Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
October 31, 2011
The stock market is on the verge of completing its best month since 1974. Who would have thought that just five weeks ago?
The ostensible reason given for the upswing is some resolution of the European debt issues. Forget that; the reason stocks recovered is the reason they always bounce back and that is higher earnings, higher dividends and a lack of alternative asset choices.
As the charts above illustrate, the Dow Jones Industrial Average and the NASDAQ Composite gained almost 4 percent each last week. Shorts were covering and hedge fund managers were caught underinvested into the end of the month. Too bad.
The Markets & Economy
Earnings have been just too darn good (see our comments on specific holdings below). Thus last week’s drama emanating from Europe could not stop the rally, and even the Thursday announcement that I defy anyone to explain the mechanics of, served simply as an excuse to chase stocks higher. The presumption being that all of these plans coming from Europe must contain some good ideas. I doubt it, and Europe is struggling this morning as they have been forced to beg the Chinese for money.
As a result the macro news hasn’t really improved despite the perception that it has. Perhaps time has been gained but that is all. The real key to the future is the prospect for global growth. Contained in the corporate earnings reports are various indications that the global economy is not on the precipice of a double dip, but neither is it going to explode into a strong leg up.
Accordingly, we will continue to experience what the last two years or so has brought us: High unemployment combining with high corporate profits. This creates societal tensions and political opportunism by politicians, who wish to play the class warfare card, but in the end stock prices respond to higher earnings and dividends and we are getting that in heavy doses.
As far as the economy itself is concerned, last week’s news that the third quarter grew by 2.5% (see chart below) is encouraging.
Do not forget this quarter contained the horrible events of Europe and the USA debt downgrade. Yet it was the best quarter this year (unless of course the revisions knock it down substantially). This news combined with Europe’s smokescreen announcements and the great earnings reports have all combined to produce quite a nice month of gains in stock prices. Now you know why we spend almost all of our investment time on fundamentals, and not the macro news items. In the short run the news stories carry the day but not in the long run.
What to Expect This Week
Quite a bit of moving parts this week... More corporate earnings, of course and this will be combined with the continued second guessing coming from Europe and a two day Federal Reserve Board meeting concluding on Wednesday. This meeting is increasingly seen to be the go ahead for embarking on the next round of quantitative easing perhaps by the Fed buying mortgages directly.
Any move by the FED to green light more easing will be good for stocks and commodities and bad for treasury bonds and the dollar.
Their reading of the labor market will heavily influence the Fed’s decision. The government releases the employment data this Friday for the month of October. With just one year to go until the presidential election, the pressure is on the Fed to act, given another lackluster report on Friday, will be enormous.
Finally, the weekly report from the ECRI showed a weekly jump, but is still showing a minus 10 for the year-over-year growth rate. Clearly, they are still in the recession camp for 2012 despite the jump in GDP for the third quarter. Should the Fed have the same outlook, then more easing will be announced this Wednesday.
Caterpillar reported blockbuster third quarter earnings results last week and raised their revenue and earnings guidance for next year. The Company earned $1.71 per share, which was 44 percent higher than last year. Revenues also surged 41 percent to $15.72 billion. Management now expects revenue growth between 10 and 20 percent, which is significantly higher than Wall Street’s consensus estimates.
Caterpillar is a barometer of global industrial demand, and these solid results are encouraging. It appears that fears of a global slowdown are overblown and emerging markets remain the main growth driver for the Company. The Company continues to hire aggressively and added 5000 jobs during the quarter.
Shares of Caterpillar rallied more than 5 percent on the strength of this report. We believe that this Company remains in the sweet spot of this current business cycle and will remain a market leader for at least the next 12 months. Shares of Caterpillar are still conservatively valued, and we expect the shares will reach $120 within the next 12 months.
Ryder Systems reported better than expected third quarter results last week and raised their earnings guidance for the remainder of this year. The Company earned $1.10 per share, which was up from $0.74 per share last year. Revenues also grew by 20 percent to $1.57 billion, and the Company raised their earnings guidance for the rest of the year by 10 cents per share.
Management stated on its conference call with investors that they expect the solid sales trends to continue, even though the overall domestic economy remains slow. The Company has taken market share during the financial crisis and a lot of its weaker competitors did not make it through the downturn. We believe the earnings guidance will also turn out to be conservative, and fully expect the Company will exceed earnings estimates for the next several quarters.
We are encouraged by this report and believe Ryder will remain a core holding for the foreseeable future. Even in a slow growth economy, Ryder will continue to take market share and its earnings growth rate will continue. We expect the shares will reach $65 within the next 12 months.
Akamai reported its best quarter in more than a year last week and gave guidance that matched Wall Street’s consensus estimates. Revenues climbed 11 percent from the previous year, to $281 million. Net income also rose to $0.34 per share, which was a penny better than consensus estimates. Management also projects revenues between $303 and $315 million for next quarter.
The Company is gaining traction with some of its new product launches during the quarter and we look for management to continue to focus on security protection. The Company’s competitive position seemed to improve over the last two quarters, and we expect margins will begin to expand again. The Company’s President, David Kenny did resign. Investors have been calling for a shake-up in management for some time.
The shares of Akamai rallied 15 percent on the strength of this report, and we expect the upward trend to continue. There have also been takeover rumors swirling concerning Akamai and we believe a deal would make a lot of sense for a larger technology company. We are encouraged with the progress the Company has made over the last two quarters and expect the shares to reach $35 within the next 12 months.
(c) McIntyre, Freedman & Flynn