Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
March 14, 2012
Stocks have endured a rough couple of weeks as it has finally become obvious to everyone that the so-called recovery in the US has been a mirage while the difficulties in Europe have never been addressed. The latter problem is due to the flawed structure of the European Monetary Union, while our problem has to do with an incorrect mixture of policy choices from Washington and in many of our larger states such as California and Illinois.
As the charts above illustrate, last week saw a decline of 1.7% for the Dow Jones Industrial Average and .76% for the NASDAQ Composite. These declines were very modest compared to the carnage in Europe and Asia.
The Markets & Economy
There can no longer be any spinning from the White House concerning the job market and income growth. We simply do not have any. Tax receipts are flat and personal income growth is nonexistent. Instead of dealing with these problems, the nation is being subjected to a barrage of cultural issues for which the office of the President actually has little power to impact. These are state matters according to everyone from the President on down.
At the same time, the news from Europe is ghastly. Those socialistic countries have created a structure which creates dependency and penalizes initiative. France has just elected a socialist president (albeit one with THREE mansions on the French Riviera) who wishes to reduce the retirement age, increase government spending, and waive the deficit rules just recently agreed to.
Keep in mind, the government sector already accounts for fully 50% of the French economy. This entire fiscal disaster is accompanied by the monetary union treaty that obligates France to keep spending within bounds, or else. The or else is, of course, what has now happened in Greece and is happening in Spain, Portugal and Italy.
In other words, the European monetary union is now dead. The only thing left is to figure out how to dismantle it with the least amount of economic damage. At the same time the political will throughout Europe has collapsed. These people simply do not know what to do, and as a result, fringe political parties on both the left and right are being elected. Trouble is ahead and that is for sure.
Back in America, one would think that our leaders would see these developments and seek to take steps to allow us to avoid any such scenario from happening here. Instead, what do we get? The governor of California (who was first elected in the 1970’s) is announcing a doubling in their budget deficit. His policy response (the same one for forty years) is to raise state taxes that are already the highest in the country.
California has become our Greece and there will be more states to follow. At the federal government level over 50 percent of the spending is based upon borrowed money, there are no proposals from the current administration on how to handle these issues. In fact, our government has not passed a budget under the Obama administration. Incredible and where is the media coverage? Instead we are bombarded with wedge issues on a daily basis in an attempt to fool the electorate until after the election.
For instance, how many people out there understand that under current law, the tax rate on dividends, and interest next year will zoom to over 40%? Don’t expect to hear this discussed before November. Does anyone really think our economy can absorb this sort of tax hike next year? While Warren Buffett will be happy the rest of us will feel duped that the campaign largely ignored issues that actually make a difference to people.
From the market’s point of view, these issues are well understood. Meaning, quite a bit of bad or disappointing news is already in current stock prices. That is why our market, in particular, has proven so resilient. A zero percent interest rate policy from the Federal Reserve Board, and strong earnings, and dividend increases continue to make stocks attractive compared to bonds or real estate.
The problem is that growth is lacking, and without it societal pressures and tensions will be on the rise here and overseas, you could even see revolution and border skirmishes as countries start to impose capital controls of one kind or another. Thus our strategy is to have some cash for opportunities, and focus on global leaders who can actually improve their competitive position throughout this ugly cleansing process which I discussed above.
What to Expect This Week
I have one word here and that is Greece. They have a bond payment due under English law tomorrow, and they have not said whether they will honor it. If they do then some additional time will have been bought. If not, then the exit from the Euro zone has happened.
At home, the debate on the economy is no longer a debate. We have ground to a halt no matter how it is measured. No jobs, flat earnings, slowing of exports etc… Just listen to the Cisco earnings call from last week to get the details.
With this we have seen a drop in commodity prices, which brings us ever closer to the FED making another move to goose the stock market. With the ten year Treasury bond below 1.8%, the coast is clear for the FED to move, and while this would do nothing for the economy it would goose the stock market. Look also for the ECB to be forced into another round of easing unless, of course, it simply gives up.
Finally, the update from the Economic Cycle Research Institute is not good. The charts below show that the index is now some 3.8% lower than last year, and nobody thought that it was any good at this time last year. I continue not to look for a formal double dip recession because we never actually recovered from the 2008 decline. I just think the economic growth rate is going to fall before it rises. Depending upon the Fed’s policy moves, and perhaps its influence on the election, this just might be very bullish for stock prices in a counter-intuitive way.
Next week’s update will be done on Tuesday morning due to my travel schedule.
Biogen Idec reported solid first-quarter earnings results as the Company continues to grow its industry leading position in the treatment of multiple sclerosis. Net income rose 3 percent to more than $300 million, and revenues grew by 7 percent to $1.29 billion. Management also reiterated its earnings-per- share guidance for the remainder of this year, and believes they will earn at least $6.15 per share.
The Company sells two drugs for the treatment of multiple sclerosis: Tysabri and Avonex. Even though sales of Avonex were somewhat disappointing during the quarter, the strength of Tysabri led to further market share gains for the Company. The disappointment in Avonex was attributed to a one-time event in January that was caused by a shift in pharmacy benefit managers to some 5 million US government workers. Global sales of Tysabri were up 14 percent during the quarter, and the long-standing fears about the drug seem to be put to rest.
The success of these two drugs has placed Biogen as a leader in the pharmaceutical sector, and we feel the future will be better for shareholders. Management continues to highlight the successes of its BG-12 drug, which is an oral MS drug. More positive findings were released last week, and the Company filed for FDA approval in February.
Biogen has been one of the best performing stocks in the S&P over the past two years and we expect the outperformance to continue. The stock is not sensitive to global economic growth, and the shares will climb higher as they continue to build their multiple sclerosis franchise. We expect the positive news flow from the Company to continue, which should push the share price up to $160.
Pioneer Drilling reported its best quarterly earnings report in more than a year, but due to the market malaise investors didn’t take notice. Earnings and revenues both came in much better than expected, and the conference call was more positive than we have listened to in quite some time. The management team raised its guidance for the rest of the year, and we are more positive on the shares than we have been recently.
Both the drilling and production services divisions experienced strong margin growth during the quarter. The Company’s utilization rates remained at 87 percent, but margins expanded by 11 percent as pricing pressures eased. Well servicing utilization rose by six percentage points to 92 percent, and hourly rates were also higher. March was the best month in the Company’s history, as the Company recorded its highest revenues and most rig hours booked.
Shares of Pioneer barely moved due to this report, which was surprising. The markets traded very poorly last week, and investors didn’t take notice of these strong results. We expect the shares will play catch up when the market conditions improve overall. We believe the risk/reward relationship is excellent for shareholders of Pioneer and expect the shares will reach $15 within the next 12 months.
This earnings season Akamai reported first-quarter earnings results that were better than Wall Street’s consensus estimates, although the Company warned that earnings for the rest of the year wouldn’t meet estimates. This was quite a surprise to investors, and the stock gave up all of the gains it had for 2012. The Company has also started a search for a new CEO as founder Paul Sagan plans to leave the Company within the next 18 months.
The recent run-up in Akamai’s share price was fueled by the two acquisitions of Blaze and Cotendo, which were supposed to raise margins and help the Company’s competitive position. Due to the acquisition costs, these deals will actually lower margins for this year, but should help the Company going forward. This is disappointing, but Akamai needed these companies in order to grow its industry leading position, and we believe shareholders will eventually be rewarded.
Shares of Akamai sold off sharply on this report, and general market conditions didn’t help. We are maintaining our position in Akamai, and believe margins will improve in the second half of the year. An acquisition of Akamai is still very possible, as a larger technology company would love to be in this space. As the news improves at Akamai, we believe the shares could still reach $40 within the next 12 months.
(c) McIntyre, Freedman & Flynn