Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
August 1, 2011
Concern over the debt ceiling debate had the stock market down each and every day last week despite stellar earnings reports.
As the charts above illustrate, the Dow Jones Industrial Average fell by 4.2% while the NASDAQ Composite dropped 3.58% last week as Washington dithered.
The Markets & Economy
Today is a new week, and with the erstwhile deal announced last night, the stock market should enjoy a very sharp snap back. Fears about the financial system not being able to function normally should dissipate despite some worry that the deal will not be approved in the House of Representatives.
The chart on the next page shows the history of the debt ceiling growth pattern over the years, and explains the concerns most sane people have about the size and scope of the government financing problems, both today and into the fairly near-term future.
Quite simply, the federal government cannot afford itself and those politicians who think you can tinker with tax policy to close the gap are delusional. Currently the entitlement programs consume the entire budget. This means that we are borrowing to provide the rest of government services, including all discretionary spending, as well as defense.
Thus today’s budget deal is barely a dent on the side of an elephant when it comes to fixing the issue. For now the can has been kicked down the road past the 2012 presidential election. That election will determine the direction or even the ultimate failure of the United States. We cannot keep raising the debt limit by trillions of dollars with this no-growth economy.
Speaking of the economy, last week’s horrific news on the US economy was drowned out by the false drama concerning the politicians in Washington DC. Our economic growth rate was revised down going all the way back to the 2008 recession (see chart below). We now know that the total decline was greater than 5% and the US economy has still not exceeded its level obtained in early 2008. This explains in a nutshell why the employment rate is rising, and makes you wonder what the trillion dollar stimulus and zero percent interest rate policy of the Federal Reserve accomplished other than to stifle growth via redistributionist policies.
You really do not need to be an economist to understand that the private sector provides the money for the public sector. As such, a shrinking private sector accompanied by an expanding public sector, led by entitlement programs, which increase automatically and dramatically due to demographics, is wholly unacceptable. Our elected leaders must come to grips with this problem and set out a solution instead of what you just witnessed this past week otherwise the dollar will lose its status as the globe’s reserve currency, and then the game will truly be over. That may be a few years down the road, but those are the stakes.
More immediately, our economy continues to lose momentum, but still exhibits a very strong corporate profit picture. Hence, stocks are in many cases a preferable investment to even government bonds. After all, this past week there were stories of how many corporations had more money than the US Treasury. Can you imagine this in the United States of America?
We have been discussing, for several months, the irony that this muddle through economy can be good for stocks. This irony will continue and it is important that it do so as stocks gaining value is the only possible way, in the short run, to combat the depressing economic impact coming from the budget problems both here and abroad. In addition, the Federal Reserve Board is likely to figure out some way to prop up asset prices via another round of extraordinary intervention. Look for the stock market to anticipate this now that the budget ceiling debate is soon to be over.
What to Expect This Week
We need to wrap up this agreement and then the focus will return to earnings and the slower economy. On Friday, the unemployment report for July will be released. I cannot see how this will be very good, but expectations are quite modest, and so the market may look at the glass as half full for a change.
Finally, our weekly look at the Economic Cycle Research Institute’s leading economic indicators shows that stability is the key word (see chart below). The year over year growth rate has improved to plus 2%. This is still pathetic, but at least it is not worsening.
Remember, while it is counter intuitive, buying stocks when investor and consumer confidence is low like today, is a time proven path to picking good entry points for the stock market. This recent 5% correction or so looks like it may just be playing that same sort of pattern.
Dow Chemical reported much better than expected second quarter earnings results last week as global demand for the Company’s products exceeded estimates. Quarterly profits rose by 75% from last year to $0.85 per share, which was 4 cents higher than consensus estimates. The management team was very confident on the conference call with investors and Dow is a great barometer of the strength of the global economy.
This management team sees better growth in the developed markets, despite the high unemployment and sovereign debt issues in Europe. This is a very encouraging sign for investors and led to revenue growth of 18 percent from the previous year. The Company also continues to buy back its debt and has reduced its total debt by roughly 10 percent to $18.5 billion.
The Company did say that they are experiencing some inflation due to the increase in prices for energy and livestock, but management was able to pass the cost increases to its customers. Management raised its prices by 19 percent across the board. Even despite these cost increases, total volume shipped was 9 percent higher than last year.
Shares of Dow surged initially on these positive results, although the overall down market weakened most large cap stocks. We believe that Dow will not have a problem exceeding guidance for the remainder of this year, and a strengthening global economy will certainly help. We believe that shares of Dow will reach $45 within the next 12 months.
Boeing reported better than expected second quarter earnings results last week and raised its guidance for the remainder of this year. The Company earned $1.25 per share, which was 27 cents better than consensus estimates. Revenues also grew by nearly 7 percent and the management team raised earnings per share guidance for the remainder of this year by 10 cents.
The Company believes that they are at the beginning of another boom time for commercial airplanes, as the carriers have to update their aging fleets. The Company delivered 118 planes during the quarter, which was four more than last year. Plus, the backlog for new planes continues to grow every quarter.
The Company did warn that they would not be delivering as many of the 787 Dreamliners this year as they previously expected, although they still believe they will deliver the first during this quarter. This is key to the Company’s growth plans and management wants to move to these larger high-margin aircrafts. We hope to hear some encouraging news regarding the 787 within the next couple weeks.
Shares of Boeing traded slightly better than the market following this report, and now all eyes are back on the launch of the 787. Once the Company can get these airplanes in mass production, the planes become virtual annuities for the Company. We believe Boeing is entering a strong three-year period, and expect the shares will reach $100 once the 787 reaches mass production.
Ryder Systems reported blockbuster second quarter earnings results last week, and indicated they see demand gaining traction during the second half of this year. Earnings per share rose by nearly 60 percent from last year to $0.92 per share, which was higher than the $0.77 per share consensus estimate. Management also raised guidance for the rest of this year by more than 10 percent.
The management team cited a pickup in commercial rentals and used vehicles sales during quarter. We expect this trend will accelerate during the second half of this year, and demand for shipping freight domestically remains surprisingly strong. The Company also has strengthened itself through recent acquisitions and has a much stronger position in their industry than when this economic downturn began.
Shares of Ryder spiked to new 52-week highs following the release of these results and we look for the transportation stocks to remain market leaders. We are more impressed with this management team after each quarterly report and expect the shares will reach $75 within the next 12 months.
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