Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
April 18, 2011
Last week saw the stock market drop slightly over ongoing European default concerns as well as the sting of high oil prices feeding through into inflationary pressures.
As the charts above illustrate, the Dow Jones Industrial Average fell just .3% while the NASDAQ Composite dropped .57%. The few earnings announcements also caused some investors to lock in some trading profits.
The Markets & Economy
The big news last week was the so-called “budget agreement” reached in Washington DC. No one should feel comforted. Our federal government is still on pace to show a larger deficit this year than last, which is odd given a growing economy. The latest estimate calls for an approximate 1.5 Trillion dollar shortfall. Thus last week’s agreement to cut maybe 38 billion dollars is not worth the paper it is printed upon.
This morning’s news proves this point without question. The ratings agency Standard & Poor’s has affirmed the triple A rating of the sovereign debt of the United States, but dropped its outlook to a negative rating. This action has sparked an early morning sell-off in the stock market even though S&P did nothing but point out the obvious.
Just look at the chart on the following page which tracks federal government spending versus receipts since 1990. One can quickly see that America has a spending addiction at a time when receipts, while recovering, have not yet returned to the pre-recession level.
The point that S&P makes, and again it is self-evident, is that even if the economy continues to advance the government cannot continue to spend 25% of GDP while receipts historically in good times and bad only come in at 20% or so.
Accordingly, unless America is to become a different sort of country (like socialized Europe,) then spending levels must change and soon. This is both a political debate about the type of country we wish to have, and it is also an economic issue that will impact the prices of financial assets until resolved. I will say one thing and it is not meant to be political - just a matter of historical fact. This country cannot successfully tax its way back into prosperity. The government sector must shrink and growth policies must be pursued or the worst off in our society will be crushed in much harsher terms than the so-called rich.
What to Expect This Week
- First of all this is only a four-day week for the financial markets. On Friday the markets will be closed in observance of Good Friday.
- Earnings reports on several of our company names will be forthcoming this week and we will update you next Monday.
- Finally, the ongoing concern about an overheating economy has now been replaced by concerns over a slowing economic outlook due to higher oil prices etc…
Personally, I never thought the economy was on the verge of booming, and that the unemployment rate had not meaningfully declined, and neither am I concerned the economy is about to plunge into reverse. The latest reading from the Economic Cycle Research Institute (see chart below) shows a year over year growth rate of 6.8%. Thus it remains all clear for now.
In fact, the slowing consensus on future growth combined with the threat of sovereign default and weakness from Japan may all combine to forestall any sudden move by the Federal Reserve Board to change its zero interest rate policy. In my estimation the risks to the global economy continue to be mainly from the downside.
DIVIDEND PAYING STOCKS
SYMBOL: DOW SYMBOL: EPD
As the economy continues to exit the financial crisis, more companies are raising their dividends as management teams have done a good job of improving their balance sheets. This past week two of the companies we invest in raised their dividend/distribution to shareholders and we look for this to become a more popular trend in the capital markets.
Dow Chemical raised its quarterly dividend by 67 percent to $0.25 per share. This comes two years after the Company had to cut its quarterly dividend for the first time in the Company’s history. We believe this shows the level of confidence the Company has in its balance sheet and earning power going forward. The management team has been paying down debt for the past two years, and was able to pay down $2.5 billion in debt in the first quarter. This dividend hike came at the high-end of expectations and we expect a more normalized dividend policy from the Company going forward.
Enterprise Products also raised its quarterly cash distribution by more than 5 percent, to $0.5975 per common unit. This is the 36th distribution increase since the Company went public in 1998, and the 27th consecutive quarterly increase. Enterprise has one of the best balance sheets in the energy industry, and we look for continued small increases in distributions going forward.
Both of these companies have performed extremely well the past two years, and this is management’s way of giving back to shareholders. In this current environment we believe that investors want higher dividend payouts and look for several other of our companies to be raising payout rates. Both of these companies remain core holdings in our accounts and we believe they will be market leaders as the economy continues to improve.
(c) McIntyre, Freedman & Flynn