Weekly Commentary & Outlook
McIntye, Freedman & Flynn
September 27, 2010
Last week saw the stock market continue its unusual advance (for September) as diminishing fears of a double dip recession and the outlook for future Federal Reserve Board easy money forced money into the stock market.
DJIA Weekly Chart
NASDAQ Weekly Chart
As the charts above illustrate, the Dow Jones Industrial Average jumped 2.4% while the NASDAQ Composite did even better at a gain of 2.8%. Merger activity has also become an important factor in keeping stock prices moving higher.
The Markets & Economy
As we mentioned last week the financial markets have been encouraged by the economic data which is showing an economy not on the verge of a double dip, but rather one which is muddling along at a rate that while good for corporate profits is not strong enough to generate job creation.
Thus the dilemma for policy makers in Washington DC is - what to do about this. Clearly the political and economic realities on the ground rule out tax increases of any kind. The democrat party, despite huge majorities in Congress, will not even schedule a vote on raising taxes as they would suffer so many defections that it would be defeated Consequently, the tax bill for next year is scheduled for the lame duck Congress.
Only in America can the majority party not clarify its policy on such an important matter as future tax policy before an election and hope that the voters will not notice.
Over on the interest rate side of the policy making ledger, last week the FED basically came out and lowered their forecast for economic growth for next year. This statement was widely viewed as a precursor to another round of quantitative easing (fancy phrase which means printing money). The FED has indicated in no uncertain terms that nominal growth in the economy is too low and they will goose it regardless of the longer-term costs, if there are any.
This statement is regarded as a positive for many asset classes, including stocks of course. The FED will not allow for widespread deflation to become imbedded in consumer psychology.
In addition, we have seen other Central Bankers in Japan, Switzerland and perhaps the Euro zone introduce the printing presses in the hopes of raising asset prices. This is good news for stocks as they are the implied recipients of money growth. Real Estate will continue to have its problems and thus this policy may help in some long-run fashion, but in the immediate future this excess cash will flow into stocks via merger and buyback activities. Both of these are now dominating the financial news.
As to the discussion of the economy itself, not much change there. The weekly reading from the Economic Cycle Research Institute shows that the economy is not as bad (see chart below) as was feared in early summer. The year over year number has improved to minus 8.7% and the index itself has stabilized since late spring. The message from this index and other data is that the global economy is not collapsing but neither is it springing to life in a traditional manner associated with prior recoveries.
This slow bounce up has severe political repercussions around the globe and, of course, on our own mid-term elections in just five weeks.
What to Expect This Week
The last week of the third quarter is upon us. Many money managers have underperformed and will be looking to load up their portfolios before Thursday.
In addition, the most significant economic data will not be released until Thursday and Friday. This is the monthly look at the national manufacturing sector for September. This could cause some excitement depending upon the strength or weakness announced. But, look for some quiet back and forth trading until then.
Clearly, investors understand that earnings will be decent when they are released in late October, that the FED will be printing money starting in November and that a more business friendly election change is just a few weeks away. These are all supportive of stock prices. As a result, for the next few weeks it seems to me that only an event out of left field could meaningfully upset the stock market apple cart.
Biogen Idec gave back some gains last week as a competitor got a less restrictive approval for its multiple sclerosis drugs by the Food and Drug Administration. Novartis won approval for its multiple sclerosis drug Gilenya from the FDA, and many investors were surprised by the lenient label warnings for the drug. We believe that Biogen Idec is still very conservatively valued and look for the shares to quickly recover the losses from last week.
While this is clearly not great news for shareholders of Biogen, investors have known for years that Gilenya was probably going to receive FDA approval. Gilenya will likely receive approximately 15 percent of the market for patients with relapsing forms of multiple sclerosis. Gilenya’s side effects are still very onerous and a setback for drugs like this is likely. Biogen still has the industry leading position in this market and we look for the strength of the Company’s brand to broaden over the next few years.
Biogen Idec is only trading at ten times our earnings estimate for next year and we do not think that is sustainable given the Company growth opportunities and dominant market share in the multiple sclerosis market. There have been rumors recently that large pharmaceutical companies are looking to acquire Biogen Idec. We believe that would make a lot of sense. Large pharmaceutical companies don’t have the growth rates or product pipelines that they had over the past decade and they need to acquire new drugs from their smaller competitors.
Shares of Biogen Idec fell roughly 7 percent following the announcement, but they have been creeping back up the last several days. Moves like this are commonplace when competitors receive approval for rival drugs, although they are normally short-term in nature. We believe that Biogen Idec is still positioned nicely for the next two years, and expect the shares will reach $70 within the next 12 months.
(c) McIntyre, Freedman & Flynn