Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
May 2, 2011
Strong earnings and a benevolent report from the Federal Reserve Board combined to keep the stock market rally roaring ahead despite scant media coverage.
As the charts above illustrate, the Dow Jones Industrial Average gained
2.44% led by our shares in Boeing and Caterpillar while the
NASDAQ Composite reached multi-year highs and gained 1.84% on the week.
The Markets & Economy
This morning the financial markets are celebrating the capture and killing of Osama bin Laden in Pakistan yesterday. Oil prices have retreated somewhat and stocks are firm on this first trading day of May.
More fundamentally though, the market should be higher today. The economic data announced over the weekend shows the Chinese economy slowing down without fear of recession and last week our Federal Reserve Board stated that it was steady as it goes with its printing-money policy. Thus the fear of rising interest rates in China has lessened and the notion that the Fed would suddenly hint at changing policy was discarded even as it was a canard to begin with.
In fact, the first quarter GDP report for our economy as feared came in at just 1.8% annual rate with real final sales (the best gauge of underlying activity) rising just 1.6% (see chart below). This is simply not the sort of growth that will foster gains in employment or strike fear in the Federal Reserve that the output gap in the economy is being closed to the point that real fears of inflation should be entertained.
Following up on this last point, it is instructive to note that these anemic economic growth numbers were achieved with zero interest rates and government deficit spending, which annualized in the trillions of dollars. This puts the lie to the notion that our economy has embarked on some sort of self-sustaining recovery and it begs policy makers to think about what they are doing in terms of fiscal and other policy options. My point is simple, if taxing and borrowing cannot get this economy to grow then maybe a change is necessary.
As investors though, the story is quite different. Corporate earnings are surging and global opportunities are presenting themselves. In addition, productivity moves, which will enhance future earnings power, continue unabated. Mergers, dividend increases and stock buyback programs along with low interest rates and a preferential tax treatment for dividends and capital gains are all serving to support the markets and economy. Frankly, at this point, this is about all that is working well. Hence while the stock market receives nothing but fear mongering, it is doing its best to rise with as few investors on board as possible. The trillions and trillions of dollars earning virtually nothing on the sidelines is proof of this.
What to Expect This Week
Focus will return to the domestic economy with the report on unemployment for the month of April due out on Friday. The four-week moving average of initial jobless claims has been on the rise, and given the pathetic GDP report mentioned above, look for a disappointing number this Friday. This should remove any doubt about the Federal Reserve Board raising interest rates soon.
Also, this week our Congress will resume its work on what to do about the country’s debt limit. Look for quite a bit of posturing without any solutions. On any given day this sideshow could hurt market sentiment.
Finally, our look at the Economic Cycle Research Institute’s leading economic indicators (see chart below) shows that it still is in an upward bias and thus continues to forecast that the economy will continue to be ok. Accordingly, the job creation ability of this economy will continue to remain suspect.
Netgear reported first quarter earnings results that were much better than Wall Street was expecting. After special items the Company earned $0.65 per share, which was $0.17 better than consensus estimates and 55 percent higher than last year. Revenues also rose 32 percent and the management team significantly raised earnings guidance for the remainder of the year.
The Company is really gaining momentum in the wireless market and continues to take market share from all of its competitors. Netgear’s main competitor, Cisco Systems, has been having problems with its consumer electronics division, and is now contemplating exiting the business. We look for the Company to become the dominant player in the router and wireless security businesses over the next two years.
Since we have been investors in Netgear we have been trumpeting the Company’s growing product portfolio and now we are seeing the success of the new products. During the first quarter the Company launched 20 new products and expects to introduce 17 more products in the second quarter.
Shares of Netgear rose by 25 percent to an all-time high, and we believe the shares are still conservatively valued. We look for the Company to continue to exceed Wall Street’s expectations, as the new products should gain traction in the marketplace. We are raising our price target on Netgear to $50 per share within the next 12 months.
Caterpillar reported much better than expected first quarter earnings results last week, giving investors much more faith in the strength of the global economy. First quarter profits soared more than five-fold from the previous year to a record level for the Company of $1.23 billion. Revenues also rose by 57 percent to $12.95 billion and management raised their earnings guidance for the rest of the year.
This Company is in the sweet spot of the global economy and demand for their products surges worldwide. The emerging markets, as well as China, continue to be the growth areas for the Company as demand for mining equipment has soared due to the rise in commodity prices. Management stated that earnings would have been even better, if it weren’t for the earthquake and tsunami is Japan.
We believe the growth at Caterpillar is sustainable and the recent acquisitions the Company has completed will raise growth rates over the next two years. Management now expects annual revenues in the range of $52 to $54 billion, up from their previous guidance of $50 billion.
Shares of Caterpillar are trading at all-time highs this morning, and we believe the Company is poised for strong growth for the foreseeable future. Even as the shares are trading at highs, we believe the shares have far more upside in coming years. Caterpillar is a core holding for our clients, and we expect the shares to reach $150 within the next 12 months.
Ryder Systems reported better than expected first quarter earnings results last week and the stock is now trading at a new 52 week high. Earnings more than doubled from last year and the Company earned $0.51 per share during the quarter. Revenues also rose by 17 percent to $1.43 billion and management raised earnings guidance slightly for the remainder of the year.
Ryder is an excellent barometer of the strength of the domestic economy, so we are encouraged by these excellent results. The Company has one the best balance sheets in the trucking industry and we expect they will buy out weaker competitors over the next two years. We are more impressed with this management team than any other company that we follow and the operational efficiency at the Company is superb.
Shares of Ryder have been trading well since releasing these results and we expect the shares to move to all-time highs in the coming months. As the economy continues to improve we believe that Ryder is positioned to take market share in the trucking industry. We believe the shares will trade up to $75 by the end of this year.
(c) McIntyre, Freedman & Flynn