Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
December 4, 2012
Stocks continued to bounce back from their post-election sell off. In fact for the entire month of November the popular averages were virtually unchanged.
For the past week one can see from the charts above that the Dow Jones Industrial Average was flat and the NASDAQ Composite gained 1.5% as
Apple starts to regain some of the ground it has lost since September.
The Markets & Economy
Categorically, there are two themes dominating the near-term outlook for stock prices.
- The first is the emerging consensus view that economic growth is slowing once again in the fourth quarter of this year. This morning’s national ISM report will add some emphasis to this argument, especially the employment component, which fell to its lowest level since 2009.
- The second theme which has paralyzed Wall Street is the focus on our President and Congress trying to avert the fiscal outcome, which they combined to put into law over one year ago. This outcome calls for a combination of tax increases and spending cuts both of which will exacerbate next year’s economic outlook.
As most of you know, President Obama wants to raise 1.6 Trillion dollars in taxes over ten years, and to actually increase spending via another stimulus program. The Republicans, for their part, wish to reform entitlement programs and reduce discretionary spending. Neither position is possible in a lame duck session of Congress.
The purpose of the last election was to address these matters. While it will not happen, the best course of action would be to keep everything the same and use the next six months with the newly elected Congress to legislate an outcome which is not subject to an artificial deadline. Remember, these very same people that put the deadline in place can extend it anytime they wish.
The Bush tax rates have been in effect for twelve years. The notion that keeping them in effect represents some sort of danger to economic growth is preposterous on its face.
Remember also that there are many new taxes due to take effect in the New Year separate and apart from these negotiations. The timing of these taxes to pay for Obamacare was chosen to start after the election. This is another cynical use of governmental power for which the taxpayers will soon be feeling the pinch.
I say all of this because economic growth is declining and all of these measures will make it worse. In fact, as I have already predicted, there has become a wave of special dividends being front loaded into this year to avoid higher taxes in 2013. This will have the impact of lowering next year’s investment and growth plans.
I do not know how the end of year shenanigans will play out. I personally think there will not be an agreement, and that the markets will show their displeasure over both that and the coming economic slowdown. Consequently, we continue to adopt a conservative stance and will use the turbulence to reposition the portfolios.
Clearly, with interest rates near zero and with dividend yield to support stock prices, the conclusion that equities will do relatively well versus other asset classes remains my firm conviction.
What to Expect This Week
Friday’s report on unemployment will be a whopper. No more elections means the Bureau of Labor Statistics will need to clean up some of their sloppy assumptions which gave the appearance of an improving economy throughout the fall.
The last several weeks of initial employment claims have been terrible, and an hour does not go by when there is not an announcement by someone over job cuts or the switch from full-time to part-time jobs. This is being done in an attempt to circumvent the new rules of coverage under Obamacare.
Additionally, the initial reports from the consumer for the holiday season have not been good, and I expect a lot of price cutting to move inventory off the shelves. As a result, we would avoid retailers other than Walmart.
Finally, our weekly look at the Economic Cycle Research Institute’s leading economic indicators shows that the recent bounce there is now swinging back down. They continue to think we are in recession. I don’t. I think we are in a 1% growth economy which is about to be burdened with more taxes and regulations. In that context next year does not look good to me- but stocks will remain the best asset class for the reasons mentioned above.
Brocade reported solid fiscal fourth-quarter earnings results two weeks ago, as the Company continues to execute on its turnaround strategies.¬† Revenues were five percent higher than a year ago, and comfortably beat Wall Street’s consensus.¬† Earnings per share also topped estimates and came in at $0.17 per share.¬† On the conference call with investors, management also indicated that first-quarter guidance is conservative.
This is the third quarter in a row that Brocade has reported a better than expected earnings report, and we expect the trend to accelerate into 2013.¬† Gross margins were up nearly 3 percentage points to 62.9 percent as the Company is still having success bringing down its cost structure.¬† We are encouraged by the progress this management team has made, and their product portfolio is stronger than ever.¬† The Company also repurchased 11.2 million shares during the quarter.
Shares of Brocade have been trending higher since releasing these results, but we don’t believe Wall Street is giving the Company the credit they deserve for this turnaround in operations.¬† Revenues are growing again, and we expect the next two earnings reports will exceed expectations.¬† We believe the shares are undervalued at these levels and expect the shares will reach $9 by the end of 2013.
Last week we sold our clients’ shares in Netgear.¬† The Company has reported two consecutive disappointing earnings reports, yet the shares have not sold off.¬† We are more concerned about their European operations given the Company’s large percentage of sales in the region and worsening economic conditions.¬† Netgear is still a good company but we don’t see many catalysts that would lead to a higher price.¬† We look to put that money to work in more favorable investment options.
(c) McIntyre, Freedman & Flynn