Encouraging Employment Report Indicates Happy Holidays for Retailers

Includes: DCI, SLB, TGT, UN
by: Ben Marks

[Excerpted from Marks Group Wealth Management's Monthly Market Recap]

The U.S. stock market was virtually flat in November, as sovereign credit concerns held back significant market gains. Ireland was front and center this time around, and despite numerous headlines saying Ireland is not Greece (and Spain is not Ireland, and Portugal is not Spain), there was a strong sense of déjà-vu.

INDEX NOV 2010 YTD 2010

DJIA - 1.00% + 4.34%
NASDAQ - 0.35% + 9.05%
S&P500 - 0.16% + 4.88%

Meanwhile, there was a resurgence of border tensions in Korea, reminding us that although South Korea is a rapidly emerging economy, it is also a dangerous place in a world full of geo-political tensions. Perhaps because there was nothing truly new in these news items, stock markets held on to September’s record gains and October’s follow through.

New winds may be blowing elsewhere. As we noted last month, PIMCO’s Bill Gross boldly called an end to the 30-year bull market in bonds in the company’s November monthly outlook. In November, yields on the 10-Year Treasury bond rose from 2.6% to 2.8%, and as a result bond prices dropped.

Some cited the September increase in durable goods orders as evidence that the Federal Reserve’s continued expansion of the money supply (popularly called QE2) was unnecessary. The 3.3 percent decrease in new durable goods orders in October should have quelled critics. Still, we are not confident that interest rates will remain low.

In the spirit of the holiday, investors/speculators gobbled up shares of the New General Motors (NYSE:GM) – liberated of one-third of its workforce, 100 percent of unionized retirees’ benefits, and its crushing debt load – to the tune of $23 billion. The label “Government Motors” still applies, though, as U.S. taxpayers hold 37 percent of the restructured company. The Treasury Department would need to sell this remaining stake for $53 per share to break even on the $50 billion bailout/investment (Bloomberg 11/25/2010).

The rate of increase in the price of Gold slowed in recent months, with the metal up just 3% in November. Two news items reinforce our skeptical view of the continuing rally. One is the creation of gold vending machines, currently found in multiple locations in Germany, Spain, Italy and Abu Dhabi, and expected to pop up in Las Vegas (where else?) in the New Year. The other is the recent run-up in silver, which jumped 15 percent in November. Silver is normally a cheaper, more volatile investment in the late stage of a gold rally.

Looking Ahead

Americans are waiting for a sign from Congress on the 2011 personal income tax structure. Cuts enacted early in the Bush administration are scheduled to expire at the end of this year. If that happens, an average household with $100,000 income and two children would see a tax increase of $335 per month. (Wall St. Journal 10/7/2010) This would burden already struggling consumers and weigh down economic growth. We expect the political parties will reach a compromise that preserves current tax rates for households with incomes under $250,000.

The big question is whether they will make some or all of the cuts permanent, or simply kick the can down the road by extending current rates for another two years. Also up for consideration is the rate for qualified dividends, which are currently taxed at capital gains rates but could go back to being taxed as ordinary income. Whatever the decision, we believe removing the uncertainty may be a positive catalyst for the markets.

Another good omen for equity returns is the so-called third year effect. Studies of the post-WWII era show that the third year of a presidential term is the best for the stock market. We think current fundamentals support a continuation of this pattern.

For example, this month’s unemployment numbers were encouraging. Much attention is given to the unemployment rate, but most people do not realize that average hours worked and average wages are more important as leading indicators. In the November employment report, each improved by nearly 2 percent over the prior year. This may set the stage for some very happy holidays for retailers, and a good start to the New Year.

Stock News

During the month, we sold positions in two Consumer Staples companies, Kraft (KFT) and Kimberly Clark (NYSE:KMB), based on diminishing outlooks. Dividend yields from the two companies have been strong contributors to total returns, but each company’s prospects for volume, pricing and profit margins leave us less than enthusiastic about future returns.

We bought shares in Unilver (NYSE:UN), the world’s second largest consumer packaged goods company, with the broadest reach in Emerging Markets (52% of sales). Growth has already shown improvement under new leadership, and we expect further acceleration in 2011 fueled by a richer product mix targeting the needs of developing country consumers. UN shares are currently the most attractive in their sector based on valuation, and the 4% dividend yield provides downside protection.

Schlumberger (NYSE:SLB) stock rose 12% following a great earnings report (up 11%, in line with consensus estimates). The outlook for SLB – the world’s largest oil and natural gas services company – includes some near term deliveries of deep-water exploration programs, which both increase exploration activities and carry the highest profit margins.

Rising oil prices, resumed oil drilling activity in the Gulf of Mexico, and reductions in borrowing costs are also positives for the stock. SLB has a current market value of over $100 billion and has been a top performer all year, beating Standard & Poor's top performing Oil & Gas sector in November.

Donaldson Companies (NYSE:DCI) reported profit growth of 42% on a 25% revenue gain for their first fiscal quarter. Net income rose 54%, beating consensus estimates by a wide margin. The rising stash of cash indicates share buybacks are likely to accelerate, a positive for shareholders. This Minnesota-based company produces filtration systems and emission control products for markets over the world, and their quarterly report identified Emerging Markets as the strongest current drivers of revenues.

A 4% dividend hike was also announced this month, the 24th consecutive year of such increases. While it is rare to find a company that has raised its dividend annually for nearly 25 years, it is rarer still to find an industrial company that has accomplished this feat.

Target’s (NYSE:TGT) management outlook was upbeat in the quarterly conference call, anticipating the best fourth quarter sales in three years. The new frequent-shopper reward card (“Red”) will be rolled out gradually over the next year, and is expected to lift total sales by 1-2% in markets where it is available.

For a retailer that has been happy to see 2.5% growth in same-store sales, the prospective lift from Red would be big news. Moreover, although Target is widely considered a “staple”, it stands to benefit more than most discounters as people loosen purse strings and increase purchases of clothing, electronics and other discretionary items.

Disclaimer: The opinions voiced in this material are for general information 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, consult with Marks Group Wealth Management or another trusted investment adviser. Marks Group Wealth Management performs in-house analysis on companies. Statistical information on mentioned companies is obtained from company reports, news releases and SEC filings. 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. Additional information is available upon request. Past performance is no guarantee of future results. 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. Precious metal investing is subject to substantial volatility and potential for loss. Commodities are subject to fast price swings which can result in significant volatility in an investor’s holdings. International and emerging market investing involves special risks such as currency fluctuation and political instability.