Storm clouds clearing, time to resume boarding.
The arrival of quarterly earnings reports stiffened investor courage. The early reports, like the splendid one from Intel (INTC-$22), sparked initial buying interest but that faded, apparently due to prior fears accumulated during the financial crises. As succeeding favorable reports came in, increasing confidence became apparent and even disappointing reports like that from Amazon (AMZN-$117) failed to squelch the resurgence; a summer rally then began to develop.
August is often a soft month and stocks may pull back before football season begins but I still expect a more sustained market rally this fall that will take us into overall double digit returns for the full year. There are neither signs nor historic precedents for slipping back into a recession at this stage.
Earnings reports have not only shown increased profits for companies, a relatively predictable result from downscaling their work forces, but they have also shown increasing sales. Almost three-quarters of companies reporting have beaten expectations on their top line revenue numbers. Combined with favorable surprises on bottom line profits, it’s clear that analysts have short-changed the vigor of the economic recovery. While stock prices may pause for breath, the continuing rollout of earnings reports will rebuild investor confidence and support the next leg up.
Although that will probably see the Dow Jones Industrials above 11,000 by yearend, the slow pace of the economic recovery will prevent a breakaway. The probable end to government stimulus spending, persisting high unemployment, tight credit and weak housing market will slow the economy to a 2-3% growth rate.
All this is plagued by “unusual uncertainty,” in Fed Chairman Bernancke’s words. Overly sensitive media magnify every new uncertainty from fiscal crises in Southern Europe to inscrutable currency changes in China. Some of this is passing. Only recently, the daily news was dominated by preparations for a public hanging of first, Goldman Sachs, and then BP. A financial reform bill then emerged and the damage from the vast oil spill was arrested.
As wounds heal, the recovery period from the financial crisis leaves an investing environment in which nervous business leaders and consumers have shuffled trillions of dollars in cash to the sidelines. For once, inflation is almost totally absent and interest rates are absurdly low. This is a favorable playing field for large, solidly financed companies whose earnings reports reflect their ability to compete successfully.
DuPont (DD-$41) reported that its June quarter profits almost tripled. Sales and margins were also up. Its CEO said she expected growth to return “to a more sustainable pace” in the latter half although the company increased its 2010 earnings forecast to a range from $2.90 to $3.05. That equates to a Price/Earnings ratio of only 13 DuPont’s dividend yield is 4.1%. Its stock is an exemplary buy.
Transportation stocks are gaining momentum, a traditional accompaniment to an economic recovery. Two successful prime movers are FedEx (FDX-$83 and UPS (UPS-$65). Both companies beat forecast earnings and, more critically, raised their outlooks for the rest of the year. UPS yields 3%, FedEx less but offers a faster growth rate.
Norfolk Southern (NSC-$55) also raised its forecast and brought back its furloughed employees. SeaSpan (SSW-$11), the leading container ship carrier, just raised its dividend and now yields 4%. Storm clouds are clearing and it’s time to begin boarding.