The high flying NASDAQ Composite Index added another 25 points today, which has extended the rally since the October lows of last year to make a new 14-month high. The Dow Industrials remained in negative territory for most of the day, but a late surge of buying pushed the Industrials into the plus column by six points with a close of 9,223, while the S&P 500 also added marginally to yesterday’s gains with an increase of three points to close at 1,007. The debate rages on; are we in a new bull market or are we at the tail-end of a bear market rally? It doesn’t really matter much what you call it; the question remains, will stocks continue to climb or roll-over to new lows?
What bothers me most about this rally is the fact that there is nothing out there that can justify the fundamental valuations. Stocks are still way too expensive for the amount of earnings they will generate for the shareholders. This rally is being driven by pure momentum, hope and hype. This is what the professionals refer to as a “technical rally.” Don’t even trouble yourself by looking at business plans, debt ratios, price/earnings ratios, sales growth, etc. Fundamentals don’t work when fund managers, individual investors and institutions are chasing returns to buy anything that’s moving up in price.
Buyer Beware
To jump into stocks on the long side requires some guts in my opinion! The lack of fundamental strength in this market and the fact that the individual investor is jumping back in with both feet are signs of trouble ahead. When I see momentum buying and sentiment indicators screaming euphoria, the contrarian in me says to stay away. As the NASDAQ moves higher, more people jump on board to get a piece of the action. The way I see it, the higher the market moves, the greater is the risk that it could move back down. Investors buying stocks in this environment can only be operating on “The Greater Fool Theory.” To buy a stock at today’s price means that you believe that there is a fool out there greater than you that will be willing to purchase the shares from you at an even higher price. I’m not quite sure where momentum investing stops and the greater fool theory begins, but somewhere in the middle there should be good fundamental reasons to own a company, otherwise it is pure speculation.
Some of you might consider me the greater fool for not participating in this rally, but I prefer to do without the risk. Money can be made in these markets without taking on inordinate risk. I guess I just dislike losing money more than I feel a desperate need to chase rising equities along with rising risk. I would rather work to preserve capital for now and deploy the capital more aggressively when the markets operate on fact instead of fiction and hope.
When you get right down to it, the stock market is telling us right now that investors believe the work of the government tax cuts and easy monetary policy from the Fed are going to rescue the economy. It’s that simple. The market believes all the stimulus will work. It has every time in the past. Every time we have had economic or financial problems, the Fed opens the money spigot and like magic it’s all fixed and we’re off to chasing riches again. Think about it folks, how many balls can the Fed keep juggling to impute value that just isn’t there? Now we have stocks, bonds and real estate, ALL THREE, with artificially high valuations driven by increasing debt loads.
Higher Interest Rates = Problem
The problem right now with the “assumed” economic recovery is that money is now flowing out of bonds and back to the stock market, which is effectively raising interest rates. In the last three weeks, interest rates have gone up over 60 basis points for the 10-year Treasury Note, which means mortgage rates are on the rise. I believe the Fed has been counting on long-term interest rates remaining low, to the point that they would intervene should it become necessary. Next week Alan Greenspan will address the House Financial Services Committee (on Tuesday) with his semi-annual report on the economy and monetary policy. Since interest rates have been climbing the last three weeks, there is a very good chance that Greenspan will target the long bond with RHETORIC (no real action) that will influence money to move back into bonds. The timing is just about perfect, since bonds are approaching an oversold condition which should correct to the upside, especially with a little help from Uncle Al.
Mergers and Acquisitions
I don’t usually go into detail on specific companies, but I thought this little “industry tidbit” was an interesting development. In Bloomberg news, the lead sentence to the article reads, “Yellow Corp., the second-biggest U.S. trucking company by sales, agreed to buy larger rival Roadway Corp. for $966 million in cash and shares to lower costs and broaden the combined companies’ customer base.” This follows just nine months after the third-largest U.S. trucker, Consolidated Freightways Corp., shut down their operations. If you like to buy companies that monopolize an industry, this could be a good one.
As of a year ago, there were only four companies that handle “LTL freight.” LTL stands for “Less than Truckload,” which means they are freight consolidators. Basically, they combine many small freight orders at terminals that are strategically located around the country. Orders traveling in the same direction go on full trucks to maximize efficiencies, where they are then delivered to a local terminal, broken down to local routes and then delivered. Now you are looking at one trucking company that has the combined strength of the two leaders, with the number three player out of business. The new company will only have to deal with one competitor, Arkansas Best Freight Systems (ABFS), which is much smaller since they were number four in the industry to begin with.
We are clearly seeing a consolidation in the trucking and distribution business. Somewhere down the road, the players that are left standing will inherit all the remaining freight in the USA. It makes me think of Warren Buffett’s purchase of the McLane Company (Walmart’s distribution network). Remember that McLane’s big competitor in food distribution was the Fleming Company, who went belly-up not too long ago. Mr. Buffett was really on his game when he identified the opportunity in the distribution business. He will have guaranteed business since the goods must get to the marketplace. Roadway Corp. added $16.08 per share today or a WHOPPING 53.6%, VERY NICE!!!
The Dow Jones Industrial Average fell as Altria Group slumped on concern that a court may reinstate a $12 billion deposit required for the company to appeal a ruling. The 3-point decline in the stock was the major downside influence on the Dow Jones Industrial Average. Otherwise, respectability reigned with a late downside flurry, bringing declines over advances. The DJIA dropped 66 points (-0.7%) to 9156. The S&P 500 slipped 5 points (-0.6%) to 1002. The Nasdaq squeaked out a one-point gain to 1747, closing at the highest in almost 15 months for a second straight session. On the calendar, U.S. wholesalers trimmed their inventories 0.3% in May. As sales slowed, the inventory-to-sales ratio remained at a tight 1.25, close to a record low of 1.21, all of which underscores the lean-and-mean nature of U.S. business. Some money managers may be too optimistic about the prospects for growth in the economy and earnings. U.S. companies expect the economy to increase at an annual rate of as much as 4 percent in the second half, according to a survey by the National Association for Business Economics. It grew 1.4 percent in the first quarter.
Strong Sectors: oil & gas services, gold, electronic manufacturing services
Top Stories . . . U.S. wholesale inventories fell in May for a second month, a government report showed. A strengthening of demand with fewer goods on hand may spark a rise in production and help lift the economy later this year, economists said.
Tenet Healthcare, the second- biggest U.S. hospital chain, said the U.S. Securities and Exchange Commission is investigating its Medicare billing and financial disclosures back to 1997.
NCR Corp., the world's biggest maker of automated teller machines, had a second-quarter profit rather than a loss as analysts expected, partly because the dollar's decline boosted sales.
Ford Motor, the world's second- biggest carmaker, said it may cut production at three of its largest factories in Europe after sales in the region declined in five of the last six months.
Alcan, the world's second-biggest publicly traded aluminum maker, may have to sweeten its hostile 3.4 billion-euro ($3.9 billion) bid for rival Pechiney SA after Pechiney's board rejected the stock and cash offer as too low.
Of Note . . . According to USA Today, not much change among the strategists. Tom McManus of Bank America, who has been out in front of this advance, says we have just gone through the appetizer, and the main course will be served when-and-if the economy shapes-up. Richard Bernstein of Merrill Lynch remains the bear, suggesting we are re-flating the bubble. Somewhere in between is Steve Galbriath of Morgan Stanley, who has taken some money off the table, and Tobias Levkovic of Smith Barney, who cites ten reasons the rally can continue. And finally, there is Ed Yardeni of Prudential, who says it's show time, and the economy and earnings have to come through in the second-half to justify the move.
Gurus . . . Richard Dickson, technical analyst at Lowry Research, said the equity market's technical condition continues to point to higher prices ahead. He said only the Nasdaq Composite is sporting any overbought readings, and those are only "very short-term" momentum indicators. He did say, however, that if short-term demand readings continue to be "sluggish," it would "raise a red flag" about the prospects for sustainable gains over the next 2 to 4 weeks. "But, absent any accompanying signs of distribution or rising supply, these indications of lagging demand provide little basis for expecting an imminent market top," Dickson said in a note to clients.
Quote of Note . . . ``You are making the highs for the summer here as you go into the reporting season,'' said Jeffrey Saut, chief investment strategist at Raymond James & Associates, in a radio interview with Bloomberg News. ``I am less sanguine than most however on a robust second-half recovery. I just don't see it in the CEOs and CFOs that I talk to.''
Mortgage of Note . . . With interest rates rising and many Americans on holiday, U.S. mortgage lending activity abruptly slowed in the week ending July 4, the Mortgage Bankers Association said. The bankers' group said applications dropped 17.7 percent from the previous week. Refinance applications dropped 21.3 percent and purchase applications fell 5.5 percent. The average rate for a 30-year fixed-rate mortgage rose to 5.37 percent from 5.23 percent the previous week.
Eco Speak . . . U.S. wholesalers trimmed their inventories 0.3 percent in May as sales slowed 0.5 percent, the Commerce Department reported Wednesday. The inventory-to-sales ratio remained at a tight 1.24, close to the record low 1.21 reached in March. Inventories also fell 0.3 percent in April. Wholesale sales dropped 2.5 percent in April, largely the result of falling petroleum prices. Durable goods sales fell 0.4 percent in May while inventories sank 0.3 percent. Sales of non-durable goods dropped 0.7 percent in May while inventories dropped 0.1 percent.
Financials . . . Bradley Ball at Prudential sees upside in American Express' revenue growth outlook in the second half of the year due to the recent appreciation in the equity market and to the likely more positive fund flows at its financial advisors division. Ball is also more confident in his second quarter earnings estimate for the company. He reiterated his "buy" rating stock and $52 price target.
Michael Mayo at Prudential raised his rating on Citigroup to "hold" from "sell," citing an increased earnings outlook resulting from "unique positioning" and low rates, expectations of a 20 percent dividend hike and the belief that trading revenue may be more sustainable. Mayo also upped his second-quarter earnings forecast, for the second time in a month, to 82 cents a share from 80 cents, and his full-year estimate to $3.35 a share from $3.30. He added, however, the banking giant still does not warrant a "buy" rating, given lingering structural issues, a belief that the legal reserve is insufficient and seemingly unrealistic consumer growth expectations.
Oil & Gas . . . Financial Times said Halliburton could save over $3.5 billion under asbestos legislation being considered in the Senate. The stock was upgraded overnight by JP Morgan to overweight from neutral as the company's "asbestos travails are nearing an end."
Energy . . . CMS Energy plans to privately sell $150 million worth of convertible notes due 2023 and $250 million of senior notes due 2010. The electric and gas company also granted the initial purchasers of the convertible notes an option an additional $50 million of convertible notes. CMS plans to use the proceeds form the sale to redeem its 6 3/4-percent senior notes due January 2004 and to reduce debt under its senior credit agreement.
Metals . . . Wayne Atwell at Morgan Stanley downgraded Alcoa to "equal weight" from "overweight," citing the aluminum company's plans to invest in low return projects over the next 3 to 4 years, poor results from its diversification program and limited near-term financial flexibility resulting from a highly leveraged balance sheet. Atwell said believes the company will need to close some smelting operation to lower costs. He raised his 2003 earnings estimate, due to stronger than anticipated second quarter results reported late Tuesday and a lower tax rate, but cut his 2004 and 2005 forecasts.
Food & Beverage . . . David Adelman at Morgan Stanley said he now anticipates "two likely short-term negative developments" for Altria. Adelman said legal anxiety will increase given his belief that the Illinois district court of appeals will find trial judge Bryon did not have the authority to change the required Miles bond of $12 billion. He also thinks that second-quarter unit volume growth will be 1 to 1.5 percent, well below expectations of 4 percent.
R.J. Reynolds and Brown & Williamson have held discussions to merge their tobacco operations due to severe price competition.
Retail . . . Movie Gallery expects adjusted earnings before items of at least 31 cents per share for the second quarter, above its previous projection for a profit of 26 to 29 cents per share. The movie rental firm cited its strong same-store revenue growth of 6.5 percent for the quarter for the higher outlook. It had been expecting low- to mid-single digit growth on this basis. Net income for the quarter is now anticipated to come in at least 26 cents per share, reflecting the non-cash impact of a stock option expense and an accounting change for rental inventory amortization.
Smith Barney upgraded BJ's Wholesale to "outperform" from "in-line," citing store appearance and merchandising initiatives and valuation. "Our feeling is that the 'worst' is almost over and the BJ's is gaining traction in the form of increased frequency of store visits and larger average ticket sizes," Analyst Deborah Weinswig said.
Helen of Troy reported first-quarter earnings of $14.8 million, or 50 cents per share, including a gain from a litigation settlement. Before items, the El Paso, Texas, maker of personal care products earned 42 cents per share in the period. Four analysts polled by Thomson First Call were looking for a profit of 24 cents per share in the quarter, on average. Sales jumped 4 percent in the latest three months to $106.5 million from $102.5 million in the same period a year earlier. Looking ahead, Helen of Troy raised its outlook for the full year to earnings of $1.75 to $1.80 per share from a range of $1.45 to $1.50 per share. The company's board also approved plans to buy back up to 3 million shares of its common stock.
Healthcare . . . The Securities and Exchange Commission has launched a formal probe of Tenet Healthcare. The company said it was subpoenaed by the SEC Tuesday afternoon. The SEC seeks documents relating to Medicare payments and other financial disclosures dating back to May, 31 1997. Tenet said it is cooperating with the investigation. In a separate development, Tenet shareholders are questioning the company's search for a new chief executive. Former CEO Jeffrey Barbakow was removed in May.
Media . . . A French court has blocked a 20.6 million euro ($23 million) payment to Jean-Marie Messier, the former head of Vivendi Universal until shareholders can hold a vote on Messier's severance package, Reuters is reporting from Paris. The regulators said the agreement between Vivendi and Messier was not approved by the board. Last month, a U.S. arbitration panel said Vivendi should pay the severance.
FCC report says the average cable-TV bill jumped 8.2% Year/Year. News is positive for Satellite TV. Although report did not indicate % price increase in DBS rates, both DISH and DirecTV continue to offer price points about 25-35% below cable. Satellite TV also provides superior customer service than cable according to SG Cowen Survey.
Telecom . . . Alvarion (wireless broadband services) will work with Intel to develop certified wireless access systems.
AT&T will adopt Gric's wireless access services to offer remote access to its virtual private network from more than 2,000 access points in 20 countries. AT&T expects to complete the integration of Gric's access points by the end of the year.
Storage . . . Sun Microsystems has been awarded a three-year, $50 million contract to provide technology for the second phase of the Defense Advanced Research Projects Agency's (DARPA) High Productivity Computing Systems Program. The purpose of the program is to develop high-level computing systems for items such as weather and ocean forecasting, surveillance and reconnaissance.
Network Equipment . . . John Chambers expects the IT market to recover within months. Chambers based his prediction on numerous conversations he had held in recent months with economists and with top executives of companies including Telefonica, Bank of America and Citigroup. Chambers was also quoted as saying "We are going aggressively on the takeover trail. But we will now do fewer, more focused takeovers,". Chambers' comments are consistent with those he made in June at a brokerage conference. His willingness to place a definitive timeframe on a potential recovery indicates a slightly more optimistic outlook than in year past.
For network Equipment earnigns. Expect most companies to largely meet expectations but guide cautiously for 3rd quarter. Remaining constructive in the service provider market. Expect cautious 3rd quarter guidance, but the market is beginning to see some early signs of a turn and believe it's possible to see some growth in 2nd half 2003. Cautious on the enterprise outlook. Believe modest pent up demand for new products likely aided several back-end loaded Quarter’s. Expect networking to lag an overall IT recovery, with some growth from installed base, market share gains, federal government., and low-end (SMB/SOHO market). Area to watch over next several Quarter’s is the SMB/SOHO. While this market is fragmented, has lower margins and different distribution channels, we expect it to be a source of growth.
With the acquisition of Linksys completed at Cisco. Anlaysts are adding $65 million in revenue to July (4th quarter) Quarter forecast and $455 million to 2004. The result is that absolute 2004 EPS estimate still rises by $.01. 4th quarer 2003 estimates for CSCO are $0.15 (unchanged) on revenue of $4.72 billion. 2004 estimates are $0.64 on rev of $20.13B (+6.5% Year/Year).
Analysts favor CSCO for its carrier and managed services opportunities; Lucent and Nortel for their
large installed bases; and Foundry for its presence in federal government.
Enterasys will likely have flat revenue with new products helping drive growth in 2nd half.
Cisco, Lucent, Ciena and Juniper are likely the front runners for the GIG-BE contract.
Expect disappointments from Extreme Networks, Avci, and Redback, Riverstone report this Quarter.
Semiconductor Equipment . . . Merrill Lynch raised its rating on Asyst Technologies to "buy" from "neutral," citing expected gains in market share, cost reduction and anticipated higher peak margins. Brett Hodess said Tuesday's announcement that the company was awarded a multi-million dollar order to provide its 300mm automated material handling system to UMCi, a joint venture between United Microelectronics, Infineon and the Singapore Economic Development Board, was a "highly competitive win" as it gives Asyst penetration with all semiconductor foundries at 300 mm.
United Micro’s June revenues reached NT$7.027 billion, -4.5% Month/Month and up 4.7% Year/Year. 2nd quarter revenue NT$21.71 billion up 21% compared with 1st quarter.
Semiconductors . . . UBS raised its price target on Intel to $29 from $26 ahead of Intel's second quarter, slated for release on July 15. "While we do not expect Intel to materially beat our $6.7 billion sales estimate for the second quarter, we do believe that the Centrino results will be strong."
Continue to expect 14% PLD industry growth in 2003 following the EDA survey published today. Drivers for migration to FPGAs continue to increase. The survey results indicate (1) the size of IC design teams is growing and (2) chip design times are also increasing. Both observations would favor a shift to FPGAs from ASICs because FPGAs facilitate faster and easier designs. The survey results suggest the FPGA design tool market is saturated with only 5% growth expected over the next two years. However, the survey was aimed primarily at higher-end EDA tools. 2003 industry forecast remain intact as we expect N-T growth to come from lower-end applications. Growth on low end favors Altera over Xilinx in Near-Term.
Software . . . An SG Cowen/EE Times survey of 400+ IC design engineers/mgrs reveals weak Near-Term expectations for EDA spending but suggests a 2004 rebound driven by increasing design starts/design activity. Survey suggests 'flattish' EDA budgets in 2003, in line with our expectations. EDA historically rebounds with a two-Quarter lag. Expect 7-10% bookings growth in 2004. Design starts are expected to increase in 2003. Continued migration to 90nm will drive EDA growth--investment cycle just beginning. This should drive strong tool upgrade cycle over two
years. Sector valuations (17-25x) remain attractive. Perception of Cadence technology/support improved dramatically. Synopsis still leads, but survey suggests that CDN's competitive position has strengthened meaningfully. 30% (21% in 2002) of respondents see CDN as the technology leader in three years. SNPS 41% vs. 52% last year. CDN support viewed as best by 25% (13% in 2002). SNPS 31% versus 36% last year. Magma Design and Verisity should outgrow broader industry. Physical synthesis and functional verification are highest growth, most critical investment areas. VRST and LAVA are advantaged given their focus.
MSFT announced it would stop issuing options and instead begin giving its 50,000 employees restricted stock. The decision is following a trend insisted upon by the accounting societies, and one which enhances the quality of earnings. Will likely dampen EPS but have no fundamental impact on balance sheet or CF. Based on recent filings, historical impact to MSFT earnings resulting from stock option grants has been in the 30-35% range. Move will likely shine brighter light on option practices and expense recognition of other large-cap SW companies potentially causing pressure. Earnings hit likely greatest for newer, faster growers like Veritas and BEA Systems and least for older vendors like Computer Associates.
SAP, Europe's largest software maker, is considering whether changes should be made to its employee stock options compensation plans.
WSJ article says Oracle and other database suppliers face a growing threat from below: "open source" databases, which give customers a free or low-cost alternative to commercial products. Open source DBMS is not news but profile has been rising lately, helped in part by SAP's endorsement of mySQL. As with Linux, use of open source DBMS has started at the low end and will take many years to migrate up to truly attack mainstream market. Nonetheless, it is clearly a commoditizing force that must be watched.
Phoenix Technologies expects third-quarter revenue to fall short of its previous indications due to a decrease in sales of its traditional PC BIOS software products. The San Jose, Calif., firm now expects revenue of $20 million to $21 million for the period. A single analyst polled by Thomson First Call was looking for revenue of $23.9 million in the period. The company said expenses were in line for the quarter but it can't provide a bottom-line estimate until it has assessed its tax liabilities and other non-operating costs.
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