By the Associated Press, with BW staff reports

The end of the housing downturn keeps fading like a mirage.

The Home Depot («www.businessweek.com»), the world’s largest home improvement store chain, warned on July 10 that its earnings will decline this year more than previously expected because of weak conditions in the housing market and the sale of its wholesale distribution business.

The Atlanta-based company said it now expects its earnings per share to decline by 15% to 18% for fiscal 2007. In May, the company had projected an earnings-per-share decline of 9% for the year.

The earlier guidance included an estimated 18 of earnings-per-share contribution from the company’s HD Supply unit for the last six months of the fiscal year.

Home Depot shares fell 24 to $39.99 in pre-market activity on July 10.

Last month, Home Depot said it was selling the unit to a group of private equity firms for $10.3 billion. Home Depot said on July 10 it was updating its guidance to reflect the unit as a discontinued operation.

The company said it expects total retail sales to be down 1% to 2% for the year and sales at stores open at least a year to be down in the mid-single-digit range. Buyback Tender Offer

The fiscal 2007 earnings-per-share targets reflect 52 weeks and do not include the impact of the 53rd week. The company will have 53 weeks of operating results in its fiscal 2007 financial results. Home Depot projects that the 53rd week will add approximately 3 to its consolidated earnings-per-share guidance for fiscal 2007.

The company said its updated earnings-per-share guidance does not include the gain on the sale of HD Supply.

“While we expect the housing market to remain challenging for the rest of 2007 and into 2008, we plan to continue our reinvestment plans for the long-term health of our business, understanding that it will put short-term pressure on earnings,” Chief Financial Officer «investing.businessweek.com» said in a statement.

She added, “We are confident that over the long term, we will deliver productivity improvements and enhance returns on invested capital as the investments take hold.”

Also on July 10, Home Depot said it was launching a tender offer for 250 million shares of its common stock at a price range of $39 to $44 per share. The tender offer is scheduled to expire on Aug. 16. Home Depot shares have been trading recently at around $40 a share. Blog Critics Weigh In

Last month, the company announced a stock repurchase program in which its board had authorized the company to buy back up to $22.5 billion of Home Depot stock. The tender offer is part of that plan. At the midpoint of the tender offer’s price range, the 250 million shares represent less than half of the value of the total stock repurchase authorization. Home Depot has said it wants to complete the stock buyback plan as quickly as possible.

Bloggers reacted to the news with a mixture of criticism and resignation. One blogger in Germany took issue with Home Depot’s decision to lower guidance and buy back stock at the same time. The writer charged that the company was masking poor results with buybacks and undermining its financial strength at a critical time. “They risk their strong financial position just when the housing market is facing a long year bear market,” the blogger wrote on «immobilienblasen.blogspot.com». Others in the blogosphere said the move was understandable given the ongoing troubles in the housing market. “This should surprise no one,” wrote a blogger on «bonddad.blogspot.com».

In addition, Home Depot, which has more than 2,000 stores in the U.S., Canada, Mexico, and China, said on July 10 it will open approximately 108 new stores in fiscal 2007.

Through June 15 of this year, the S&P 500 rose 8.1%, all 10 sectors in the “500″ were in the black, and 80% of the 130 sub-industries gained on the year. In addition, 52 groups recorded double-digit gains, while only three sub-industries fell by 10% or more: gold, homebuilding, and motorcycle manufacturers.

Should the S&P 500 rise for the entire month, the index will have advanced in 16 of the last 18 months, with only May 2006 (down 3.1%) and February 2007 (off 2.2%) in the red.

This market breadth, strength, and longevity have left analysts scratching their heads and asking, “Why have equity prices strengthened, when fundamental factors have weakened?”

In the past three months, oil prices increased by $10 a barrel, yet stock prices climbed. The forecast for the first Fed rate cut was delayed to the first quarter of 2008 from the third quarter of 2007, yet stock prices climbed. The yield on the U.S. 10-year note rose to 5.25% from 4.65%, yet stock prices climbed. The full-year operating earnings growth estimate for the S&P 500 fell to 7.3% from 9.6%, yet stock prices climbed. The S&P 500’s P/E on trailing results expanded from 15.9 times to 17.1 times, yet stock prices climbed.

In the past six months, the market appears to have blissfully bypassed events that individually could have triggered a selloff, yet collectively have been treated as non-events. Are we missing something? It’s possible in the near term, but most likely not in the longer term.

Mark Arbeter, S&P’s chief technical strategist, says the S&P 500 should be able to make a run at the 1540 to 1560 zone fairly soon. Should the market break above that level, we believe it has a good chance of extending gains into the 1575-1625 area. Arbeter thinks a lot of individual investors are still watching from the sidelines and may regret missing out on this rally, thus extending the time and magnitude of the eventual advance.

Longer-term, however, S&P’s Investment Policy Committee (IPC) believes the market will not likely be willing to accept additional risks this late in the market and economic cycles, particularly in a period of decelerating earnings growth. As a result, it has maintained its year-end 2007 target for the S&P 500 at 1510, 6.5% above the closing value of 1418 in 2006, and 2% below today’s level. GLOBAL ALLOCATION RECOMMENDATION

More important than a year-end target, in our opinion, is the appropriate asset allocation. Our IPC benchmark (”all things being equal”) allocation suggests that a typical “balanced” investor have a 60% exposure to equities and a 40% exposure to bonds, also known as fixed income, and cash. Within the equity holding, we typically suggest a 45% exposure to domestic equities and a 15% exposure to foreign stocks. Within fixed income, we normally recommend a 30% weighting in intermediate-term bonds and 10% in cash. Based on our current view of domestic and foreign equity and fixed income markets, we are suggesting a slight underweighting of U.S. stocks and an overweighting of international equities, as well as an underweighting of an investor’s bond portfolio. Specifically, our current allocation calls for 40% in U.S. equities, 25% in foreign stocks, 25% in bonds, and 10% in cash. UNDERWEIGHT U.S. EQUITIES, OVERWEIGHT INTERNATIONAL

Even though U.S. equity prices continue to be supported by M&A activity (S&P Capital IQ reported that through June 18, global announced and closed M&A transactions surpassed $2.1 trillion, ahead of the 2006 year-to-date figure by 57%) and share buybacks, we believe foreign equities will be relative outperformers. HIGHER RATES, LOWER BONDS

We recommend underweighting bonds, as we see the yield on the 10-year Treasury note rising in the next 15 months. David Wyss, S&P’s chief economist, projects the yield on the 10-year note to close 2007 at 5.22%, and then rise to 5.55% by the third quarter of 2008 and remain at that level during the rest of the year. But he believes the rise in U.S. rates will have more to do with the repatriation of foreign investments in search of higher yields closer to home than he does a pickup in the rate of U.S. inflation. He forecasts core CPI to advance by less than 2.25% in each of the coming three years. He thinks core inflation is under control and reminds us the PCE deflator is up only 2.0% from last April, and now sits atop the Fed’s “inflation comfort zone.” He expects the Fed to delay cutting rates until early 2008, since the unemployment rate remains low, and thinks any early move would be a hike, caused by an upside inflation surprise.

The bill has arrived for Google’s protest party at last week’s eBay conference. And even though the party was canceled, the cost is much higher than Google probably expected for its poke at a rival Internet powerhouse.

In apparent retaliation for the planned intrusion on its annual pageant, eBay abruptly pulled all U.S. advertising for its online auction and shopping sites from appearing with Google’s search results. Having made its point, eBay (http://www.businessweek.com/ticker/) is ready now to resume paying for Google (http://www.businessweek.com/ticker/) search ads—only at lower levels than before.

But eBay says the reason for scaling back goes beyond displeasure at Google’s ploy, which was meant to protest the exclusion of Google’s Checkout service from the list of accepted payment providers on eBay’s sites. During the 10 days that eBay did not place ads for its sellers’ products next to Google’s search results, traffic on some eBay sites actually increased, says eBay spokesman Hani Durzy.

Some of that increase was undoubtedly due to the immediate impact of the hype over the eBay Live! conference, held in Boston June 14-16 (see BusinessWeek.com, 6/15/07, http://www.businessweek.com/technology/content/jun2007/tc20070615_205887.htm). Ad Dollars Headed Elsewhere

But eBay also found that reallocating ad dollars to the search engines at Yahoo! (http://www.businessweek.com/ticker/), Time Warner’s (http://www.businessweek.com/ticker/) AOL, and Microsoft’s (http://www.businessweek.com/ticker/) MSN resulted in new buyers shopping on its sites. “One of the biggest takeaways is that we are not as dependent on Google AdWords as some may have thought,” says Durzy.

That’s good news for Yahoo and Microsoft, two of the likely beneficiaries of eBay’s change in spending. Durzy wouldn’t say exactly how much eBay spends with Google, or by what percentage that spending will decrease. However, eBay is known to be one of the largest buyers and bidders for a multitude of keywords, thereby securing the right to have its ads appear next to the search results whenever those words are typed by Google users. Financial analysts estimate eBay has spent just shy of $25 million per quarter on Google AdWords in the past.

Google won’t quantify its ad revenue from eBay publicly. In a statement, the company would only confirm that eBay is again buying ads: “Over the last seven years, we have worked closely with eBay to drive customers to their site and build value for their business and the business of their sellers. We look forward to a continued partnership.” Shifting Balance of Power

Compounding Google’s loss of ad revenue from eBay is a potential drop in the prices other advertisers may pay the search provider as a result of eBay taking some of its ad dollars elsewhere. Google sells ads by auctioning off search terms, with the bids setting the price an advertiser is willing to pay each time a user clicks on its ad. EBay’s presence in those auctions drives up prices because rivals must compete with those bids to get their ads displayed prominently. If eBay bids less aggressively or doesn’t bid at all on certain terms, the reduced demand may push prices lower.

A significant eBay scaleback would give smaller AdWords buyers reason to celebrate. Small businesses with modest advertising budgets have found themselves on the losing end of the bidding, with more big companies, such as eBay, spending on search ads (see BusinessWeek.com, 1/22/07, http://www.businessweek.com/magazine/content/07_04/b4018076.htm).

Still, eBay needs to be careful, too. While it may not want to spend more money on Google ads than it has to, the company also may not want to make it too easy for the little guy to win keyword auctions. In many ways, eBay competes with those smaller vendors, many of whom are eBay sellers with their own Web sites. The easier it is for eBay sellers to market directly to consumers and drive large numbers of buyers to their Web sites, the smaller the cut they’ll have to give to eBay for an auction sale.

And then there’s Google. Despite the rare display of contrition in calling off its party, now that eBay is making some of the punishment permanent, who’s to say the mighty search engine doesn’t have a few vindictive tricks up its own sleeve?