Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
August 30, 2010
The past two weeks has seen the stock market come to grips with the notion that the domestic economy slowed down from May through today. Thus while the market rallied strongly in July due to corporate earnings,
it has pulled back somewhat in August due to these macro concerns.
As the charts above illustrate, the Dow Jones Industrial Average dropped .6% last week while the NASDAQ Composite, that of course is more sensitive to growth, dropped by 1.2%.
The Markets & Economy
Several months back when the concern in the financial press was all about the recovery and how the FED would need to pull back from its stimulative stance, I mentioned that the economy was likely to be slowing down and such talk as hiking interest rates or raising taxes was absurd.
Today, most of the media is now focused on how the stimulus package of the Obama Administration has failed (as we have highlighted over many months) and that the Fed needs to do something despite the fact that interest rates are near zero.
There is even growing discussion that taxes not be raised next year on anyone, as the economy is too weak. This talk is occurring before the mid-term elections that are now clearly anticipating a change of power in the next Congress.
Thus investors, despite all of the uncertainties which our government is presenting business with, are now anticipating future policy changes. The result is a stalemate for now on Wall Street. Corporate profitability remains excellent as witnessed by such comments from global bellwethers Caterpillar and Boeing, but employment gains are subpar and likely to get worse.
Frankly, our own government has made the underlying conditions for hiring very difficult in anything but the public sector. Various new taxes and mandates, given the slow domestic economy, simply make hiring here in the United States difficult to justify and so it is not happening. The sad thing is that neither the media nor our government seems to understand how the business of our economy actually functions. We are at a stalemate.
What to Expect This Week
…More debate about the state of the economy. Last week saw the Economic Cycle Research Institute gauge rise again slightly (see chart below) but it remains nearly ten percent lower than one year ago. This along with other coincident economic indicators does NOT support the notion that the economy is going negative. It is simply not growing fast enough to put a dent in private sector unemployment.
Therefore, the stock market is more likely to focus on secular high growth areas such as the mobile Internet etc… Thus stock picking is much more important.
One other important feature is that the banking sector while dismal is not in the dire financial shape of two years ago. To the extent that it is a problem, it exists in the southern European countries, which may still ultimately spell doom for the Euro. Remember, a united currency without a political unification will not succeed in the long run.
Finally, Friday of this week we will get our monthly update on employment. Another dismal report is already baked in the cards so perhaps the stock market will respond positively to anything less than a disaster.
In this regard the news last week that investor sentiment had fallen to one of its lowest levels in many decades leads me to think the pessimism is over done. Look at the graph below to judge for yourselves what it means for investors when the sentiment becomes too negative.
This along with the various reports this week on the manufacturing sector and non-manufacturing sectors will set the pace for the direction of the stock market.
Our next update to you will be Tuesday of next week due to the end of summer holiday -Labor Day on Monday.
With acquisitions dominating the headlines on Wall Street the last two weeks, rumors have started to spread that Akamai Technologies would be a logical takeover target in the technology sector. There have been several high profile announcements over the past two weeks: Hewlett-Packard and Dell have been in a bidding war for 3Par; multiple suitors are lining up to buy Potash; Intel bought McAfee; and Sanofi-Aventis is planning to launch a hostile bid for Genzyme. This is the most merger and acquisition news we have had in the market in years and should lead to more deals and speculation.
Akamai is the perfect acquisition target for a large-cap technology company that wants to be the market leader in the delivery of high-definition video through the Internet. This space is growing rapidly, still in the early stages of growth, and Akamai has the dominant position in the market. While Akamai is no longer a cheap stock, and recent insider buying would mean that a deal is probably not currently in the works, we believe Akamai will eventually get bought. So many large cap technology companies have tons of cash on their balance sheets and picking up a gem like Akamai makes perfect sense.
Several of our other names are also possible takeover targets, and some have been rumored to be looking for suitors. It was rumored that Sanofi-Aventis was interested in either Genzyme or Biogen, and we would not be surprised if those rumors heat up again if Sanofi has to walk away from Genzyme. Also, Brocade has been mentioned as a target over the past several years and has some of the same technology that Dell and H-P are trying to acquire at 3Par. Finally, we believe Netgear would make an attractive fit for a larger company looking to compete in the consumer networking market.
As always you never know if a deal is going to happen until everything is finalized, although we believe the current conditions are ripe for more merger and acquisitions. Companies have record levels of cash on their balance sheets and they need to purchase growth engines to propel them forward. Hopefully this uptick in mergers will lead to higher share prices and resume the economic recovery.
(c) McIntyre, Freedman & Flynn