With Friends Like the Fed...

 |  Includes: CVX, DD, ERO, FXC, KO, MMM, SPY, UTX, WMT, XOM
by: Chris Damas

With friends like the Fed, who needs enemies? The Fed continued resuscitory monetary policies and the US stock market took this as a sign the economic patient was showing no vital signs. This of course was all based on a weak Beige Book report that is already out of date.

The DJIA is down 272 points at 10,373, erasing a week of hard-won gains. The S&P 500 and Nasdaq Composite indices decided to fall off a cliff (down almost 3%) rather than break out to new three month highs.

The Fed (US Federal Reserve Open Market Committee) met and decided to continue their policy of US economic support by holding firm with near zero interbank lending rates and measures to boost liquidity, declaring plans to roll over their $2 trillion balance sheet of mortgage backed securities and agency notes into US Treasury notes of the 2-10 year maturity range.

Yesterday's 10-year Treasury note auction participants responded by bidding them down to a low yield of 2.73%.

The market could easily be up a couple of hundred points next week. Employment components of regional manufacturing reports in the US have been increasingly positive. We might just get some upside indication for jobs when we see results from Monday’s August Empire State Manufacturing Survey.

We still need to get by US Jobless Claims (today) and July Retail Sales and CPI readings on Friday, not to mention a shot of morphine will probably be required to endure the University of Michigan's August Consumer Sentiment reading.

Why was the stock market rolling over yesterday? I'm starting to think someone up there just doesn't like us bulls.

It might have been the technical failure for the S&P 500 to breach a perceived ceiling of 1,130 that has been in place for almost 3 months, exacerbated by low summer trading volumes.

Or it could be the strengthening US dollar versus the euro which at 1.288 USD is down sharply since breaking below 1.30 (NYSEARCA:ERO). A stronger dollar put the kibosh on crude oil, which leaked almost two bucks.

The Canadian S&P/TSX index, heavy on energy, is down 252 points to 11,586. Ouch.

If a few more of the major DJIA components had enjoyed dividend increases this earnings quarter - only Coca Cola (NYSE:KO) gave us a boosted payout from our top ten - I think we could have been going higher right now.

Corporate boards seem cautious in committing to dividend hikes and enlarged share buyback plans.

That three high-yielding DJIA components went ex-dividend yesterday did not help matters on the average - DuPont (NYSE:DD), Wal-Mart (NYSE:WMT) and ExxonMobil (NYSE:XOM).

Three more of our top DJIA movers go "Ex" next week - Chevron (NYSE:CVX), 3M (NYSE:MMM) and United Technologies (NYSE:UTX). So if you don't sell, at least you get a nice dividend.

In 1997, major S&P 500 (SPX) component dividend yields and share buybacks could equal as much as 5% of the stock price. We used to add the short position to this stock price raising activity and call it "BullPower". The DJIA powered past 10,000 by 1999. Seems a long time ago.

A quick review of current DJIA top movers' stated share buyback plans shows that activity is comparatively muted.

Bipolar traders, summer doldrums, what have you, in the absence of better news, this market needs some cash flow Viagra to maintain any sort of upward trajectory.

I’d like to point out that in spite of the carnage in the overall indices our two most favorite stocks in Canada, Bell (NYSE:BCE) and TELUS (NYSE:TU), were down only a percent yesterday. They both yield over 5.0% at these prices (Telus non-voting shares).

Recycled box, container and tissue producer Cascades Inc. reported $107 million in Q2 EBITDA slightly above our expectations of $100 million (CDN).

Cash flow before working capital changes came in at a healthy $71 million on $998 million in revenues, versus $38 million on $942 million revenues in Q1.

Containerboard was particularly strong with EBITDA up $11 million (Q2/Q1), boxboard up $6M, specialty products up $2M, and tissue products up $5M.

The company earned 22 cents per share versus analyst expectations for 18 cents.

The company bought back 325,463 shares at $6.66/share during the quarter.

Cascades was hit by some nervous selling during the downdraft yesterday to $6.51, but has since bounced back to $6.97 after opening at $7.30.

We continue to rate Cascades a buy on a Q3 positive outlook. Note most of Cascades’ corrugated and box board customer usage is food related, either wholesale, or at your neighborhood fast food outlet.

When you stop going to the supermarket to buy fruit and vegetables or give up making a quick stop for a Tim Horton’s donut (they make the paper containers that keep you from spilling your cofee), we’ll start selling our Cascades.

Their Q3 will benefit from continued implementation of price hikes, a stronger euro and lower OCC (Old Corrugated Container) costs, offset by any possible strengthness in the CDN - no sign of that yesterday as the Loonie is weaker by 1.24 at 95.63 USD (NYSEARCA:FXC).

Cascades does have significant long-term debt - $1.486 billion but they have extended the maturities and debt ratings are stable.

Our target for Cascades is an EV/EBITDA ratio of five on our estimated 2011 EBITDA of $450 million.

Assuming Cascades $120 million investment in Boralex is sold over the period to pay down debt, this equates to a $9.50 target price.

It would appear the US market cannot shake off its woes very easily and we feel the market will require further consolidation during the summer lull before making any further upward move. The Canadian financials should benefit from bank Q3 earnings which begin their release period on August 24 with the Bank of Montreal (NYSE:BMO).

Hopefully the Fed will just keep quiet until their next meeting on September 21.

Disclosure: Long US and Canadian ETFs and small cap stocks including Cascades