Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
December 7, 2010
The last two weeks have offered a seesaw affair as concerns about Europe a few weeks ago were replaced with economic optimism last week.
As the charts above illustrate, both the Dow Jones Industrial Average and the NASDAQ Composite gained well over 2% last week thus recovering the losses from the previous holiday shortened Thanksgiving week.
The Markets & Economy
Frankly, there are many cross currents and news items floating around today. The bailout of Europe and presumably other European countries continues to be a headline risk that impacts the currency markets greatly which heavily determine the daily direction of stock market futures. Tomorrow’s vote in the Irish parliament to ratify the conditions of the bailout package will be another reminder of the unpredictable nature of the overnight headlines.
In addition, we have the ongoing concerns of the direction of tax and spending policies. Our lame-duck Congress should quickly extend the tax rates for all Americans and go home. In our Country elections should have consequences and it should not be for the lame-duck Congress to involve itself in anything other than the minimum necessary to keep the government functioning. The new Congress will be sworn in the first week of January and should determine longer-term policy at that point.
Nevertheless, the continued dragging out of extending the tax rates (note, no one is getting a tax cut - just keeping the rates the same) is not helpful to the economy, nor is it helpful to the markets.
Finally, while the economic data, exclusive of employment, is showing solid improvement the release last Friday showing a jump in unemployment to nearly 10% is disappointing but very predictable if you have been reading our weekly commentaries.
Government policy such as the aforementioned confusion about tax rates is simply providing employers (yes, those mean people) with a reason to avoid hiring unless absolutely needed. The cost of employment in this Country is moving higher and the supply of labor is bountiful. Thus there are few incentives to hire and few pressures to compete on wages especially for those without a college education.
Perversely, as I have pointed out many times, this has not and will not be bad news for investors.
- First of all it guarantees low interest rates (look at Chairman Bernanke’s comments last night on CBS’ 60 Minutes show).
- It has also produced the dynamic which will prevent the Obama administration from raising income or capital gains taxes and
- Finally, it has produced corporate profits based upon high productivity that are giving corporations opportunities to expand overseas, merge with others or otherwise return capital to investors via dividends or stock buybacks.
This explains in a nutshell why the market and economy continue to move along, which employment becomes a bigger and bigger political problem that can only be addressed by pursuing growth initiatives and not by focusing upon income redistribution.
Our focus remains the same. Watch what actually happens in Washington and ignore the political posturing. Then focus on what is actually happening with the global economy and try to ignore the morning headlines, which if they are headlines, means they will have a negative slant.
In that regard, the latest from the Economic Cycle Research Institute is that their forecast now specifically rules out a double-dip recession. Their weekly index shown on the next page has improved to a minus 2.4% from one year ago. This is the best in several months and their longer-term indicators are combining to give them the confidence to make the forecast mentioned above.
This in itself will not cure the employment problem, but as investors we can continue to focus on what the stock market is focused upon and that is profits and what companies are doing with their profits.
What to Expect This Week
I mentioned tomorrow’s Irish voting. This will set the stage for whether or not we get treated to another European sovereign debt crisis this year or not. In addition, the soap opera that we call the Congress must stop fooling around and pass tax legislation or many people could be hurt starting on January 1st. The best news is that the stock market likes to rally into year-end and the adjournment of Congress will help that trend once again this year.
Brocade recently reported its fiscal fourth quarter earnings results that were essentially in-line with consensus estimates. The Company earned $0.14 per share, which was a penny better than expectations as revenues grew by 5.5 percent from last year to $550 million. The management team did give some cautious guidance for next quarter that did lead to a sell-off in the share price.
Unlike recent quarters Brocade’s operating results didn’t disappoint Wall Street, but the cautious guidance was a bit of a surprise. According to CEO Mike Klayko, uncertainty about federal and local government spending in the US is the reason for the cautious outlook. Other networking equipment companies have warned about similar trends in government spending, although we believe the concerns are overblown.
After selling off following the report, the Company received an upgrade from a large Wall Street brokerage house that pushed the shares back to levels from before the report was released. The analyst cited better than expected recent channel checks and overall improving business conditions at the Company. The options market continues to be active in Brocade, indicating that traders still believe a buyout of the Company is probable.
Shares of Brocade have been a disappointment over the past 12 months, but we believe the Company is positioned for growth again. We believe that current management must improve operations at the Company or they will be removed. We expect the shares will reach $8 within the next 12 months.
Enterprise Products Partners announced last week that they priced a public offering of 13.225 million common units at the price of $41.25. The deal was oversubscribed and the underwriters were able to purchase the overallotment. The Company was able to raise approximately $528 million and will use the proceeds to temporarily reduce borrowing under its credit facility. Enterprise does these offerings routinely and it only improves the strength of the Company’s industry-leading balance sheet. We believe the shares of Enterprise will reach $50 within the next 12 months.
(c) McIntyre, Freedman & Flynn