Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
August 7, 2012
Last week gave us quite a bit of information, but on balance the stock markets did not seem fazed one way or the other.
Disappointment at a lack of policy initiative from the world’s Central Bankers was offset by an employment report, which was very confusing at best,
but certainly did not indicate a meltdown in the economy.
As the charts above illustrate, while there were some daily fluctuations for the week, both the Dow Jones Industrial Average and the NASDAQ Composite gained marginally.
The Markets & Economy
Quite a bit of lip work emanated from the Federal Reserve Board meeting last week as they continue to state their willingness to do more if necessary. This song is starting to become a bit old, and frankly the consensus of opinion seems to be that there is precious little they could do anyway.
The European Central Bank, however, clearly disappointed investors who were hoping that concrete steps would be announced and a timetable given. It appears though that there is not a consensus as to what to do. Germany’s Chancellor Merkel stayed on vacation, and let her underlings take pot shots at the ECB for even hinting at policy changes. Thus we have the European crisis still unresolved, but the good news is that everyone over there is on vacation until September, and therefore, for the moment, no one cares. This is quite a sad state of affairs to say the least.
Closer to home the employment report for July had something for everybody. The actual unemployment rate rose to 8.3%. This was because the number of people actually working in America fell by 195,000 for the month. The unemployment rate would have been even higher except for the decline in the labor participation rate (see chart below).
This chart shows the percentage of Americans actually working, and it has declined to 58.6%. Think about it! How can we run our society and pay its bills, with its ever-burgeoning social welfare system, if increasing numbers of people don’t work and pay the taxes needed? This is not a rhetorical question. Policy makers in Washington DC and the various state capitals must address this question, and, of course, the people need to choose the government it wants to answer this issue come November.
However, the employment report did show an improvement of 163,000 nonfarm payroll jobs, and the market took some comfort from that. The problem is that it was all done from the various seasonal and birth/death adjustments which will get revised. The corroborating data was bleak.
The workweek was unchanged at 34.5 hours and hourly earnings rose less than .1%. In addition the non-manufacturing ISM data on employment fell quite a bit for July. Accordingly, it seems to me that the Bureau of Labor Statistics continues to virtually fabricate these numbers without regard to the real world. Remember, the number of jobs in America today is no higher than what we had back in 2005. Given the population growth etc, this implies that the “true” unemployment rate is considerably higher than the 8.3%, which our government asks us to believe.
For stocks however, as I have reiterated steadfastly, this muddle-along news is good. Europe is a problem, but the can is getting kicked down the road. Here at home the GDP is not negative, and many companies can borrow money at interest rates below their stock yield. They then buy in their stock, which increases the EPS. While this is nothing more than financial arbitrage and not a sign of underlying economic strength it is an effective use of capital. This is crazy, but it is the world we live in for now. This explains the strength in the US stock market.
What to Expect This Week
Earnings season should be wrapping up, and the August summer doldrums will soon be upon us. Even Congress is out of session until September. Thank goodness!
The update from the Economic Cycle Research Institute shows another week of trendless results. The growth rate has improved but remains negative. Until the numbers change, I continue to believe that this means our domestic economy will continue to muddle along with a growth rate above zero, but not strong enough to actually lower the unemployment the old fashioned way. By that I mean - people getting jobs rather than simply no longer being counted in the labor force by bureaucrats at the BLS.
Marathon Oil reported strong second-quarter earnings results that matched Wall Street’s consensus estimates, even though the price of oil fell throughout most of the quarter. The Company earned $0.59 per share during the quarter, and revenues were a little better than expected at $3.78 billion. The Company still possesses one of the top balance sheets in the industry, and we would not be surprised to see the management team taking advantage of some of the prices in the energy sector.
Even though the price of oil slumped during the quarter, the Company operations were solid as they continued to grow production. Production in Marathon’s US unconventional resources grew by 20 percent from the first quarter of 2012. We could see these production gains slow during the second half of this year, but it is mainly a factor of the price of oil and natural gas. The management also continues to grow its capital budget and spent $1.2 billion on capital programs during the quarter.
Marathon Oil has performed similarly to its main competitors, even though the Company has such a strong balance sheet and attractive assets. We recently sold shares of Marathon Petroleum, however we remain committed to owning shares of Marathon Oil, and expect the shares will break out to a new trading range. We still believe the shares will reach $40 by the end of 2013.
Southwestern Energy reported second-quarter earnings that essentially matched expectations. The Company earned $0.26 per share, and revenues declined by 21 percent from last year to nearly $600 million. Management did reiterate their earnings guidance for the remainder of this year and that they continue to expect to grow production through 2012.
This Company has been a victim of lower natural gas prices, but management still makes strides in its production at their Fayetteville Shale operations. Production for oil and gas rose by 12 percent from last year, primarily by growing its natural gas operations. Even though the price of natural gas has rallied in recent weeks, the average selling price was 27 percent lower than last year’s price. We are encouraged by the recent gains in the natural gas market, and look for the trend to continue throughout the remainder of this year.
Southwestern has been a frustrating stock. The company operations have been solid, but end markets have remained weaker than we anticipated. We look for natural gas to have a much greater role in our nation’s energy policies, and Southwestern should be the largest benefactor given their financial strength and dominant assets. We believe the shares should rally to $45 per share within the next 12 months.
Pioneer Drilling announced last week that they are changing their name to Pioneer Energy Services, and stock symbol to PES. This is now a more accurate reflection of the Company’s operations due to its acquisitions over the years. Also, companies that are strictly focused on drilling tend to receive lower valuations. This Company releases its earnings report tomorrow morning and we will update our clients next week.
(c) McIntyre, Freedman & Flynn