:INTC) $7.7 billion offer to buy McAfee (MFE), and First Niagara Financial's (FNFG) $1.5 billion deal with NewAlliance Bancshares (NAL) ushered in the biggest week for mergers since late 2009, and helped stocks recoup losses Friday afternoon. But the Dow Jones Industrial Average still ended the week down 90, or 0.9%, to 10,214. The S&P 500 fell for a second straight week, its first back-to-back losses since early July, as it gave up 8, or 0.7%, to 1072. But the Nasdaq Composite Index gained 6, or 0.3%, to 2180, while the Russell 2000 added a point, or 0.2%, to 611.\nTHERE'S ANOTHER DIVERGENCE in the market: \"Macro\" investors watching the big picture can't help noticing the economic deceleration, but \"micro\" investors scrutinizing companies see generally robust profits, record cash holdings and chastened managements, wiser after the 2008 crash. In fact, slumping Treasury yields may be a response to the gloomier big picture, even as stock investors focus on specific companies with healthy balance sheets and good odds of survival.\nThe bearish macro view and the more benign micro stance can be reconciled in at least one way, suggests David Kostin, Goldman Sachs' U.S. equity strategist. Companies can prop up earnings–and stock prices–even in a plodding economy by running lean, tight ships and squeezing the most from their profit margins. Alas, that means keeping a tight rein on hiring, since wages are the biggest chunk of most companies' expenses. In fact, Goldman's economists see the unemployment rate clinging close to 10% well into next year, one reason why Kostin is cautious about consumer discretionary stocks.\nHome Depot (HD), to cite one example, last week flaunted a 6.8% jump in second-quarter profits even though same-store sales increased only 1.7%. It raised its profit projection for the year even as it cut revenue forecasts. That's possible partly because the home-improvement retailer is buying back shares, but largely because it's reacting to the economic malaise by maintaining disciplined inventories and keeping a tight lid on employee work hours. That's bad news for those investors betting on a job-market revival and a rebound in consumer spending.\nAt Wal-Mart (WMT), same-store sales are down for five straight quarters. Once-haughty Abercrombie & Fitch (ANF) had to cut prices 15% to coax a 5% sales increase. Hot Topic (HOTT) saw second-quarter sales slide 6.5%, and even Twilight movie merchandise isn't generating the same buzz, thanks to sequel fatigue and the sudden surfeit of vampires in popular culture.\nRetail apparel stocks have been marked down 18% since late April, but they're still no bargain. For a start, the traditionally strong second half could see more price wars to spur traffic. Retail stocks are still up 11% this year, and teen retailers like Abercrombie and Hot Topic fetch forward multiples of 19 and 29, respectively, even though unemployment among teens is triple the dire national average.\nRetailers face another challenge. With so much of our goods made in China, the country's appreciating yuan, rising wages and increasing transportation costs will eat into profit margins. In fact, half of the American and European companies recently surveyed by Credit Suisse expect the cost of Chinese goods to increase 6% to 10% over the next 12 months, and 93% are bracing for a margin hit because they can't pass higher costs on to their customers.\nWhat businesses will be hardest hit? China exported $301 billion of electrical equipment last year, along with $236 billion of power-generation equipment and $101 billion of apparel. China accounts for 20% to 40% of the cost of goods sold among broad-line retailers–including roughly 5% at Home Depot (HD), 15% for Best Buy (BBY), 20% for Macy's (M) and Target (TGT), 25% for Office Depot (ODP) and 40% for Dollar Tree (DLTR), Credit Suisse estimates.\nMany stores are already battling on price to lure deleveraging shoppers, so they can't easily hike prices to cover costs. Inventory is already managed tightly, and margins are near peak levels. And analyst Michael Exstein expects \"gross margins to be pressured in 2011.\"\nTake Dollar Tree, for example. A mere 10% cost increase would trim 2011 margins to 34.1% from 35.8% and per-share profits to $2.78 from $3.35, if the discounter manages to pass half of its higher costs on to shoppers. But if it absorbs the full brunt of the cost increase, margins will shrink further, to 33.2%, and profit drops to $2.51.\nAmong apparel and footwear companies, Credit Suisse pegs the cost of goods sourced from China at 55% for Carter's (CRI), 50% for Maidenform Brands (MFB), 35% for Foot Locker (FL) and Jones Apparel Group (JNY) and 30% for Liz Claiborne (LIZ)—and it flags these as most susceptible to rising Chinese costs.\nIn contrast, household-products companies are more immune, with China accounting for less than 5% of Colgate-Palmolive's (CL) or Procter & Gamble's (PG) cost of goods sold. China's rising minimum wage also could help global restaurant chains like Yum! Brands (YUM), McDonald's (MCD) and Starbucks (SBUX), since that gives customers there more purchasing power. A stronger yuan further inflates Chinese profits that are translated back into the buck.\nONE QUESTION REMAINS, now that Potash Corp. of Saskatchewan (POT) has spurned BHP Billiton's (BHP) unsolicited $38.6 billion takeover bid: How much will BHP jack up its offer?\nBHP's $130 a-share cash bid offers Potash Corp. shareholders a 32% premium to average prices 30 days before the bid, but is well off the stock's (admittedly unrealistic) 2008 peak near 242. With merger speculation rife, and vague hopes that the Chinese will scramble to snag a fertilizer source, the market quickly came to expect a sweetened offer of at least 150, and the stock jumped to 149.\nPotash Corp, which produces a key ingredient in fertilizers, is up more than 230% since it was profiled in Barron's a few years ago (\"On Fertile Ground,\" Nov. 6, 2006). It's easy to see why BHP, a metal mining giant, is keen: Potash Corp. controls a fifth of the globe's supply of potash, but nearly three-quarters of the excess capacity, which lets it adjust supply to meet demand. Deposits are scarce, with just a dozen countries exporting potash to more than 150 countries. It takes billions and many years to fire up a new mine. Some analysts now think shares are worth more than 180–if production were ramped up.\nBHP has lined up a $45 billion loan, said to be the fifth largest ever, fully underwritten by banks including BNP Paribas, Banco Santander and JPMorgan. At 150, Potash Corp. shares fetch 24 times projected profits, above its five-year median of 20, and its enterprise value is more than 21 times its cash flow.\nBHP could boost its bid to 163, which carries a harder-to-refuse 50% premium. But this deal won't add to BHP profits until 2014, says Credit Suisse. There aren't that many suitors who can afford a $44 billion target, and far fewer still who are eager to join a bidding war. It would be wise to take profits the closer shares push to 160.\nSoft Patch?\nRising jobless claims, falling bond yields and slowing economic growth sent the Dow down for a second straight week. The blue chips have lost 4.1% in that time."