Weekly Commentary and Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
July 23, 2012
Stock prices recouped their early week losses, as earnings reports were not as bad as feared. Friday’s session, and again today though, have seen investors reminded that Europe is a broken economic zone which cannot be repaired using the current European Monetary Union framework.
As the charts above illustrate, both the Dow Jones Industrial Average as well as the NASDAQ Composite showed fractional gains (less than one percent) for the week.
The Markets & Economy
If one was hoping for a quiet summer, then once again our hopes are being dashed much like in previous years. Believe it or not (and I have been warning you) the European situation has turned even worse. Greece has never seen their situation resolved, and concern is mounting that they may miss an August 20 bond payment. Spain’s bailout has not even happened yet, and they are lowering their estimates of growth and deficits for this year and next.
In other words the so-called bailout of Spain, that may never actually happen, has already fallen behind on its projections and this has been complicated by the fact that as many as six regions of Spain have already warned of running out of money themselves and want their national government to bail them out - to which I ask, with what?
Of course, Italy is now impacted as well as Sicily and many Italian cities suggesting they too are out of money. So what do the Europeans suggest as an answer? Higher taxes, more regulation and control from Brussels by unelected bureaucrats. Obviously this will not work, and the markets are delivering that message today as yields on the sovereign debt of the distressed nations have blown out to levels which forecast that defaults and/or bailouts are near.
This has caused US Treasury bonds to fall to record low yield levels. My advice to President Obama would be to borrow five trillion dollars today. Of course that would break the debt ceiling limit law, but at least we would secure cheap financing since as long as Obama is President we will be running trillion dollar deficits for as far as the eye can see.
Last week, saw Fed Chief Bernanke mouth the usual words to Congress about fixing the upcoming fiscal cliff, which is code for a trillion dollar tax increase next year after the elections. He suggested the Fed would/could do more, but really what does that mean to the real economy? The answer is nothing, but it will help markets and that is why stock prices held on last week. This morning’s action of near panic in Europe further hastens the day when the Fed will move. Their next meeting is July 31 and August 1. Stay tuned as the perception of imminent Fed action will act as support for stocks as will record low yields in treasuries.
The entire beat simply goes on. Stocks benefit from being the best asset class in a lousy world. Earnings are still ok, dividends are rising and valuations remain attractive relative to government securities. We have raised a little more cash and will wait for giveaway bargains to emerge to put the money back into the market.
What to Expect This Week
Earnings reports will take over from the macro garbage influencing trading today. Apple reports tomorrow, and this is the most important report for the week.
In addition, the first reports for the GDP growth for the second quarter will be released. I expect the numbers to be below two percent, which will be politically damaging to the President’s reelection chances. Consequently, expect the campaign to continue to focus on extraneous issues as the media tries to keep the electorate’s mind off the bleak economic outlook.
The update from the Economic Cycle Research Institute shows no change in the trend (see charts next page). The numbers are not deteriorating, but neither have they given any indication that better economic growth is in our future. My reading of this is that our domestic economy continues to run at just above breakeven. This is not great, but many companies are doing just fine in this environment. The price you pay for them then becomes the key item for consideration and that is what we are doing.
Last week EMC raised its earnings guidance for its second quarter, and announced management changes at EMC and its majority owned VMWare. The market liked both announcements, as the stock rallied more than 10 percent and was able to hang on to most of those gains.
First of all, the President and COO of EMC, Pat Gelsinger will become the CEO of VMWare, while the current CEO of VMWare will become the chief strategist at EMC. This gives Mr. Gelsinger an opportunity to run a large company, and to see if he will be able to take over the reins at EMC. The current CEO of EMC, Joe Tucci, is also postponing his plans to leave the Company by the end of this year. This should allow for a smooth transition over the next 2 years, as it is clear Mr. Gelsinger is the choice to run EMC when the time is right.
Secondly, the Company raised its earnings guidance for the second quarter by $0.08 per share. The Company now expects to earn $0.39 per share, which is up 11 percent from last year. Also, they expect revenues to jump 10 percent from last year to $5.31 billion, which meets Wall Street’s expectations. This was a surprise to many investors, as the stock had been punished as many of its competitors have recently announced poor earnings guidance.
This is a win-win situation for shareholders of EMC, and we were perplexed by how low the stock had fallen. This remains our top pick in the technology sector, as the stock still has a conservative valuation. It is clear that EMC is separating itself from the competition and should warrant a higher earning’s multiple. We believe that EMC shares should trade up to $32 within the next 12 months.
Freeport McMoRan reported better than expected second quarter earnings results last week, and indicated they look to increase copper production by 25 percent over the next three years. Earnings per share came in at $0.80 per share, which was 5 cents better than expectations. Revenues matched expectations at $4.48 billion. Even though the Company beat Wall Street’s consensus, both of these numbers were significantly lower than last year’s results due to lower prices and less demand for copper.
Despite the softness in the copper market, the management team gave a pretty rosy outlook for the next several years. First the Company continues to expand its Brownfield development projects, which will increase its copper production by 25 percent over the next three years. Management also plans to increase its cap-ex budget from $2.5 billion last year to $4 billion this year. Finally, the Company continues to strengthen its balance sheet, with $4.5 billion in consolidated cash, compared to just $3.5 billion in total debt.
Freeport is an accurate barometer of the strength of the global economy, and we believe the fears of a global depression are overblown. The Company has a strong balance sheet, dominant market position in the copper market, an attractive dividend yield and extremely conservative valuation. This is our top stock in the commodity sector, and we expect the news flow from the Company to improve now that many of its labor issues are behind them. We look for the shares to trade back to $42 within the next 12 months.
Last week we sold the shares of Marathon Petroleum for our clients. The shares of Marathon Petroleum have performed extremely well since splitting off from Marathon. We continue to like the prospects for the Company, although we believe the stock price got ahead of the fundamentals. We sold the shares just below $46, which is near an all-time high for the Company. We will continue to follow the Company and if there is a large sell-off, it is a name we will likely revisit.
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