[Excerpted from Marks Group Wealth Management's Monthly Market Recap]
In less than 48 hours, we should know the outcome of the much-anticipated mid-term elections. Regardless of their political persuasion, there is strong historical evidence that investors prefer gridlock in Washington. Polls indicate that this is the likely outcome, but if not, there may be a short-term selloff in equities. The market doesn’t like surprises.
INDEX OCT 2010 YTD 2010
DJIA + 3.06% + 6.62%
Nasdaq + 5.86% +10.50%
S&P500 + 3.69% + 6.11%
The rally that began on August 31st continued through October, albeit at a slower pace. It is possible that recent gains were in anticipation of the election, and equities could experience some short-term weakness regardless of the election results. In other words, the election results are “baked into the market”. After the event investors will refocus their attention on other matters, including uncertainty about future tax rates, the continued slump in housing prices, or the stubbornly high unemployment rate.
When the Federal Open Market Committee meets this week, Bernanke and company will give us more clues as to how they plan to use their latest gadget, “QE2”, to stimulate the economy. QE2 refers to a second round of quantitative easing, and it is interesting for both how it is being used and how investors are responding to it.
Quantitative easing is one process by which the Federal Reserve increases the money supply, first by crediting its own account (in other words, printing money), then by using those funds to buy long-term Treasury bonds. In theory, this keeps long-term interest rates low, which has a stimulative/stabilizing effect on the economy as a whole (and housing in particular) and could help avoid a double-dip recession.
The first round of quantitative easing began in late-2008, when the Fed tried to prop up the economy by buying $1.25 trillion in mortgage-backed securities. With the Fed “backstopping” these bonds, and the economy, markets began to recover. So it’s no coincidence that soon after Fed Chairman Bernanke hinted at a second round of quantitative easing in a speech on August 27th, markets began their ascent.
But investors may be less enthusiastic about the longer-term implications of a second round of this strategy. Bill Gross, Chief Investment Officer for PIMCO and a powerful figure on Wall Street, recently stated that further quantitative easing would signify the end of the 30-year bull market in bonds.
Others believe that interest rates could remain low for an extended period as central banks, in attempting to keep their currencies from appreciating vs. the dollar, continue to buy dollar-denominated assets. This consistent demand for long-duration Treasuries will keep prices high, and interest rates low.
Regardless of when interest rates rise, we believe that high quality U.S. stocks offer greater value than most bonds at current prices.
Gold is the other asset that has investors’ attention lately. It is one of the best performing assets over the past five years, and the upward trend continues. We question if it is for the right reasons. Gold bullion ETFs, products created by Wall Street to make it easier for investors to buy gold, now represent most of the demand for gold. The fact that Wall Street created a product to exploit an asset class is, to us, a red flag.
Warren Buffett, who has a flare for putting things in perspective, recently described gold in these terms:
You could take all the gold that’s ever been mined, and it would fill a cube 67 feet in each direction. For what that’s worth at current gold prices, you could buy all of the farmland in the U.S. Plus, you could buy 10 Exxon Mobils, and have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?
No one knows how high gold prices will go, but we do agree with Mr. Buffet that there are other less popular and better valued opportunities.
Noble Corporation (NE) – Noble and other deepwater drilling companies continue to trade at historically low levels due to the lingering hangover from last April’s disaster on the Deepwater Horizon Rig. Now that the government imposed moratorium on offshore drilling has been lifted, we believe that could be a positive catalyst for stocks like Noble.
As the second largest company in its field, we believe that Noble stands ahead of its competition. Nearly 85% of its 62 offshore drilling units are outside the U.S., providing insulation from the recent disruptions in the Gulf. The company also has maintained a very solid balance sheet with their debt equaling a modest percentage of total capital.
Noble’s profit margins of about 50% continue to be far greater than its closest competitors such as Transocean’s profit margin of 35%. During the 3rd quarter, the company repurchased 4 million shares of its stock at an average unit cost of $32.67, bringing the total number of shares repurchased in 2010 to 6.1 million as of September 30th. (Credit Suisse 10/21/10)
TCF Financial (TCB) – For much of 2010, TCF has fought an aggressive battle to maintain its fee income that has been threatened by proposed legislative changes. The bank has encouraged customers to sign up for overdraft protection, following new federal rules that went into effect in August that bar banks from automatic enrollment.
In addition to new restrictions on overdraft fees, TCF faces a potential revenue hit from planned new fee limits on debit-card transactions. As part of the financial regulatory overhaul passed this summer, the Federal Reserve is allowed to severely restrict the amount that banks like TCF can collect from retailers in interchange fees each time consumers swipe their debit cards at the register. TCF has responded by taking legal action against the debit-card fee section of the Dodd-Frank financial reform bill, calling it “unconstitutional.”
Despite these head winds, Minnesota’s third-largest bank reported a strong quarter in which profits doubled compared to the same quarter last year. TCF Financial CEO, Bill Cooper stated last week that the bank’s service fee revenue is down just 13% while similar revenue streams fell more than 20% at Wells Fargo (BWF) and US Bank (USB) during the 3rd quarter. (Credit Suisse 10/21/10)
Starbucks (SBUX) – Starbucks jumped more than 3% in October thanks to increasing demand for breakfast snacks and higher-priced coffee. Despite new competition from frappes and smoothies at McDonalds, the company shows strength and proves yet again the potential for coffee category growth.
Starbucks has continued to invest in advertising and innovation throughout the recession, creating compelling reasons for consumers to support their brand. Multiple industry analysts have raised their price target to $30 or greater within the past month, in anticipation of the quarterly earnings report scheduled for November 4th.
Starbucks said last month it would raise some prices to account for some more labor-intensive drinks and the surging prices of green Arabica coffee beans. Third party research provider Credit Suisse believes Starbucks has enough growth momentum to keep raising their earnings estimates over the next 12 months, and maintains its $34 price target on SBUX. (Credit Suisse 10/12/2010)
Johnson Controls Inc. (JCI) – Since we added JCI to our Core Equity Portfolio in August, the stock is up over 4.6%. Double-digit sales growth in its automotive businesses and increased orders for energy efficiency projects in buildings have helped lead the charge. During a time when many companies continue to pad their earnings by cutting costs, JCI posted their 3rd consecutive quarter of top-line revenue growth.
The company has continued to benefit from higher battery sales linked to its role as the exclusive provider of batteries to Wal-Mart (WMT) and its aggressive expansion in emerging battery and automotive markets. During a conference call with analysts, Steve Roell, chairman and chief executive, said the company benefited from cost-cutting and restructuring early in the year and then capitalized on the recovery of the auto industry and growth in international markets.
The company has become more aggressive in accelerating its growth initiatives, boosting its capital spending plan, said Bruce McDonald, chief financial officer. These plans include a recent expansion of production of automotive batteries for carmakers and the aftermarket in China, the only country where Johnson Controls is not the leading supplier of lead-acid batteries. The company now ranks fourth in market share in China. (Credit Suisse 10/27/10)
Disclaimer: The information set forth herein has been derived from sources believed to be reliable, but is not guaranteed as to accuracy and does not purport to be a complete analysis of the securities, companies or industries involved. Opinions expressed herein are subject to change without notice and are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual. To determine which investments and strategies may be appropriate for you, please consult with Marks Group Wealth Management or another trusted investment adviser. Stock investing involves market risk including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Past performance is no guarantee of future results.