Weekly Commentary and Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
May 22, 2012
Last week saw the worst week for stocks of the year, caused by the continued fears over the impending break-up of the European Monetary Union as well as the colossal flop of the IPO of Facebook, and the burgeoning horror at the trading losses at JP Morgan.
As the charts above illustrate, the Dow Jones Industrial Average dropped 3.5% last week while the NASDAQ Composite declined 5.3% as global growth concerns dominated thinking.
The Markets & Economy
Sad to say that the fears of the past several months, as expressed in these weekly commentaries, seem to be materializing. The circus act known as Europe is back in recession, as political leadership is simply not possible given the pressures of seventeen sovereign nations. Each nation is not happy, thus traditional parties are losing power, and fringe groups and other market unfriendly types such as the socialists in France are attaining power.
To put it frankly, the markets do not like this and that is why the European stocks are trading particularly weak, especially the European banks. Everyone is sick of the mess the European elites have put the region in and more summit meetings are not likely to change the game. Ultimately (when things seem their worse) the European Central Bank will unleash trillions of Euro’s to paper over the problems. If Germany tries to prevent this then the Euro, as a bloc and currency, is finished.
Such a move by the ECB will put the stock market and commodity markets on fire. I suspect though that nothing is going to happen until the Greeks vote again in mid-June to determine whether or not they want their government to stay in the EMU. Should the Greeks essentially vote to withdraw (I actually do not think they ultimately will) then the ECB will print money like there is no tomorrow because there would not be.
Closer to home, our economy continues to be affected by the global slowdown, as we expected. No one anywhere claims now that we have decoupled from the world. Such a silly and nonsensical notion has been retired. Thus we are not immune to developments around the globe. On the good news side, the global slowdown is bringing lower oil prices and record low interest rates. Thus not all is lost, but clearly the economic momentum (if there ever really was any) is gone.
The USA is settling into a growth rate between zero and maybe two percent depending upon the quarter. This, of course, is not enough to bring down unemployment unless you work for the Obama administration’s Bureau of Labor Statistics. As a result our political cycle should be focused on our economic future. I hope so. An informed electorate rather than one manipulated by the mainstream media is our best weapon to solve our problems because they will be there no matter who is elected in November.
What to Expect This Week
The continuing flop of the Facebook IPO and the trading disaster at JPM seem to vie with Europe for the leading stories of the day. The rest of the stock market is bouncing back as we do have many factors which favor stocks as the asset of choice as we have previously noted.
The upcoming Memorial Day weekend, and the beginning of summer should lessen the trading as the week draws on - barring any stunning news etc…
The update on the economy from the ECRI leading index (see chart below), which has been revised from previous data, still shows a lackluster outlook. The group itself is maintaining their call for a recession in this Country. I believe all of this is setting the stage for the Federal Reserve Board to make a move in mid-June to goose the stock market in an attempt to stabilize confidence and to improve the chances for President
Growth will not be impacted, but stocks and commodities will go higher from here at that moment which could easily correspond with action by the other Central Bankers around the globe.
Due to the upcoming holiday, our next report will be Monday June 4th 2012.
Last week Brocade Communications reported better than expected fiscal second-quarter earnings results and reiterated its previous guidance for the remainder of the year. Even though revenues shrank slightly year over year, the Company still took in $543 million, which was $3 million ahead of consensus estimates. Earnings per share were higher than last quarter, and toppedWall Street’s estimates by $0.03.
This was a solid operational performance by the management team, and their focus on improving profitability is starting to show in the Company’s results. Margins were significantly higher across the board, and we believe these levels are sustainable at least for the next several quarters. Management is also expecting new products, which will be launched this quarter, will drive the sales numbers higher for this year.
The Company continues to improve its balance sheet and reduce the number of shares outstanding through its share repurchase program. The Company has reduced its shares outstanding by 24.7 million shares from last year, and remains aggressive in its share buyback. Management stated on their conference call that they have already repurchased more than $30 million worth of stock during this year’s third quarter.
The performance of the stock has been muted since the Company released these strong results, and we believe this is mostly market related. There needs to be consolidation in the networking space, and we think Brocade would fit in nicely with a larger technology company. We remain optimistic about the prospects for Brocade and expect the shares to reach $8 within the next 12 months.
This earnings season Spectra Energy reported first-quarter earnings results that were a little light of expectations due to the warm weather around the Country and lower natural gas prices. The Company earned $0.51 per share, which was a penny under expectations. Revenues also fell by 4 percent from last year to $1.54 billion. Even though the earnings were slightly disappointing, this management team has done a terrific job of building its business during this period of depressed prices in the natural gas market.
Management continues to expand their business in this difficult climate, and we believe that investors will reap the rewards in better times for the natural gas market. It is hard for some investors to believe, but the price of natural gas is 40 percent lower than it was this time last year. Despite the lower prices, the Company’s financial strength has allowed them to continue to make investments in Canada. They recently announced a $6 billion project expansion. Spectra’s position in the industry has never been stronger, and we would not be surprised if the Company buys up some of its weaker competitors.
Shares of Spectra have performed well this year, even after the recent muted sell-off. This is one of the safest stocks that we own, and the shares still yield more than 4 percent. The price of natural gas has been moving higher the last 10 days, so this could lead to more interest in the natural gas sector. We believe there is very limited downside at these levels, and expect the shares will reach $35 within the next 12 months.
(c) McIntyre, Freedman & Flynn