Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
December 20, 2010
The holidays are soon to be upon us and the financial markets are quickly winding down for the year. Despite news of the tax rate extension and developments in Europe and Asia the markets were largely quiet last week.
As the charts above illustrate the Dow Jones Industrial Average gained .7% last week led once again by shares in our holding of Caterpillar
while the NASDAQ Composite barely budged with a gain of .2%.
The Markets & Economy
The big news last week was the final passage of the extension of the tax rates first enacted under President Bush some ten years ago. Mind you, there are no income tax cuts for anyone as the media seems bent on convincing people. Come the New Year, the withholdings for income taxes will be the same. The Social Security Tax for individuals is reduced for one year. This payroll tax holiday will be a boon to consumer spending and saving, but of course, will make the deficit facing the Social Security system that much larger.
Most of this program has long since been anticipated by Wall Street even as politicians and the national media had a difficult time coming to grips with the notion of the correctness of simply leaving tax rates alone in a slow-growth economy.
Thus the impact for us investors is a positive one. The taxes on dividends and capital gains remain the same and the likelihood of a double-dip recession further diminishes. Accordingly, while last week’s reaction was ho-hum, the longer term outlook has been improved by this action.
The latest readings from the economy continue to cause us to expect better growth in the next few quarters, but still at a pace, which will not unleash the sorts of pressures that will cause the unemployment rate to fall meaningfully. To do that will require a more growth oriented policy prescription from Washington DC. It is not enough for the Federal Reserve Board to print money to prop up asset prices. The real solution to keeping asset prices from falling is to create fundamental underlying demand, which means growth. This will only occur with the proper economic incentives and not by borrowing trillions of dollars per year from foreign investors or from the Federal Reserve which of course is ultimately just a creation of Congress.
As a result the issues facing us as we head into 2011 are better than one year ago. In many ways the threats to the recovery remain and it will be important to see just what policy moves come out of not only our government, but others as well.
For now, investors continue to enjoy high profits, stable taxes, low interest rates and a continued drive by corporations to engineer returns for their shareholders via stock repurchases, merger activity, dividend payments and participation in the quicker growing regions of the global economy.
Our portfolios are positioned to participate in all of these trends.
Finally, the weekly reading from the Economic Cycle Research Institute as shown in the graph below shows continued improvement with the year over year reading now flat. Last spring this gauge had fallen to a negative 11% reading and fears of a double dip were everywhere. Today they simply do not exist.
What to Expect This Week
Obviously, we are heading into the holiday season. This week will see the financial markets closed on Friday in honor of the Christmas federal holiday. European markets tend to take even more time off, so this week should be very quiet. Even Congress, hopefully, will just go home before any further damage can be done.
The economic news is light until Thursday when reports for new home sales and durable goods will be announced. Neither will move the market.
Our next update to you will be two weeks from this morning,
this will be the first day of trading in 2011.
Most likely the news between now and then will not be momentous, but we will provide our first look into the New Year.
Merry Christmas & Happy New Year!
Southwestern Energy announced their budgeting plan last week for 2011, and also stated they might want to monetize some assets during the year. The Company now expects its capital budget to be $1.9 billion for next year and an annual production growth target of 18 percent. Both of these estimates were at the higher end of expectations and help ease concerns that growth rates would be coming down further.
There had been some Wall Street analysts expecting much gloomier guidance, but we feel that 2011 will be a strong year for the natural gas industry. The Company expects higher natural gas prices in 2011 compared to 2010, which could lead management to raise its production schedule. We have been surprised by the weakness in natural gas compared to other commodities and look for the price of natural gas to play catch up in 2011.
The Company also focused investors on their improved efficiencies of their drilling practices and the Board of Directors decision to place their midstream business up for sale. We expect the midstream business will be sold in the first half of 2011, and the Company will continue to have higher recovery rates as their drilling procedures are streamlined.
Shares of Southwestern, along with the rest of the natural gas industry, have not performed well in 2010. Fortunately, we see demand for natural gas rising in 2011, which should lead to substantially higher stock prices throughout the industry. We believe that Southwestern currently has one of the most attractive risk/reward relationships of any of the stocks in our universe. We believe the shares will reach $50 within the next 12 months.
Suncor Energy also announced their capital budget expectations and gave a strategic growth update for the next several years. The budget and growth plans were similar to consensus estimates, although the Company announced a partnership with Total that will expand its oil sands production. Management also highlighted its intention of keeping a strong balance sheet and its focus on lowering the production costs in the Company’s enormous oil sands holdings.
The deal with Total was the highlight of the presentation and might be a foreshadowing of how the Company wants to develop its start-up projects. As a part of the deal Suncor will receive $1.75 billion. That should close in the first quarter of next year. This deal will free up additional capital so that the Company will be able to fund the rest of their growth projects.
The management team does have an aggressive growth strategy through 2015, which could lead to more deals like the Total deal. That being said, the Company does have a strong balance sheet and assets it can sell if it has to finance these growth plans. We believe that Suncor is positioned to become the dominant oil sands player in the world and their global footprint in the sector should be growing over the next several years.
The shares of Suncor trade in-line with the price of oil, even though we believe management is taking the steps to improve the Company. We do expect higher oil prices in the coming years, which should help to drive the share price higher. This management team has an excellent reputation of growing businesses at appropriate rates. We believe the shares should reach $45 within the next 12 months.
(c) McIntyre, Freedman & Flynn