Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
January 23, 2012
The New Year’s rally continued last week.
Solid earnings reports, for the most part, along with the belief that the Federal Reserve Board will offer up some policy changes this week served to
support stock prices across the board.
As the charts above illustrate the Dow Jones Industrial Average gained 2.4% and the NASDAQ Composite jumped 2.8% last week to extend their early year gains.
The Market & Economy
The economic news was mixed last week. The weekly reading on initial jobless claims fell dramatically, after rising dramatically the previous week. The unadjusted claims numbers though, are not nearly as encouraging.
At the same time the inflation reports are now showing a pullback, which may give the Fed some leeway to announce new measures (read that to mean printing money and otherwise manipulating financial markets) this week at the conclusion of their two-day meeting. Clearly, the financial markets are expecting something more than the usual cookie-cutter announcement, which routinely bemoans the fact that GDP growth is insufficient to shrink the ranks of the unemployed.
Herein lays the conundrum. The FED is in an election year mode. Tomorrow night President Obama will give the annual State of the Union speech that, of course, will be nothing but a glorified campaign speech. This though will serve to up the ante on the Fed to do something, as Congress is most likely to do the minimum in this election year.
On the other hand, the actual reports on the US economy indicate that while a boom is out of the question, the often-feared double-dip recession is similarly just not happening, although there are some warning signs out there from Europe and China especially.
Thus the Federal Reserve Board, which has a new and much more dovish composition this year, will have a higher standard of explanation on any moves that they either announce or are contemplating. One thing is for certain, the level of government intervention in the world’s bond and stock markets is sapping investors of their confidence. This, of course, is counter productive to efficient capital investment choices and thus a negative for global growth.
Thus it is imperative for the Fed to attempt to hold a fig leaf around its “independence,” in order to maintain investor confidence. Otherwise they could do more harm than good.
Meanwhile though the earnings reports are fine, but concerns over mid-east tensions are keeping oil prices high and serving to support the dollar. Not a bad backdrop for the stock market. Even the European sovereign debt problem and the negotiations occurring in Greece are not generating the fear of a few months ago. The ECB has seen to that by making three-year loans available to their banking system at a very low rate. There isn’t any contagion coming from the eventual Greek default (either consensual or otherwise).
What to Expect This Week
The focus on earnings will, of course, continue. The aforementioned Federal Reserve Board meeting, concluding with a press conference on Wednesday afternoon could create some jumpiness and, of course, the future direction of the economy will remain the focus.
As such, the government will release its leading economic indicators report on Thursday. Of interest to us is that the Economic Cycle Research Institute weekly index of leading indicators jumped last week (see chart below) but still remains negative at -7.5.
Clearly, the indicators overall are mixed, which is consistent with my view that the economy will continue to simply muddle through, as the imbalances in the global economy and the lousy government policies here at home, serve to depress growth and encourage people to leave the work force, and perhaps sign up for various entitlement programs such as food stamps.
Last week’s announcement by President Obama cancelling the Keystone pipeline has been universally panned by labor and business, as just a horrible outcome that will have negative effects on employment and our nation’s dependence on foreign energy imports. How sad it is to see our President making political decisions on matters that would help our country. The proof of the pudding for this is that after next year’s election regardless of who wins this pipeline will be approved. Why the wait Mr. President?
Flextronics reported third quarter earnings results that essentially matched Wall Street’s consensus estimates. Revenues decreased by 4.3% from the previous year and earnings per share came in at $0.16 per share. The management team gave earnings guidance for the next quarter that was at the high-end of expectations.
These results were affected by the Company’s choice to exit the ODM PC business, which will make the Company much stronger in the years ahead. This business was a serious drain on gross margins at the Company, and we should see significant margin expansion over the next several quarters. Management’s movement into higher margin and more exciting markets, should lead to a higher valuation.
The Company’s financial position continues to improve, as this is the fourth consecutive quarter of positive free cash flow generation. The Company also repurchased about 19 million shares, or 3% of the shares outstanding during the quarter. Since announcing the most recent share repurchase plan last June, the Company has bought back 15% of the shares outstanding, which has positively affected earnings per share. We believe this is an excellent use of the Company’s capital and look for the Company to remain aggressive in its share repurchases.
Shares of Flextronics traded slightly higher following the release of these results. This is one of the cheapest stocks that we follow, and we believe that the restructuring of the business should lead to a higher valuation. We are expecting a higher share price over the next several months for Flextronics and continue to evaluate whether we want to be long-term shareholders. We believe the shares should reach $9 within the next 12 months.
Last week Biogen Idec and its partner Elan won FDA approval to modify its label for its multiple-sclerosis drug Tysabri. This drug has been rather controversial for the Company, but this label change should allow the Company to double its Tysabri sales worldwide. Most analysts believed the annual sales would have topped out between $1-$2 billion, and now they estimate annual sales between $3-$4 billion worldwide. This is more good news for the Company as they continue to distance themselves from the competition in the multiple-sclerosis market.
Biogen has been one of the best performing stocks in the S&P 500 over the past 18 months, and we believe the news flow from the Company should continue to improve. There also has been plenty of consolidation in the biotech industry, and Biogen has one of the best pipelines in the industry. We believe this would be an attractive takeover target for any large pharmaceutical company. We expect shares of Biogen to reach $150 within the next 12 months.
Jana Partners, an activist hedge fund, disclosed it took a 5.5% stake in Marathon Petroleum last week, which makes it the largest shareholder of the Company. Jana has had success recently breaking up energy companies and selling them at a significant premium for shareholders. We are encouraged by this news and look forward to hearing about Jana’s plans for Marathon Petroleum. We believe the shares are currently undervalued, and believe the shares should be trading around $50 per share.
(c) McIntyre, Freedman & Flynn