Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
April 23, 2012
Last week was a seesaw affair, with the macro news being a negative, while
corporate earnings served to support stock prices.
The charts above illustrate that the Dow Jones Industrial Average gained 1.4% last week as the blue chips reported pretty good earnings and outlooks. The NASDAQ Composite though fell .36%, mainly because of concerns and some confusion developing in the shares of Apple, which reports tomorrow evening.
The Markets & Economy
The economic data, led by the deterioration in the employment data (weekly initial claims jumped again to almost 390,000), has fueled the notion we have put forth for some time that the global economy, as well as our domestic one, is sputtering. The notion that the dominant media featured last winter of a strong and self-sustaining growth economy was a simple mirage. Part of it was what the media wanted you to believe, and part of it was based upon the very poor data being compiled and seasonally adjusted (read that to mean fixed), which gave an incorrect reading of the world.
Today we have a total reversal in perceptions as Europe has once again entered full- blown disaster territory. The prospects of a socialist victory in France, and the fall over the weekend in the Netherlands government (a triple A rated country in the Euro zone), has combined with the usual concerns over Spain, Italy, Greece and Portugal, to cast serious doubts as to how this region can possibly bring itself to recover economically.
The Euro was ill conceived, but now represents an additional and crucial impediment to solving Europe’s economic problems: Namely, just how does a country get out of this arrangement or more broadly just how does the entire fiasco get dismantled? This question will not go away, and remains a problem for economic growth and how the stock market views the future (or is unable to view the future).
Thus the familiar battle will continue to take place, as concerns over the ultimate resolution are offset by aggressive worldwide central bank intervention and easing combined with strong corporate results. For the past three years this has been the hallmark of the bull market here in the United States (note there has been no bull market overseas in either Europe or Asia), and I expect it to continue - but alas the day-to-day volatility is back.
Given that we have our own economic problems and elections to deal with, it is likely that investors will become increasingly selective about which company names they hide out in, and which ones to stay away from. In other words, companies need to have strong earnings and dividend record (or other returns of capital to shareholders) to compensate for the risk of holding their shares in this uncertain period.
What to Expect This Week
As I said, we are off to a difficult start this morning, and this week will have loads of economic data for the market to chew on. For my money though, the biggest issues will be Apple’s earnings tomorrow night, and the two-day Federal Reserve Board meeting that concludes on Wednesday afternoon.
As far as the Fed is concerned they will not meet again until June, so given the changing outlook, the time to lay the foundation for doing something for the economy is this week. If they do not allow for that notion to gain credence then the market will be disappointed.
The Federal Reserve is, unfortunately, very political.
- Our elections are now just six months away.
- The employment trends are now looking lousy.
- They are running out of time to play a role in shaping economic confidence before the election.
- That timing is also exacerbated by the fiasco that we have simply come to know as Europe - a region led by competing government bureaucrats, which has seen their economic zone become dominated by central planning and a dependency on government that can no longer afford the promises it has made. (Sound familiar?)
As far as our economy is concerned, the Economic Cycle Research Institute is now showing a pronounced decline in their weekly index level. The four-week moving average has yet to plummet, but simple arithmetic indicates it must follow (see chart next page). Their forecast from last September of a recession is starting to look more plausible, but clearly our domestic economy, having never recovered from the 2009 recession, is not as vulnerable to what will likely be a continued slowdown.
In any case, the Federal Reserve Board will consider this in its policy statement, and for stock investors the major point of interest will be on additional quantitative easing. For most others the concern should be on the crazy policy ideas that continue to emanate out of Washington DC, such as the so-called “Buffett tax proposal”, which is really a way to double the capital gains tax to 30 percent. No one will simply say this, but I just did.
EMC reported better than expected first quarter earnings results. The Company also maintained their earnings and revenue guidance for the remainder of this year. First quarter revenue came in at $5.1 billion, which was 11 percent higher than the previous year. Also, the Company earned $0.37 per share, a penny a share higher than Wall Street’s consensus estimates. This was a solid quarter for the Company, and any weakness in the share price is mostly market related.
The conference call with investors went well, and the Company’s CFO, David Goulden, focused investors on the industry-leading sales growth. Mr. Goulden referred to the quarter as a “triple play,” as the Company took market share, reinvested for growth and delivered improved earnings for the year. We believe the market-share gains are sustainable, and the revenue growth projections are too conservative.
This management team has a history of giving conservative guidance, and we expect the earnings results will exceed expectations for the remainder of this year. Management also believes they will be able to achieve consolidated revenue of more than $28 billion by 2014. This would represent an annual compounded growth rate of at least 13 percent from 2010.
Shares of EMC traded a few percentage points lower following this report, and we believe this represents a good buying opportunity. EMC is our favorite large cap technology company, and we think investors are undervaluing EMC’s holding in VMWare. We expect the share price of EMC will reach $35 within the next 12 months.
Freeport-McMoRan reported solid first quarter earnings results last week, and maintained their outlook for global copper demand. The earnings numbers matched Wall Street’s estimates, and management also continued to lower the cost structure at the firm. Added to that, labor conditions at the Company’s troubled Indonesian mine are starting to improve and management believes they can get production back to historical levels by the end of this June.
Shares of Freeport trade much more in line with the price of copper than earnings and revenue targets, and management believes that 2012 will be a very good year for copper. 2012 will likely be a deficit for the global copper market, which indicates there is too much demand for the current production estimates. The urbanization of China continues to be the main growth driver for the industry, and China currently accounts for 40 percent of the global copper demand.
We do believe that investors in Freeport will be rewarded this year, as the news flow from Indonesia should improve, and China should continue their impressive growth. There have also been some takeover rumors during the last couple of weeks, and we would not be surprised if a foreign conglomerate might try to acquire the largest domestic copper producer. While always volatile, we believe that Freeport has a conservative valuation, and expect the shares to be trading over $50 per share within the next 12 months.
(c) McIntyre, Freedman & Flynn