Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
October 23, 2012
Stocks remained sluggish last week as earnings guidance more than last quarter’s reports put a damper on stock prices. In addition, the European summit was a failure and investors remain hesitant before the November elections.
As the charts above illustrate, the Dow Jones Industrial Average was flat for the week with Friday’s losses offsetting earlier gains.¬†
The NASDAQ Composite showed a drop of 1.26%, as earnings troubles from Google,
¬†and a perception of poor technology earnings weighed on that index.
The Markets & Economy
Earnings reports are coming in fine, but there are at least two problems.
- First of all, few companies if any are achieving their top line revenue growth projections.¬† This is indicative of a slowly-growing nominal economy in which we exist. It is also consistent with a very sluggish employment outlook as firms feel no need to hire when their growth rates are decelerating.
Thus, this is another solid piece of economic evidence (not provided by the government) which implies a rather tepid 3rd quarter GDP report when it is announced this coming Friday.
- The second problem with the earnings reports so far is the guidance. The chart below shows that currently the corporate view of the next three-to-six months is very downbeat. This has to do with many things, but the problems in Europe, which remain unresolved if one reads the news out of last week’s summit, and the upcoming so-called fiscal cliff here in America are two huge issues that business does not know how to plan for.
Of course, the November 6 elections in America will clarify how the country deals with our fiscal cliff and that will grant clarity, but will it be construed to be good news? I don’t know. The European mess will likely heat up again as Germany increasingly looks to thwart the ECB from socializing the sovereign debt of the southern nations of Spain, Italy and Greece.
For now, though, earnings are pretty good and through expense cuts and other financial maneuvers, the outlook is for neither a collapse in earnings nor a surge. This combined with zero interest rates makes equities as an asset class still attractive albeit we are looking for some clarity before we commit our cash reserves.
What to Expect This Week
Tonight is the final Presidential debate which is supposed to be on foreign policy only. The previous two debates seem to have put Romney ahead slightly in the national polls, but the election is still two weeks away. Investors should be paying close attention to tonight’s debate and the trends which emerge these last two weeks.
Additionally, the Federal Reserve Board conducts a two day meeting with their announcement on Wednesday. No policy moves are expected because the Fed is already all about the printing of money on the one hand, and zero interest rate policy on the other. The verdict is out as to whether this policy mix is what the economy really needs at this time. My opinion is that while it forestalls disaster it does not encourage growth.
Finally, the economy remains in focus with the GDP report for Q3 due this Friday. It won’t be pretty. The weekly update from the Economic Cycle Research Institute, shown below, shows another positive week - but this is now flying in the face of economic data and may be influenced by stock prices which are more influenced by Fed policy than underlying fundamentals.
Freeport-McMoRanreported earnings that were slightly below expectations as labor issues at the Grasberg mine in Indonesia weighed on the Company’s bottom line.¬† The Company still earned $0.68 after one-time charges, which was 5 cents below expectations.¬† Revenues fell to $4.4 billion from $5.2 billion a year ago on lower production output.¬† While these numbers are lower than expectations, the labor issues at the Grasberg mine are improving, and we expect growth will return at the Company.
Even though revenues and profits were lower at the Company, the prices of both copper and gold are higher than a year ago.¬† Spot prices of gold are up 9 percent from last year, while copper prices are up more than 16 percent.¬† We believe the price of both copper and gold are headed higher, which will lead to better profits for the Company.
Shares of Freeport have been trading much better over the past couple of months and we see no reason for that trend to change.¬† The price of copper is a real barometer of the strength of the global economy and prices continue to climb, primarily due to the quantitative easing governments are providing around the world.¬† With labor issues easing, we look for the shares of Freeport to reach $50 within the next 12 months.
This morning Caterpillar reported better than expected third-quarter earnings results, but did bring down earnings guidance for the next year.¬† Revenues rose by 5 percent from last year and earnings per share came in at $2.26, which was 4 cents better than consensus estimates.¬† Management did reduce next year’s earnings guidance by roughly 2 percent to the range of $9 to $9.25, citing a slower global economy.
Like Freeport, Caterpillar is a barometer of global growth, and concerns over Europe weigh on the Company.¬† With that said, CEO Doug Oberhelman did state on CNBC this morning that China appears to be on the edge of a recovery.¬† He also stated that even though growth is slowing, he does not see a global recession on the horizon.
Shares of Caterpillar initially opened down, but have rallied sharply this morning.¬† Even though the global economy has slowed, we think that the selling of Caterpillar has been overdone.¬† By any metric, this stock is cheap, and investors have discounted the slowing global growth.¬† We expect Caterpillar to again become a market leader, and look for the shares to reach $100 within the next 6 months.
Last week Flextronics reported better than expected second-quarter earnings results even though revenues fell by 23 percent from the previous year.¬† The Company earned $0.26 per share, which was 3 cents higher than consensus estimates.¬† Management also maintains its earnings guidance for the remainder of this year.
Flextronics operates in a low-margin industry, but the Company has been able to grow free cash flow, and is aggressively buying back its stock.¬† Free cash flow increased to $342 million this quarter and management expects more than $500 million for this fiscal year.¬† The Board of Directors has also authorized the management team to buy back more than 10 percent of the current outstanding share base.
Shares of Flextronics have not moved much since the earnings release, but we expect better market conditions should lead to a higher price.¬† Even though this stock is extremely cheap, we are disappointed with the share performance.¬† We believe the stock should hit $8 within the next 12 months and we would likely be sellers at that level.
(c) McIntyre, Freedman & Flynn