It’s déjà vu all over again! (Source: Yogi Berra) A year ago we wrote about weak consumer confidence, slow housing starts, unemployment still near 10%, a teetering Greek economy and even China showing signs of slowing.
What has changed since last year’s June report is that oil prices dropped for the second consecutive month to $95 per barrel after reaching a peak of $115. The higher cost of oil flowed through to higher product, packaging and shipping costs for many companies, so we have been watching second quarter earnings estimates come down.
More importantly to stock prices, the oil price decline should provide for a better outlook for sales, earnings and consumer confidence. Now if we could just see some improvement in jobs. New jobless claims accelerated to the 428,000 area the past few weeks, and there is no change expected for the unemployment rate by year-end.
During the month we saw mostly negative days in the market offset by a few significantly positive days spurred by news of strong (yet slowing) growth in China and Japan. At month end, the Greek parliament authorized further austerity programs to qualify for the bailout funds viewed as necessary to avoid a long-dreaded default, a positive for the financial markets.
Estimates for GDP growth continue to slide from the 3.5%-plus forecasts at the beginning of the year to the 2.8% area. We continue to believe that the lowered growth is driven by higher oil prices and disruptions from the earthquake in Japan. With improvements on both fronts, we expect the market declines will prove to be transitory. Indeed, on Thursday, the Chicago manufacturing index rose nicely after a three month losing streak. (Source: ISM-Chicago)
QE2 ended last Thursday, a decision which was widely telegraphed. The Federal Reserve has vowed to keep the Federal Funds rate between zero and 0.25%, and it is likely to continue buying Treasuries after QE2 ends. Bonds may become less liquid near term, but as long as there is slow GDP growth, any rate hikes are likely to be minor. The ten-year Treasury yield is unchanged from a year ago at 3%. In this low interest rate environment, demand for fixed income from retirees will keep prices high and interest rates low.
It is the less obvious scenarios that are worthy of consideration. We believe repatriation of foreign earnings by US based companies is forthcoming at a 10% tax rate or twice the rate charged last time there was a tax holiday during the Bush administration’s first term. This would generate billions of dollars of tax revenues.
Much of this repatriated cash could be used for share buybacks, buoying stock prices later this year, or acquisitions that would add to earnings. We also think it’s likely that the US could see a significant increase in spending by travelers from overseas later this year and into 2012. The government has recently streamlined the unwieldy process for obtaining a tourist visa. Core holding Disney (NYSE: DIS) would be a major beneficiary. Hotel rates have been climbing over the last year; we are anticipating that occupancy rates will also begin to rise.
General Mills (NYSE: GIS) raised its dividend by 9% as it reported earnings in line with expectations, up 27% on an operating basis. The company is guiding to lower earnings for the current quarter due to a short term inability to fully offset 10-11% input inflation, but scheduled price increases since February have been implemented. Innovation is key, and the number of new products is sharply accelerating from last year’s lineup. General Mills is “best in class” in the consumer products group for its billion dollar brands, innovation/pricing capabilities, and geographic diversification. We believe estimates are conservative for the coming year, and valuation is compelling at 9.5 times operating earnings, toward the low end of its 10-year historical range.
Oracle (NASDAQ: ORCL) beat sales and earnings expectations when they reported this month on strength of the Software division, representing nearly 80% of revenue and generating significantly higher profit margins than Hardware. EPS rose 25% year on year on a 13% sales gain. Hardware sales declined, disappointing investors, but are expected to improve sequentially in the coming quarters.
We own shares of United Technologies (NYSE: UTX), maker of Pratt & Whitney aircraft engines. During June’s Paris Air Show, the newest, largest and most fuel efficient commercial aircraft were in the spotlight, and orders came in well ahead of expectations. Engine orders are placed later in the buying process. Following years of defense industry focus, Pratt & Whitney is a contender for the fuel-efficient commercial engines ---along with the joint venture of another Core Equity holding of ours, General Electric (NYSE: GE). We believe that our portfolio will benefit either way, and are optimistic that UTX has found its way back into the hearts and pocketbooks of the commercial airline industry.
Visa (NYSE: V) shares rose 12% at month-end on a Federal Reserve ruling that fees charged by financial institutions to retailers for accepting debit cards will not be cut as deeply as proposed last December. The rate for average debit transactions has been 44 cents, and the new rate will be 24 cents --- 2-3 times greater than the rate that had been formally proposed and well ahead of estimates.
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