Weekly Commentary and Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
June 5, 2012
Between the problems in Europe and the disappointing news on jobs and
economic growth at home, stock markets globally have taken a tumble
albeit with the USA doing much better than everyone else.
As the charts above illustrate, the Dow Jones Industrial Average gave back all of its gains for the year by dropping 2.7% last week, while the NASDAQ Composite dropped 3.2% and is now negative for the year.
The Markets & Economy
For some reason investors finally opened their eyes these past couple of weeks. They did not like what they saw. As we have commented endlessly here over the past six months, there never has been a recovery in our employment category, and the growth rate of the economy has never shown any inclination to rise above 2% on an annualized basis.
So what happened? In my mind, the financial and mainstream media was hell-bent upon painting a picture which did not exist. Look at the chart on the next page concerning jobs both full time and part time. This chart is not new and was well known all along. It shows that this country has not produced a net full time job since the Obama administration took office. That is stunning since we are now nearly four years later.
By manipulating the labor participation rate, our government has sought to convince the public (and investors) that things were looking up and strongly so. That was a mirage and I have said so previously. Last week the curtain was pulled on this project when both the revisions to previous months and the current month showed anemic growth. The politically sensitive unemployment rate rose to 8.2%, and everyone now agrees the real number is much higher.
At the same time the GDP for the first quarter was revised to below 2%. Remember last year in total was just a plus 1.7%? How is it with these numbers that so many people wanted to think that the USA had “decoupled” from the rest of the world is ludicrous to me. Clearly, attempts to convince the American electorate of a great falsehood have now failed, and thank goodness! The problems facing the global economy are significant and must be addressed and debated in this election year.
The dreadful results for the economy have already been blamed by the President upon Europe and their sad state of affairs. I am sorry to once again have to say it, but this too is not true. The European mess has been around for two years or more and the current chapter really did not boil over until the month of May. In other words, the European effect on employment will only be felt noticeably in the next several months.
In any case, last year it was the Japanese earthquake and now it is this. At some point the excuses must stop and policy choices be judged. We are at that point today.
Speaking of Europe, they have never solved their problem and actually made things worse by electing a socialist as the new President of France. The pressure is building upon the European Central Bank (which needs Germany’s blessing) to become the true lender of last resort. This I believe will happen and cause another massive rally in stocks, especially in Europe, but it will not in itself solve the underlying problem.
The problem in Europe as in the USA is that you cannot run a government without the means to pay for that government. In Europe, the public sector is already too large and must be cut dramatically or growth will never return. This has political implications as the “nanny” state has progressed to the point of being unaffordable. However, politicians from the left and right will demagogue the issue, and elections are starting to produce some strange results.
Here in America, the process is proceeding along the same path. Last week it was reported that 49.1% of all American households are getting a government check of one kind or another. That, my friends, tells me that our spending has long since gone past the safety net stage, and has progressed to the point where our growth prospects are being impeded. When the number of voters can vote themselves benefits that the remaining population does not want to pay for, then the country has a problem.
In the good news category, of course, is that the USA and corporate America in particular, have understood this all along. While the media simply thinks this is some sort of cyclical downturn, American corporations since 2008 have prepared for something far worse. That is why profits remain outstanding and dividends are increasing etc… It also explains why our stock market alone in the world has avoided the meltdown that we have seen in Europe, Asia and South America. Where are all those emerging market bulls today?
You may recall, that I suggested a few weeks ago, that I expect growth to come out between zero and two percent. That is still the case. Corporations will be challenged, but many will just continue to do what has been successful for them recently.
After the headlines from Europe subside (not for a few weeks), look for our market to first stabilize and then lead a rally as the news of the past few weeks should not really have taken anyone by surprise.
What to Expect This Week
The European Central Bank is scheduled to meet on Wednesday. While reluctant, I expect they will lower rates (foolishly they were raising them one year ago). This may be helpful psychologically, but the real question for the ECB is when will they embark on their equivalent of quantitative easing? It has to happen, but they will defer comment and be reluctant right up to the day that they do it.
Here at home, FED Chairman Bernanke testifies in front of Congress on Thursday. The markets would like a signal on his future plans, but usually he does not like to show his cards. His speech, though, does have the possibility of moving markets in either direction.
Finally, the update from the Economic Cycle Research Institute shown in the chart below is not encouraging. The actual level of the index is now some 5% below last year at this time and as I said before no one thought last year was anything to write home about.
One should look at the last few years and note that while the headlines from Europe and elsewhere have created periods of time of great turbulence, our stock market has managed its way via stock selection. In essence, during this time period the strong corporate names just get stronger and their share prices reflect that over the long haul.
SYMBOLS: NTGR EMC BRCD
There have been several high-profile earnings warnings the last couple of weeks that have weighed on our technology holdings. Cisco Systems, NetApp and Dell Computer all warned that spending in the technology sector is slowing, primarily due to the economic issues in Europe. While these warnings should not be completely discounted, given the macro economic conditions in Europe, we believe that our technology holdings are in a much better position than their competitors.
The three holdings that were affected the most were EMC, Brocade and Netgear, although we believe these companies have much different issues than their larger competitors. First of all, Netgear has been taking market share from Cisco for years, and we believe the trend is accelerating. Brocade also recently released their earnings report, and the Company’s guidance was better than expected, indicating Cisco’s problems are more company-specific. Finally in the case of EMC, we believe that this Company might be seeing some pricing pressures, but the selling of the shares has been overdone.
We do believe the economic issues that Europe is facing are real and will not be resolved overnight, but the negative effects on some of our holdings have been overblown. A spending slowdown in the technology sector could also lead to an increase in consolidation in the sector, and we believe Netgear and Brocade are two likely takeover candidates. Historically, technology stocks have been volatile to both upside and downside, although we believe this downturn has created a nice buying opportunity.
(c) McIntyre, Freedman & Flynn