It was a miserable week, what with the Boston bombings, lockdown and shootout, the horrific fertilizer plant explosion in Texas and the ricin-laden letters sent to elected officials providing vivid reminders that we still live in a dangerous world. True, the week ended about as well as it could as Friday night’s incredible drama in Watertown brought some closure in Boston (and a newfound appreciation for our law-enforcement officers) and the come-from-behind victory for the Red Sox on Saturday was right out of Hollywood—a three-run go-ahead home run after Neil Diamond leads Fenway Park in a rendition of Sweet Caroline !
While the ups and downs of the equity markets pale in significance, it was also a lousy week for stocks in general and our portfolios in particular, given our heavier concentration in the Information Technology, Energy and Industrials sectors. Of course, those sectors have actually contributed handsomely to our year-to-date returns, so the recent transgressions can be forgiven, even as weaker-than-expected personal computer sales and tumbling commodity prices have compelled us to rein in some of our Target Prices. Note that this past Tuesday, we posted updated listings to prudentspeculator.com of our valuation objectives for the 100+ stocks that have been formerly recommended but not yet closed out.
No doubt, some sort of a pullback hardly can be a big surprise following the near-vertical five-month rally stocks have enjoyed since the middle of November, but the economic news out last week didn’t do the equity markets any favors. Indeed, we learned from China's National Bureau of Statistics that growth in the Middle Kingdom’s Q1 gross domestic product slowed to 7.7% on a year-over-year basis, down from 7.9% in Q4 2012 and below forecasts that were calling for an increase of 8.0%. Other economic measures in China, such as retail sales and industrial production, also have failed to live up to lofty expectations, with fears of a continued slowdown in one of the world’s great growth engines precipitating a major decline in the price of most commodities, including copper, oil and gold.
We also heard from the International Monetary Fund, which actually lowered its global growth expectations in its latest World Economic Outlook. The introduction to the report sounded pretty good…
“Global economic prospects have improved again but the road to recovery in the advanced economies will remain bumpy. World output growth is forecast to reach 3.25% in 2013 and 4% in 2014. In advanced economies, activity is expected to gradually accelerate, starting in the second half of 2013. Private demand appears increasingly robust in the United States but still very sluggish in the euro area. In emerging market and developing economies, activity has already picked up steam.”
…but the IMF reduced its estimates for just about every major region since its last update in January. The group’s new predictions read as follows, “Growth in emerging market and developing economies is forecast to reach 5.3% in 2013 and 5.7% in 2014. Growth in the United States is forecast to be 1.9% in 2013 and 3.0% in 2014. In contrast, growth in the euro area is forecast to be -0.3% in 2013 and 1.1% in 2014.” Three months ago, the IMF expected global growth of 3.5% this year and 4.1% in 2014, and U.S. GDP growth to reach 2.0% in 2013 and 3.0% next year.
On the domestic front, the most recent statistics on the health of the economy (Philly Fed, Leading Economic Indicators, Weekly Jobless Claims) were on the disappointing side, yet economists are still looking for decent growth in the U.S. this year. The latest Wall Street Journal forecasting survey shows estimates of 3.1% for Q1 and 1.8% for Q2 with 2.5% GDP expansion the full-year 2013 projection (much better than the IMF’s estimate).The survey also found that those same folks expect GDP growth to improve to 2.9% in 2014 and 3.0% in 2015. Incredible as it may seem, that 2014 prediction would represent the strongest rate of growth since 2005.
The economists put the chance of a recession over the next 12 months at just 15%, yet it would seem very likely that the Federal Reserve will retain its highly accommodative monetary stance. After all, we heard from the Labor Department last week that the consumer price index was up 1.5% in March from a year earlier while the core rate (excludes volatile food and energy prices) was up 1.9%. With both tallies below the Fed’s 2.0% inflation goal, it would seem that the proverbial punch bowl will remain well-supplied. After all, we can’t forget the dual mandate of Ben Bernanke and Co.: “The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
The start of Q1 reporting season also proved to be a weight on stocks, even as the number of companies topping earnings forecasts remains in line or even better than average. With 103 members of the S&P 500 having reported results thus far, Bloomberg calculates that 70 (68.0%) have exceeded expectations, 14 (13.6%) have met analyst projections and 19 (18.4%) have missed estimates. This compares to respective percentages of 67.3%, 9.6% and 23.1% for the full Q1 season last year. To be sure, while bottom-lines have held up well, top-lines have proven to be disappointing as far fewer companies have been able to beat guidance. In fact, Bloomberg states that only 36% of Corporate America has been able to trump revenue forecasts with 25% matching the consensus.
On the positive side, chemical concern Celanese (CE - $47.10) blew away analyst estimates when it reported earnings of $1.14 per share from continuing operations, compared to the $0.78 projection. The dramatic outperformance arose even though revenue of $1.6 billion merely met analyst forecasts. CEO Mark Rohr said, “Celanese delivered a strong quarter. We expanded adjusted EBIT margins both sequentially and year-over-year by more than 400 basis points as we continued to deliver value added solutions to our customers and began to see the impact of the Celanese-specific actions we are implementing. Our combined efforts helped us grow adjusted earnings per share by 44% over the prior year period. Celanese continued to deliver good cash flow results in the first quarter and further increased the cash on our balance sheet. We continue to expect adjusted earnings per share growth for 2013 will be consistent with our long-term growth objectives of 12% to 14% despite the higher 2012 earnings base after our pension accounting policy change and the challenging global economic environment that we anticipate to continue throughout 2013.” Happily, CE shares rocketed higher by more than 11% on Friday, though we saw fit to only modestly boost our Target Price.
Technology giant International Business Machines (IBM - $190.00) was one of the companies that missed expectations on the top line by a fairly wide margin as revenue of $23.6 billion trailed estimates by some $1.2 billion. IBM CEO Ginni Rometty said, “Despite a solid start and good client demand we did not close a number of software and mainframe transactions that have moved into the second quarter.” Happily, Q1 earnings per share of $3.00 came in pretty close to forecasts of $3.05, with Ms. Rometty adding, “In the first quarter, we grew operating net income, earnings per share and expanded operating margins…The services business performed as expected with strong profit growth and significant new business in the quarter.” She concluded, “Looking ahead, in addition to closing those transactions, we expect to benefit from investments we are making in our growth initiatives and from the actions we are taking to improve under-performing parts of the business. We remain confident in this model of continuous transformation and in our ability to deliver our full-year 2013 operating earnings per share expectation of at least $16.70.”
Hardly sounds like the end of the world, but IBM shares sank like a stone on Friday, shedding more than 8% of their value in losing more than $17. We did take a small bite out of our Target Price, but we remain big fans of IBM as the stock now trades for little more than 11 times the 2013 earnings estimate and the company remains on track to meet its goal of $20.00 per share in earnings by 2015. For those without a position in IBM, we wouldn’t hesitate to buy Big Blue after the big selloff.
As an aside, we saw evidence on Friday of why the price-weighted Dow Jones Industrial Average is not always a great proxy for the equity markets. The $17.15 decline in IBM accounted for a drop of 137.2 points in the Dow, which finished an otherwise terrific day for stocks up only 10 points, or 0.07%. Compare that to the capitalization-weighted S&P 500, which was up 0.88%, despite suffering a sizable hit from IBM. Looked at another way, it would take a 200%+ gain in the lowest-priced Dow component Alcoa to equal the 8% decline in IBM on Friday.
There are plenty of other earnings stories to discuss but we’ll save them for next week’s missive. In the interim, we’ll say that we welcome the return of individual stock volatility as there have already been several heroes and goats and we always keep watch for outsized moves to the upside and downside as we look for opportunities to exit or enter a position.
© AFAM Capital
