We don't have to tell you this has been a tough market. Already down 10 percent from its highs, the cyclical stocks have borne the brunt of the decline.
Commodities have been weak and anything related to commodities has gone down significantly more than 10 percent. No promises here, but we don't think investors are giving American capitalism enough credit. And this is coming from someone who has been lamenting the state of American policy, deficit reduction, our loss of leadership to China - all of which we continue to believe are major problems on the horizon. Still, when it comes to the nitty gritty, the so-called bottom-up analysis, we have to salute a number of companies. And salute them to such an extent that we regard their current sell-offs, while perhaps not a bottom, close enough to suggest that any future pain will be more than made up for by later gains.
Mind you, we're talking here about cyclical stocks. In the recent past, we discussed drug companies, and yes, they're going to continue to do well. We're not going to talk about commodity plays per se, though we think commodities will definitely come back; so, no, we don't think we're at the end of a super-cycle in commodities. But clearly, companies that earn their money by producing commodities are going to be in a tough spot only because it's becoming harder and harder to find everything from copper to oil. Still, when it comes to the cyclicals, even those that earn their bread by servicing the commodity industry, there are many you have to salute.
Take, for example, Joy Global (JOY), which is one of the most significant players in mining machinery, particularly when it comes to coal. The stock has been utterly battered, falling from a high of about $100 in 2011 to recent lows under $60. Could it fall as low as $40? Sure. But is $100 a reasonable target? You bet it is.
Again, nothing fancy here, but just look at the company's earnings over the past decade. They had a couple of down years: earnings fell by four cents in 2007, and by a penny in 2010. True, their latest profit report was under Wall Street expectations, but the company has still guided to earnings of at least $7 a share in 2012.
This is a cup which you can argue is either half full or half empty. Certainly, coal has been under severe pressure because of the low price of natural gas. Our feeling is that even if gas stays relatively low we're going to need coal, China's going to need coal, and Japan is currently importing so much liquefied natural gas that on a BTU basis they're paying twice as much as they would if they were importing coal.
But more notable than anything else is the fact that Joy is a company which managed to grow profits under conditions for coal and other commodities that were far, far worse than today. We're talking about the meltdown of 2008-2009. And yes, during that period the stock did fall dramatically, much more than it has fallen today. But if you bought the stock halfway down its fall, in two years you would have had a double!
Again, we're not saying where the bottom is, but we do think absent a change in the world's whole economic structure (i.e., a massive world-wide depression), Joy Global will perhaps bring a little more pain, but then a hell of a lot more joy!
Let's change gears for a second and talk about a stock all of you should be familiar with from my previous comments, and that's Intel (INTC). This formerly highly cyclical stock didn't do as well as Joy in the recent downturn, in that earnings did fall; but relative to past cyclical events, such as the year 2000 bubble when profits fell by 70 percent, this time from highs to lows profits declined by about 40 percent. More impressive is that 2012 profits are likely to achieve a record level, and not just by a small margin. Previous record earnings for Intel were about $1.40 a share in 2005. This year they could easily approach $2.50 a share. And indeed, in 2011 it had earnings of $2.39. Talk about laughing at slow growth.
Of course, there's much more to the Intel story. There's a decent yield, an extraordinary balance sheet, and perhaps the only legitimate franchise in the entire technology arena. By some estimates, Intel's lead in manufacturing over the nearest competitors, such as Taiwan Semiconductor, is as much as four years. The question overhanging the stock is whether it will be able to translate its franchise in the PC and server market into the rapidly growing smartphone and tablet market. We think the odds are incredibly high that it will. For the first time ever the company is using an entirely different architecture for these new markets, and if this architecture is successful (and odds are it will be) no manufacturer on earth is likely to be able to produce more efficient circuits (i.e., operating at maximum speed while using less power) than Intel.
We are looking forward to the marriage of Microsoft's Windows 8 and the initial version of the Intel Atom computer. Excuse the jargon here, but the 2013-2014 version of the Intel Atom chip will use more than twice as many transistors on a chip than any other manufacturer; and again, it will have a four-year lead on even the closest competitor.
Intel has not been hurt as much as Joy. Again, no promises about a bottom, but the upside here versus the downside is clearly enormous.
There was a time in the late 1990s when crashing oil prices led to massive declines in oil service companies earnings. This time around, when oil fell from $150 a barrel in 2008 to a low of $30, Schlumberger (SLB), the clear leader in the oil service sector (and a strong recommendation of ours) saw profits fall by roughly 35 percent compared to the 70 percent declines we saw before. Though oil prices remain well below their highs of 2008, it's still likely that Schlumberger in 2012 will have record earnings. There are lots of reasons for this. One of them, which deserves much credit (and this is true of Joy and Intel, as well) is superb management.
Also credit the general situation surrounding oil. While it's true that fracking has produced more oil, it's not the easy-to-get stuff and requires a lot of hard work and extremely sophisticated (and expensive) technology. All of these characteristics amount to hanging curveballs for Schlumberger. The stock has been pummeled recently and may go still lower, while its earnings will go higher. That's a combination that can't last forever. Again, as with Joy and Intel there may be short-term pain; but thanks to the ingenuity and exceptional management skills of the individuals running these companies, the long-term gains should dwarf any of the short-term pain.
We know all of you have been reading our comments about the macro view of the economy and financial markets. We've certainly written a lot in this vein, and could wax on and on about Europe, China etc. Suffice it to say, we think China is fine and managing as it should. We're not sure about what the resolution in Europe will be, but are betting that the Germans will not sacrifice their economy for a political principle.
So instead of further observations concerning the macro view we wish to focus here on what has made this country so prosperous for so long. And that's good old-fashioned capitalism: our ability to compete, our ability to survive, our ability to get the most out of our resources when we desperately need to do so.
Disclosure: Leeb Group, its officers, directors, shareholders, employees and affiliated entities and/or clients of such affiliated entities may currently maintain direct or indirect ownership positions in financial instruments (i.e., stocks, bonds, options, warrants, etc.) of companies or entities whose underlying exposure is in the companies mentioned in this article.