Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
July 26, 2010
This is Tom McIntyre with another client only update as of
Monday morning the 26th of July 2010
Last week saw a powerful rally in the stock market as earnings reports and guidance for the future caught the short sellers on the wrong side of the price action.
In addition, stronger economic data from Europe, combined with the lack of surprises
coming from their so-called stress tests of their banking contributed to the rally.
All in all, as the charts above illustrate the Dow Jones Industrial Average gained over 3% while the NASDAQ Composite jumped higher by 4.2%.
The Markets & Economy
Doom and gloom is featured prominently in the news what with the budget deficit of 1.5 Trillion dollars and the seemingly hopeless outlook for many second tier European countries, but the stock market discounts corporate earnings as I have mentioned many times over the years.
Perversely, the cost cutting (read that to mean high unemployment) and growing use of technology (the emergence of the mobile web for example) is creating the odd occurrence of huge gains in productivity. When you combine this with the fear amongst corporations over government policy you have a situation where everyone is watching their expenses and their investment opportunities.
More than ever, corporations will only hire or invest where a profitable outcome is increasingly likely. This has created this atmosphere where no one feels like the economy is improving but corporate profits are, in fact, very strong.
This combined with the lowest interest rates imaginable provides much stronger support for the stock market than many people have appreciated.
On the other hand, the Administration continues to lecture American banks and companies on how to run their business while running budget deficits that are both staggering and dangerous. Did you know that our President and Congress this year will not even attempt pass a budget deficit because the numbers are so bad? Can you imagine the lecturing from Congressional panels to business or state governments if they attempted to operate in a similar manner? This no longer is a fringe sort of opinion. The popularity of the Congress is at just 11%. The concern over the economy, taxes and budget deficits is so high right now that one wonders why Washington continues on this path.
Unfortunately, the financial markets now regard our own government with the greatest uncertainty. Investor confidence has plummeted for the same reasons. As a result, while the profit numbers are good there could be some backing and filling until we get a solid read on the outcome of the November mid-term elections.
I remember in 1994 the mid-term elections that forced then President Bill Clinton to the middle also coincided with one of the greatest bottoms in the market in years. Maybe this year will prove to be similar.
In the meantime, let’s enjoy our companies earnings reports and dividend hikes (see our comments below) and we will adjust the portfolios as the price action dictates. I doubt we can take off until November and I also am skeptical that a big decline can occur while earnings are growing so strongly.
What to Expect This Week
More earnings numbers are due as are reports on new housing starts this morning (better than expected, but still lousy.) On Friday, the first attempt by the government to estimate the GDP growth for the second quarter will be announced. The expectation will be for 2.5% growth but no one will like the numbers once they are out.
Clearly, the economy slowed in May and June and the news from the Economic Cycle Research Institute shows that the index, while flat over the past few weeks, is now lower by over 10% from a year ago (see chart below). They are not forecasting a double dip (which is very rare over the past 50 years,) but clearly the overall economy is slowing down at present.
Takeover activity is also on the rise as our shares in Biogen have surged nearly 4 dollars this morning, as deals seem to be on the rise in this sector and because that Company had its best quarter in its history. We will watch it carefully.
Caterpillar reported better than expected second quarter earnings results last week and significantly raised the earnings guidance for the rest of the year. The Company earned $1.09 per share, roughly $0.25 better than expectations and revenues rose by 31 percent to $10.4 billion. Management raised guidance for the rest of the year to a range of $3.15 to $3.85 from a previous range of $2.50 to $3.25.
The Company experienced sales growth in all four of its geographic regions and management believes the sales gains are sustainable. The most impressive division was machinery, as sales grew by 55 percent, year-over-year. Also on the conference call with investors management maintained that this recovery is more than just inventory restocking, the Company is seeing an uptick in end demand.
We are encouraged by the progress the Company is making and believe that the strength of these Caterpillar results is a positive sign that that global economy is recovering. Another sign of increased global demand is that the Company had its largest sequential increase in production from the first quarter to the second in the Company’s history. The strength of the earnings reports from industrials in general point to only a small chance of a double dip in the economy.
Shares of Caterpillar are one of the top performing members of the DOW over the past 12 months and we expect the positive trend to continue. As the economy continues to strengthen around the world, Caterpillar will experience even better sales growth over the next 3 quarters. We believe that shares of Caterpillar are still cheap and expect the price to reach $85 within the next 12 months.
Netgear reported better than expected second quarter earnings results last week and the stock price has risen 25 percent since the Company released the results. Netgear earned $0.38 per share, which was $0.06 better than consensus estimates as revenues rose 35 percent to $196 million. The management team also raised guidance for the remainder of the year and now expects to earn roughly $2 per share this year.
Investors were worried that the Company would miss earnings estimates due to its exposure to European markets, although these results proved those worries were misplaced. The results from Europe were not bad at all, and the Company stated that they gained market share in all of its major geographies. Also, a stronger retail environment led to higher than expected gross margins during the quarter.
Netgear has a rock solid balance sheet, with about $6.50 per share in cash, and a steadily growing business. We believe that investors aren’t giving the Company the credit that they deserve and expect that the earnings multiple will expand from its current level. Also, management indicated that they expect several key new products will be launched in the second half of this year.
Netgear is the cheapest technology stock that we follow, which makes little sense given its intriguing growth opportunities. We expect the Company will be able to maintain the strength in the margins during the rest of the year, while continuing to take market share. We believe the stock will still be undervalued at $30 per share.
Ryder Systems reported better than expected second quarter earnings results last week and raised guidance for the remainder of the year. The Company earned $0.58 per share, which was $0.09 better than consensus estimates as revenues rose six percent to $1.29 billion. Management raised their earnings guidance range by $0.15 to a range of $2.00 to $2.10 per share.
This management team is the best in the trucking business and we expect them to continue to take market share during these taxing economic times. Many of its main competitors don’t have Ryder’s financial strength and can’t compete for all of the business opportunities. Furthermore, management did indicate that they expect to grow the number of leased trucks in operation throughout the remainder of the year.
Ryder is a great barometer of domestic economic activity and the strength of these results is very encouraging in relation to the economic recovery. We believe that Ryder is positioned better than any of its competitors and we look for the Company to be a market leader over the next 12 months. We think that the shares of Ryder will reach $60 within the next 12 months.
(c) McIntyre, Freedman & Flynn