Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
October 11, 2010
This is Tom McIntyre with another client only update as of
Monday morning the 11th of October 2010
The stock market rally has continued well into October confounding the conventional wisdom of doom and gloom, which typically exists this time of the year.
As the charts above illustrate the Dow Jones Industrial Average gained 1.63% last week led by shares in our holdings of Boeing and Caterpillar. The NASDAQ Composite gained 1.3% as some concerns surfaced about some of the previous high flyers.
The Markets & Economy
As we mentioned last week the employment report released on Friday (and the last one before the mid-term elections next month) once again provided evidence that the recovery we are experiencing is simply not strong enough to create jobs at a pace to lower the politically unacceptable 9.6% unemployment rate.
In fact, given the various recent speeches from Federal Reserve officials and the forecasts they are putting forth, there can be no doubt that on November 3rd they will announce (with the mid-terms having occurred) that quantitative easing or printing of money will resume.
The hoped-for impact of this policy move is to raise various asset prices with the easiest one being the stock market. That is what is making this rally so interesting. The market likes the idea of a return to a more conventional approach by government, which would occur with a republican victory in November. The markets also enjoy the excess liquidity, which the Fed has promised to provide well into the future.
At the same time the lower dollar and strong corporate balance sheets are providing investors with gains from higher dividends, stock buybacks and heightened merger activity. Thus while Main Street America continues to suffer, the investor class that is often victimized by the Obama administration and Congress is starting to gain the upper hand.
Fundamentally though, the issues remain the same. How long can the United States continue to spend beyond its means and at the same time continue to regulate all sorts of economic activity from Washington DC. Just last week the Obama administration had to grant 40 or so waivers to major corporations concerning the unpopular healthcare law.
It was either that or coverage would cease. This is an early warning sign that Congress did not understand the full implications of trying to administer the health care system from DC. Look for Obamacare to be rolled back substantially in the years to come despite the protests from many on the left.
As far as the economy is concerned, it appears that it has become stronger as evidenced by improvements in such indicators as the Economic Cycle Research Institute leading index (see chart below). This measure is now just 7% below one year ago and implies a shrinking chance of a double-dip recession. Pray that the Obama tax increases do not survive for 2011 or you could see some changes in the probability of a double dip.
The problem now is much more a societal one as the policies being pursued will not kill off corporate profits much of which are generated overseas, but they will have the impact of hurting the domestic need for labor through higher taxes and regulation. This then is unfortunately a political issue, which will be heavily influenced not just by this year’s mid-term elections but also ultimately by the 2012 Presidential election.
As such, investors should continue to watch the political tea leaves for indications of how these important issues are playing themselves out. In the near-term the outlook is for strong profits, but subpar overall economic growth. Not the best combination, but not the worst and certainly the Federal Reserve Board has made it crystal clear that deflation will not be allowed to take hold in the United States - but this too has its downside longer term.
What to Expect This Week
Today is actually a federal government holiday as the country celebrates Columbus Day. Thus the trading will be subdued and the bond markets closed.
Earnings reports will start up in earnest by later in the week. I am particularly interested in how JP Morgan’s numbers are received.
On the data front, the FOMC minutes from their previous meeting come out tomorrow, but since these people are giving speeches daily there should be no news here. The only other data point of interest to me is Friday’s report on retail sales and business inventories. This will provide more clues as to how the fourth quarter will stack up.
This week earnings announcements begin from several large bellwether companies that should show investors what to expect from third quarter earnings. Starting tomorrow railroad operator CSX kicks off the earnings season, followed later in the week by JP Morgan, Google and General Electric. We are confident that earnings results will be solid and expect the upward trend in the market to continue.
These four companies give investors a glimpse into many different industries so we should find out what to expect from the remainder of earnings season. Profit margins continue to surprise to the upside and since companies are so lean we do not expect this trend to change this quarter.
With strong profits and corporate balance sheets in great shape, we also expect the amount of mergers and acquisitions will accelerate during the rest of the year. Private equity firms are also rejoining the takeover markets again, and as the amount of capital in the system continues to grow, so will deal activity.
We believe that investors are still being overly cautious given the economic conditions and high unemployment. Strong third quarter earnings results should keep the market momentum going and we expect the market will be at least five percent higher by the end of this year. As more and more companies report their results, we will have a better idea how strong the stock market will remain over the next six months.
(c) McIntyre, Freedman & Flynn