CWS Market Review – December 9, 2011
Let me start off this CWS Market Review by discussing the dramatic events in Europe. I’m writing this early on Friday morning, and today is the day of the big EU Summit.
By common agreement, this summit is the last chance to save the euro. And by “last,” I mean the absolute last chance. That’s it—no more. Time’s up. These folks have dragged this on long enough and now it’s time to see who’s really in this thing. In last week’s CWS Market Review, I said that this summit’s aim would be to please financial markets. My belief was that this was actually an easy choice because there simply is no alternative.
Well, they found an alternative. More disagreements.
According to the latest news—and please bear with me, this is rapidly a developing story—the leaders have rejected plans to alter the EU treaty. This was the main goal. The Brits wanted an exception to protect their financial sector (London is huge for finance) and the continentals said “non/nein.”
Instead, 23 of the 27 countries have agreed to a weaker “fiscal compact” which pledges stricter fiscal discipline. There had been hopes that in exchange for this compact, the ECB would jump in and buy bonds. Though Mr. Draghi has endorsed the compact, he’s walked back any commitment to buy bonds in a serious way. This isn’t good.
Here’s the problem: Since this fiscal compact is outside the EU Treaty, there’s no way the EU institutions can enforce it. Really, the compact is nothing more than a pledge saying “I promise to be good.” Well…if they had been good, they wouldn’t be in this mess. David Cameron even said that Britain “would never join the euro.” In addition to the United Kingdom, three other countries, Sweden, Hungary and the Czech Republic, haven’t signed on.
My take is that this is a major blow for Europe. The best scenario would be that if the ECB buys enough bonds, that could hopefully restore investor confidence. In turn that could buy more time, but for now, Europe is at the mercy of a very pissed-off bond market. Who can blame them?
The question for us is: “How much will this impact our markets?” Until a few weeks ago, it’s been a lot. Slowly, however, the U.S. financial markets have separated themselves from the febrile European debt market. I’ve been generally impressed with our stock market’s wobbly recovery over the past two months. Sure, I wish it could be steadier but it’s been up against a flood of near-panic news out of Europe.
Despite several hiccups, including another 2% drop on Thursday, the S&P 500 has gained more than 12.3% since its October 3rd low—and our Buy List has done even better. That ain’t bad. The index even briefly broke above its 200-day moving average a few times this past week. Unfortunately, it failed each time to close above the magic 200-DMA.
This cautious rally has been even more impressive when you consider that the Treasury yield curve has barely changed over the past month. Actually, I’ll go even further than that: interest rates have been eerily stable. Since November 2nd, the 10-year yield has closely hovered around 2%. The 30-year has locked in on 3%, and the five-year yield has parked itself in a range between 0.86% and 0.97%.
Now here’s the important part: I strongly suspect that this tight trading range will soon come to an end. Treasury yields, especially at the long end, are simply too low. Despite more signs that the economy has steered clear of a Double Dip, the yield on 10-year TIPs is still at 0%. It was one thing when the world was ready to come apart at the seams. But now that the U.S. economy has demonstrated some resiliency, a 10-year real return of 0% just doesn’t make any sense.
It wasn’t that long ago that the bond market was expecting interest rates here to rise. I apologize, but here’s some math: Six months ago, the yield on the one-year Treasury was 0.39% while the six-month bill was going for 0.18%. That implies that the six-month rate in six months would be 0.25%. But today, it’s just 0.04%. The current yield curve implies that over the next 12 months, the one-year yield will climb from 0.10% all the way to…0.34%.
What’s the reason for this mass apprehension? That’s easy. Everyone’s sitting on mountain of cash. Recent data from the Federal Reserve shows that non-financial firms in the U.S. have stockpiled an astounding $2.12 trillion in cash. Welcome to the Age of Deleveraging. It’s long overdue.
Back to my point: I just don’t see how interest rates can stay that low in the face of recent evidence. The fact is that the economic news continues to be modestly positive. On Thursday, we learned that initial jobless claims dropped to 381,000 which is a nine-month low. Bespoke Investment Group tells us that that’s the second-lowest reading since Lehman Brothers went kablooey.
The latest inventory data indicates that companies are restocking their shelves. That’s a good sign because inventory liquidation took a bite out of the Q3 GDP. The new inventory numbers caused Goldman Sachs to raise its estimate for Q4 GDP growth from 2.7% to 2.9%. Macroeconomic Advisors raised their estimate by 0.5% to 3.5%.
Sooner or later, all that cash will want to find a place where it’s treated better. (Of course, much of that cash is trapped outside our borders.) The stock market’s favorable valuation versus bonds is especially clear in light of the fact that we don’t have to look far to find stocks yielding more than 3%. Microsoft ($MSFT), for example, currently yields 3.15% and is rated AAA which is something that can’t be said for some governments. Just this past week, one of our Buy List stocks, Stryker ($SYK) raised its dividend by 18%. In two years, SYK’s dividend is up by over 41%.
Earlier this week, Oracle ($ORCL) said that its fiscal Q2 earnings report will come out on December 20th. The consensus on Wall Street is for earnings of 57 cents per share. That’s the midpoint of the range Oracle gave us three months ago of 56 cents to 58 cents per share. That’s a pretty strong number, and yet it may be too low. I think Oracle has a good shot of earning 60 cents per share. Their cash flow has been very strong. Their licensing business continues to do well, although I’m a little concerned about the hardware side of the business which is a bit shaky. Bear in mind that Oracle earned 51 cents per share in last year’s Q2 which was very strong.
Up and down Wall Street, analysts have been warming up to Oracle. Barclays initiated coverage with a price target of $37 and an “overweight” rating. Piper Jaffray also has an overweight rating. Jefferies cut its price target from $37 to $36 (???) but kept its “buy” rating. They also trimmed their quarterly EPS estimate by a penny to 56 cents. Deutsche Bank just raised their price target to $33. I honestly don’t think Wall Street “gets it” with Oracle. But I understand the need analysts have to follow the company’s guidance closely which is something I, fortunately, don’t have to worry about. Oracle is an excellent buy up to $34 per share.
I was pleased to see that Ford ($F) has reinstated its dividend after a five-year absence. The company will start paying a nickel per share on March 1st. Ford’s CFO said, “We are confident that we can begin to pay a dividend that will be sustainable through economic cycles.” The dividend, of course, is quite modest. The yield is only 1.86% but it’s more proof that Ford has turned itself around. It was only three years ago that Ford was going for $1.01 per share. I rate Ford a strong buy up to $14 per share.
That’s all for now. Be sure to keep checking the blog for daily updates. Hopefully, Europe will still exist next week. I’ll have more market analysis for you in the next issue of CWS Market Review!
– Eddy
P.S. One more reminder that I’m going to unveil the 2012 Buy List on Thursday, December 15th. This is the day that millions of investors look forward to each year. Millions! As usual, I’ll have five additions and five deletions. Stay tuned!
Posted by Eddy Elfenbein on December 9th, 2011 at 7:40 am
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.
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