Coincident Indicators (+.1%) in March broke February’s downtrend and point to sideways, rather than down, economic momentum. Things to watch: Items deserving most careful following at present are:
Inflation – While March CPI and the core inflation rates were not excessive (.3% and .2%), the PPI (Producer Price Index) change of 1.1% was bad news and if continued, could re-route all progress to a negative direction.
Payrolls – Non farm payrolls have fallen for the three months since December to 5.1% - still a good number historically. Jobs in the private sector however have fallen for four straight months and could be a better predictor of bad times (or good).
We believe that recessions will always be a part of our system of capitalism – but, while we most certainly are in an economic slowdown, it is not yet a recession and most likely won’t develop into one. As the economy corrects the excesses of financial stupidity (in regards to the subprime and mortgage mess) and inflationary energy prices, it will ultimately emerge once again stronger and leaner.
Equities
Current trends in stocks, taken as a whole, indicate that profit margins are declining as the economy cools. As a consequence, markets may underperform long term averages this year. The always difficult task of sifting through available companies whose trends and margins are running counter to the market is just that much more difficult. Surprisingly, as of Wednesday May 7th, 76% of companies in the S&P 500 have reported earnings and the ratio of positive to negative reports is 2.2 to 1. Among those reporting, 62% have beaten expectations versus a historical 65% average (Lehman Bros). The market has recovered (S&P 500 ’08 YTD Total Return = -4.05% as of 05/08/08 from a March 10 low of approximately -12.9%). With 2008’s decline, the market’s PE has corrected to about 16X - at least reasonable by historic standards and, predictive we hope, that it does not have much farther to fall. We use periods like this to prune weaker stocks from our portfolios as market hysteria and excesses make prices reasonable for some stocks which have been overvalued. Our focus currently is on Health Care and Technology. We urge you to remember the truism that it is not “timing” the market but rather “time in the market” that results in superior returns when coupled with adequate legwork.
Most of our primary stocks are coming in with good 1st quarter earnings. A list of winners (and losers) follows:
Positive
(UTX) United Technologies – (4-17-08)
Reported March ’08 earnings of $1.05, $.04 better than estimates. Particular strength seen in OTIS elevators and Pratt and Whitney jet engines.
(NUE) Nucor – (4-17-08)
Reported March ’08 earnings of $1.41, $.08 better than estimates. Company raised the dividend to $.32 with a $.20 supplemental dividend. Lower dollar, increased exports, low inventories all contributed.
MON) Monsanto – (4-02-08)
Beat estimate of $1.72 by $.07 in the February quarter. Revenues rose 44% versus same quarter in ’07. Company is investing $200 million in Roundup manufacturing capacity.
(AAPL) Apple - (4-23-08)
Company beat estimates by $.09, with a 36% jump in profit. Apple sold 7.29 million MAC computers.
NOV) National Oilwell Varco - (4-30-08)
First quarter profit rose 44%. Net income rose to $1.11 versus $.78. There are about 170 new drilling rigs planned or under construction and each gives NOV an opportunity to sell $300 million in equipment.
Negative
(TSCO) Tractor Supply - (4-23-08)
Tractor Supply reported a $.03 loss versus an expected $.01 gain. Same store sales declined as big ticket and seasonal products fell off.
(WFMI) Whole Foods - (2-19-08)
First quarter profits fell due to costs associated with it’s acquisition of Wild Oats. Net income dropped 27% to $.28 from $.38. Same store sales were strong; we expect this weakness to be temporary.
(PAYX) PayChex - (3-27-08)
PayChex reported earnings in line with expectations ($.39/sh) but with total revenues came in somewhat lower than Wall Street had projected. However, recessionary perceptions have hurt the stock’s price – weakness is temporary.
Fixed Income
The significant “flight to quality” that began in late ’07 has continued. Treasury and agency bond prices have surged as money left stocks and particularly financial stocks. Short term interest yields have fallen drastically over the past four months – which is reflected of course in all of the Fixed Income instruments we buy – Governments, Corporates and Municipals. Given the magnitude of the disarray in bonds, which is really without modern equal, perhaps we ought to highlight our bond strategy and operating standards. We follow the following concepts:
- Higher yield is always accompanied by higher risk. The current unease in bonds began where? - In lower quality, difficult to rate (thus insure) ‘new paradigm” securities that benefited mostly the packager/seller.
- Don’t always rely only on rating. The primary rating agencies made serious miscalculations in subprime and SIVs vehicles and most likely misrepresentations which will cost them hundreds of million dollars. Buy what you understand.
- Liquidity really matters. Now that subprime bond owners are stuck with what was touted as AAA paper, no bids can be found - heads are rolling on Wall Street.
None of our client’s money is exposed in any measurable amount to subprime mortgages at this point. Our ownership of BlackRock (BLK) in equity accounts is, on the other hand, a big beneficiary of this disarray. Currently they (BLK) are managing ‘workouts’ for multiple clients – Florida, Canada, etc. and business is thriving.
We continue to emphasize corporate bonds over government agencies due to favorable risk/reward attributes.
Examples of recent purchases are:
Bond Yield Date Rating
GE 5.00 due 01/08/2016 AAA
Lowes 5.40 due 10/15/2016 A+
Nucor 5.00 due 12/01/2012 A+
Oracle 5.25 due 01/15/2016 A
