Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
August 8, 2011
Markets around the world fell last week as Europe crumbled
over the bankruptcy of Italy and what to do about it.
As the charts above illustrate, the Dow Jones Industrial Average fell 5.8% while the NASDAQ Composite dropped an astounding 8.1% last week on
both sovereign debt issues as well as global growth concerns.
The Markets & Economy
In addition, late Friday evening the Standard & Poor’s rating agency lowered their AAA rating on the United States. Thus while many people, including our Treasury Secretary and the likes of Warren Buffet disagreed, the damage was done. Clearly, the recent debate over the debt ceiling was not silly, as the oracle from Omaha had previously stated. In fact, the final debt ceiling resolution was so pathetic in terms of its actual results that S&P did what they had warned the Obama administration they planned to do.
From a practical point of view, this downgrade does not tell us anything we did not already know. Our budget is a total fantasy going into the future (see chart next page) and significant changes must occur. The deficit is in the trillions and can only be seriously addressed via entitlement program reform. Taxing the so-called rich up to 100 percent will not even make a dent and, of course, would destroy the economy.
Hence, the recent debate in Congress and the global examples of country after country running out of money, has achieved something very valuable and not silly. Namely, the American population is now engaged and while not expert on the basics of the federal budget, we understand something is not right and our government as presently constituted is not doing anything about it.
Unfortunately, we will not have a decisive election for fifteen months to determine how our Country wants to proceed. But the stakes are that high.
Incidentally, Warren Buffet is correct about one thing: It is impossible for the United States to default on our debts. Our debts are denominated in dollars, of course, and we can print as many of them as we want. Certainly, the value of those dollars over time is crucial to being able to rollover our bonds at reasonable interest rates. Therefore, people like Buffet and other apologists for the administration are correct, but only in a narrow and irrelevant manner.
The principle long-term danger from the S&P downgrade must be a concern that the dollar’s status as the reserve currency must remain. This is not a silly concern.
The economic news briefly was more of the same. The unemployment report was better than expected, but for all the wrong reasons of lower participation rate etc… Just remember, if the workforce today was simply the same as when President Obama took office, (let alone higher due to population growth), then the unemployment rate would be around 11.5%. Clearly, all of the recent economic confusion will do nothing for employment gains going forward.
What to Expect This Week
The stock market has fallen this morning while US bonds are higher. Does that make sense? I expect that margin calls and hedge fund liquidations will make for an ugly day, but would not be surprised to see a significant bounce soon. There are 8.3 trillion dollars in money market funds and savings accounts earning nothing while many stocks have very good yields, earnings prospects and the ability to increase dividends into the future.
Finally, the Federal Reserve Board meets tomorrow and my feeling all along has been that some new version of quantitative easing will take place. The Fed wants asset prices higher and as such actually represents the investor’s best and most powerful friend.
Southwestern Energy recently reported better than expected earnings results and raised the production estimate for the remainder of the year. Earnings per share grew by 37 percent year over year to $0.48, which was 4 cents better than Wall Street’s consensus estimates. Revenues also grew by 30 percent from the previous year to $765 million, and total production rose by 25 percent.
We believe that Southwestern is the top Company and stock in the natural gas industry, and its financial strength allows the Company to grow its dominant position in the industry. Management now believes that total production for 2011 will grow by at least 20 percent from 2010, although we expect the guidance to be conservative.
Until the recent market correction, natural gas stocks like Southwestern had really begun to gain traction in the market. We do not believe this correction will have negative long-term implications to the natural gas story. We expect natural gas will play a much larger role in this Country’s energy policy in the years to come.
Shares of Southwestern have sold off, even though the earnings results were excellent. We view this as a buying opportunity and would take advantage of this recent selloff. We still believe the shares will reach $50 within the next 12 months, and natural gas will be the top-performing sector in the energy sector.
Brocade shares fell last week after the Company issued a profit warning, citing lower levels of federal government spending than expected. The Company now believes they will post revenues of about $500 million, which was $50 million less than consensus estimates. Earnings per share for the quarter will also come in a penny or two light of their previous estimates.
Shares of networking companies have had a rough sledding the last three months, and Brocade’s business was affected by the slowdown in spending. While this news is disappointing, the Company’s revenues will be the same as they were a year ago, even though the stock is much lower. We believe this is an overreaction, although it will take time for investors to have confidence in this management team.
We believe the shares are oversold at these levels, and the shares are too cheap to sell. Brocade has long been rumored to be a takeover target, and this price might attract a new suitor. We believe the shares will reach $5 per share within the next 12 months.
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