One of the tech bubble’s biggest cheerleaders was back on CNBC today being interviewed. This strikes me as a sentiment tell and potential sell signal……
NOTE: Every week I write a Client Note for my clients. For a limited time, I am allowing non-clients to sign up and receive the Client Note. You can sign up at the top right hand corner of the website. I will also be posting the notes on my blog with a 24-48 hour delay from time to time. Here is this week’s.
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Last week I wrote about how impressive 4th quarter tech earnings were from Intel, Cisco, Hewlett Packard and EMC. A bunch of retailers reported recently and the same thing applies there.
One quick tell I use on consumer spending is to compare same store sales for Walmart versus Target. If you look at the attached chart, you can see that Target notably outperformed Walmart during the boom with consistent quarterly same store sales growth around 5%. The Wall Street Journal took note of this trend in a fascinating front page story, “Walmart Era Wanes Amid Big Shifts In Retail”, on October 3, 2007.
However, calls for the death of Walmart were premature as shoppers flocked back to the price leader during the Great Recession. As Target’s same store sales plunged beginning in the 4th quarter of 2007, Walmart’s surged as consumers tried to stretch scarce dollars.
That trend is now beginning to reverse itself again over the last few quarters, with Target’s same store sales rallying, including their first positive same store sales quarter in the 4th quarter in 2 years, and Walmart’s declining, including three straight negative US same store sales quarters.
The trend is confirmed when we look at other retailers who have reported in the last week. Lowe’s and Home Depot both reported improving same store sales trending towards flat. Nordstrom’s and Starbuck’s reported 6.9% and 4% US same store sales increases after more than 2 years of declining same store sales. Whole Foods reported a strong number.
All this clearly confirms that consumers are feeling better and willing to trade up and spend some money. Combined with the tech reports and overall 4th quarter reports, it is undeniable that we are experiencing a recovery.
However, there were recoveries during the Great Depression too, notably the 1936-37 surge which peaked in August 1937 after which things spiralled downward again.
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I want to say a quick word about the market action. Since hitting an intraday low beneath 1050 on Friday February 5, the S&P 500 has put together a nice rally, up about 80 points (8%) over the last four weeks.
However, the volume has been pathetic. Only one day during the entire rally has had above average NYSE Composite volume (Tuesday February 9). Therefore, the action lacks real conviction and suggests we are in a short term range between 1050 and 1150 defined by the January 19 high and February 5 low.
NOTE: Every week I write a Client Note for my clients. For a limited time, I am allowing non-clients to sign up and receive the Client Note. You can sign up at the top right hand corner of the website. I will also be posting the notes on my blog with a 24-48 hour delay from time to time. Here is this week’s.
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Client: What would it take for you to change your view?
Me: Revenue growth.
Conversation, December 2009
After reviewing 4th quarter earnings, the conclusion is undeniable: there has been a surge in business activity over the last six months which is reflected in companies top and bottom lines.
Take a look at the following data for the S&P 500 as a whole:
PeriodOperating EPS
4Q09 (88%)* $17.34
3Q09 $15.78
2Q09 $13.81
1Q09 $10.11
4Q08 -$00.09
3Q08 $15.96
2Q08 $17.02
1Q08 $16.62
4Q07 $15.22
3Q07 $20.87
2Q07 $24.06
1Q07 $22.39
Now take a look at the data from an index I created of four of the biggest tech companies in the world (Hewlett Packard, Intel, Cisco, EMC) with a combined market cap in excess of $400 billion:
Big Tech Index
Period
Revenues**
% Change
Net
Income
% Change
4Q 2009
$45,046
14.1%
$8,795
56.3%
3Q 2009
$41,875
-11.5%
$7,216
-5.2%
2Q 2009
$37,112
-17.2%
$5,486
-17.9%
1Q 2009
$35,494
-20.5%
$4,827
-25.1%
4Q 2008
$39,477
-15.2%
$5,627
-26.1%
3Q 2008
$47,314
18.6%
$7,615
7.7%
2Q 2008
$44,798
23.9%
$6,678
13.4%
1Q 2008
$44,656
24.6%
$6,441
6.9%
4Q 2007
$46,564
28.2%
$7,609
28.4%
3Q 2007
$39,884
16.8%
$7,074
28.2%
2Q 2007
$36,152
16.4%
$5,889
1Q 2007
$35,830
12.3%
$6,026
4Q 2006
$36,314
$5,926
3Q 2006
$34,145
$5,517
2Q 2006
$31,069
1Q 2006
$31,908
* 88% of S&P 500 companies reported through 2/17, the time this data was updated.
** Revenues excludes HP Services and some very small items from HP Personal Systems
Revenues for the big four tech companies are again showing year over year gains after nasty declines for the previous four quarters. Likewise for net income which is up 56.3% year over year and 82% from the 1Q09 trough.
While less pronounced, operating earnings for the S&P 500 as a whole support the trend: companies sold more and earned more in the latter half of 2009. There has been a significant bounce off the bottom.
We saw the same thing in the second half of 2003 with revenues and earnings picking up in the wake of the March 2003 low and all the monetary and fiscal stimulus. The analogy to 2003-04 that I talked about two weeks ago continues to impress me.
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While 4th quarter earnings have been impressive, the question remains how much of it was driven by unprecedented government stimulus. 0% Fed Funds Rate, $700 billion TARP, $1.25 trillion in agency MBS purchases, the $787 billion stimulus; all of this has clearly flushed the economy and financial markets with cash and jump started economic activity.
But now government officials are talking exit strategies. The Fed tested the waters on Thursday by increasing the discount rate by 1/2 a percent. Many of the Fed’s special programs expired on February 1 and the MBS purchase program ends on March 31. Obama is talking about a deficit reduction committee. (However toothless such talk might be, the fact that he is talking about it is important as an insight into the current mindset).
Without all this stimulus can the economy stand on its own?
The late January/early February selloff can be interpreted as a response to these issues. {That selloff was on heavy volume and hit the riskiest, best performing assets, hardest. The bounce the last two weeks has been on light volume and the riskiest assets have underperformed).
For now, it looks like we are in a range as life support is gradually reduced and it is hoped that the nascent recovery can stand on its own two feet.
Bloomberg (“Corriente Said to Pay Backers After Europe Debt Bets”, Bloomberg, February 23) and The Wall Street Journal (“How A Texan Bagged Europe”, Gregory Zuckerman, The Wall Street Journal, February 24, C1) reported, and the internet is abuzz with talk, about Mark Hart III, the 37 year old Fort Worth, Texas hedge fund manager who bet against Europe’s sovereign debt and won.
According to the articles Hart III is trying to keep a low profile for fear of political fallout from his trades. But an internet search I performed turned up some revealing information. Hart sponsored two Mises Circle events in 2009:
How come most of the people who forecast and profited from what we just went through have studied Austrian Economics? Makes you wonder if there isn’t something to it
Richard Duncan’s The Dollar Crisis: Causes, Consequences, Cures (1st Edition: 2003, 2nd Edition: 2005) is one of the best books of applied macroeconomics I’ve read and it is what really stimulated my thinking when I read more than five years ago and turned my attention away from philosophy and towards investing.
Andrew Ross Sorkin has a wonderful piece on the story of Duane Read, the Manhattan based drug store chain with 257 stores in the New York Area that was acquired by Walgreen’s (WGN) last Wednesday, in today’s New York Times: “Duane Reade and Its Road to Health”, Andrew Ross Sorkin, The New York Times, February 23, B1.
Duane Reade was founded by two brothers in 1960 who opened the first store on the corners of Duane and Reade streets. After building stores all around the city, the brothers looked to cash out in 1992 and sold it to Bain Capital. Bain sold a majority stake to Donaldson, Lufkin & Jenrette in 1997 which turned around and took Duane public in 1998. (For a hilarious account of working at DLJ and Wall Street in general during the 1990s, check out Monkey Business: Swinging Through The Wall Street Jungle (2001) by John Rolfe and Peter Troob, a book which The Industry Standard called “the funniest read since Liar’s Poker”).
In 2004, Andrew Nathanson, the banker who took Duane public with DLJ in 1998, now at private equity firm Oak Hill Partners, teamied up with CEO Anthony Cuti to take Duane Reade private using $500 million in debt. Mr. Cuti may have inflated the company’s income and has been charged with securities fraud. In 2006, Nathanson retired from Oak Hill and he died in a surfing accident last summer.
At that time, apparently Oak Hill installed new management which has done an excellent job of cleaning up and streamlining Duane Reade’s stores leading to an improvement in business. That caught the attention of Walgreen’s which is buying the chain for $1.1 billion, including the assumption of $480 million in debt, from Oak Hill.
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18 months ago, those of us in California were treated to a similar consolidation in the drugstore space when CVS acquired Long’s 521 stores for $2.9 billion, including the assumption of debt. Since that time, two local Long’s, one by my house and the other by my office, have been rebranded as CVS. CVS has a great rewards card that rebates 2% of the total purchase price and a lot of great coupons such as a $4 off any purcahse of $20 or more that I’ve gotten the last 6 or 7 times I’ve been in.
However, there is a price in shopping in such a large chain. On Sunday night I went into the CVS by my office and bought a Tropicana Ruby Red Grapefruit juice. When I got back to my office and took a sip, it tasted a little funny. I noticed that some sediment had settled at the bottom. The expiration date was February 22 - the very next day.
This is most clearly seen by looking at Hewlett Packard’s hardware revenues. These are the revenues they get from selling Desktop Computers, Laptops, Servers, Storage, Printers and Printer Supplies and excludes revenues from their Services, Software and Financial Services segments.*
Here are their revenues from these segments**:
4Q 2009 $20,562
3Q 2009 $19,947
2Q 2009 $17,296
1Q 2009 $17,036
4Q 2008 $18,145
3Q 2008 $23,050
2Q 2008 $21,290
1Q 2008 $21,722
* I have only used revenues for Desktops and Laptops for the Personal Systems Group, excluding small revenue generators such as Workstations, Handhelds and Other.
** HP’s fiscal 1Q 2010 ended January 31, 2010. I have recategorized it as 4Q 2009 to match it up with the calendar.
Again, the pattern, just like with Intel and Cisco, is clear: dramatically declining revenues in the 4Q 2008 and 1Q 2009, followed by recovery and undeniable growth the last 6 months.
Disclosure: Top Gun has no position in Hewlett Packard (HPQ) shares.
Our fourth quarter results suggest the worst of the economic cycle is likely behind us. While the psychological impact of falling home prices and an uncertain employment picture continue to weigh on consumers, improving comparable store sales trends, including improvement in many bigger-ticket, project categories, provides an encouraging sign that consumers are gaining the confidence to take on more discretionary projects.
Home improvement retailer Lowe’s (LOW) reported earnings for the quarter ended January 29, 2010 this morning. The thing that most caught my attention was the stabilization in same store sales which were down 1.6% compared to the year ago period. That after drops of 7.5%, 9.5%, 6.6% and 9.9% the last 4 quarters. So it looks like stabilization, albeit at a low level.
Disclosure: Top Gun has no position in Lowe’s (LOW) shares.
In range bound markets, 90% of the return comes from dividends.
- Vitaly Katsenelson, author of Active Value Investing: Making Money In Range Bound Markets (Wiley, 2007), on CNBC’s Closing Bell, Tuesday February 16
In last week’s Client Note, I declared the end of junk phase of the rally, drew the analogy to 2003-2004, and suggested that the rest of 2010 may very well be choppy and range bound. If that proves to be correct, the kind of stocks that will perform best are different from what performed best from March 2009 through January 2010.
During the junk rally, the highest risk stocks, like Citigroup, B of A, commodities and emerging markets, performed best. But in a range bound market, high quality, dividend paying stocks are likely to outperform. These kinds of stocks are not sexy and you will not make 25% a year with them. But in a stingy market, their stable businesses and especially the guaranteed returns from their dividends could well be your best bet.
With that in mind, I added two high quality, high dividend stocks to the portfolios last week: AT&T (T) and Verizon (VZ). Of course, we are all familiar with these companies and know what they do. In fact, most of us are clients of theirs with our cell phones. Combined, the two dominant wireless providers have more than 176 million cell phone customers. Their combined market value is almost a quarter trillion dollars. Both are attractively valued at around 12 times earnings estimates for 2010. Best of all, each pay a dividend of around 6.5% annually. Hence, even if the stocks do nothing, we can just collect the dividend and return 6.5%. Not bad.
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In order to juice our return on these positions, I began selling covered calls on them today. In selling these calls, we cap our gains but collect the option premiums up front. If the stocks increase by more than 20%, they may be called away from us in January 2011. If not, the calls will expire worthless and we can sell more calls on them again next year.
This is a conservative strategy of taking money up front in exchange for capping our gains. I know that when many of you hear “options” you think “risk”. But in this case we are the ones selling the options and it is the buyer who is speculating with them.
On average, it looks like we will be able to get about 40 cents a share for selling these calls, adding another 1.5% to our annual return. Combined with the 6.5% dividends, that works out to an 8% return even if the stocks go nowhere. This is a very low risk 8% given the quality of the companies and their businesses. The only downside risk is that the stocks decrease in value.
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Best of all, this 8% is real discretionary income. The dividends are deposited in our account every quarter and the income from selling the calls is available for our use immediately. For retirees or investors desiring increased income, the money can be transferred from their brokerage account to their checking account and spent as desired.
Also nice is the 15% tax rate on dividends, courtesy of the 2003 Bush Tax Cuts, through 2010. However, it seems likely that Obama and the Democrats will not renew these tax cuts next year, at which time dividend income will be treated as ordinary income and taxed at your marginal tax rate.
All in all, this is a very attractive strategy for a range bound market and in any market for retirees or others desiring current income. It is a rare investment that can yield 8% in income with the kind of safety that this strategy can. No high quality apartment, office or retail property in the states of California, New York or Florida can offer that kind of yield. Neither can treasuries, munis or high quality corporate bonds. Many junk bonds can but you are taking on far more risk.
For those of you who are interested, I offer an Income Strategy in which I build a diversified portfolio of high quality, dividend paying stocks, on which I then sell covered calls, for retirees and others seeking current income. Income from dividends and option premiums are transferred from the brokerage account to the checking account once a month or every three months.
It is one of the best strategies for living off of your money at attractive yields without eating too much into your capital. It doesn’t have to take any of your time as I manage and administer the account (which is custodied in an account with your name and address on it at Scottrade which I have no access to). It is a recipe for Financial Freedom for those who have saved up a nest egg and are looking to spend their time and energy enjoying life or pursuing other interests.
Commentators seem to be split on the important of the Fed’s 1/4 point hike in the discount rate yesterday after the close. Some say it’s meaningless and not to worry about it. Others see it was one of the first steps in a tightening program that will remove the liquidity that has stabilized the economy and propelled financial markets over the last year. I believe the latter have it right.
The stabilization in the economy and strength in financial markets, in my opinion, is almost entirely about support provided by the government, especially the loose monetary policies of the Federal Reserve. While this is a small move, it has symbolic significance. In conjunction with the Fed’s letting many of its special programs expire earlier this year, which they first announced in their Dec. 16, 2009, statement this is just another move towards tightening. If it was loose monetary policy that goosed markets, monetary policy will go from being a tailwind to being a headwind. The easy money has been made, the junk phase of the rally is over.
