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Gold Index
Last Update: Telecom
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In the last quarter of 2007, the Financial services sector lost nearly $10 billion on an operating basis, excluding one-time charges. Earnings for the entire S&P 500 slumped 23% from last year's period. But excluding the financials, earnings were actually up 16%. The financial markets are in the midst of one of the worst crises on record, as subprime troubles continue to permeate all aspects of the financial system.
What took years to build nearly unraveled in a matter of hours. The week of March 17 was one of the most dramatic since the collapse of Long Term Capital. The eleventh-hour Fed-backed rescue of Bear Stearns was one for the record books. The near-failure of an investment bank on Wall Street shook the markets. The Fed's $30 billion backing of JPMorgan's purchase of Bear Stearns will go down as one of the best deals this century. Counter-party risks from the failure of BSC would have wreaked havoc on the world's derivatives markets.
The market weathered this storm with the assistance of a creative and aggressive Federal Reserve. In an unprecedented move, the Fed is now allowing investment banks to borrow at the discount window. As a result of the drastic liquidity action by the Fed, quarterly earnings results from the investment banks and brokers showed that leverage ratios were exhibiting some positive signs and visibility has improved, albeit modestly. The industry's inherent diversity came through in the first quarter as firms benefited from record volume and volatility in currencies, commodities, and rates despite credit market uncertainty. The performance proved the brokers are capable of generating revenues in any type of market environment.
In addition to liquidity measures, the Federal Reserve is also now accepting non-agency MBS as collateral in exchange for Treasuries. Banks are quickly attempting to deal with mortgage borrowers in order to forestall foreclosures. Recently, federal regulators increased the size of mortgage loans Fannie Mae (FNM) and Freddie Mac (FRE) can buy, which is critical to getting the mortgage market running again. On March 24, Directors of the Federal Housing Finance Board approved a temporary increase for the Federal Home Loan Banks to increase their purchase of mortgage bonds by at least $100 billion as part of an effort to bolster demand for the securities.
The Financials will continue to be a drag on earnings in 2008, but there is a great deal of liquidity being pumped into the financial markets in order to get investment banks back operating normally and commercial banks to start lending again. The Fed's liquidity injections, lower interest rates, and regulatory changes are starting to thaw the credit markets. These measures should start bearing fruit midyear, which underscores our Market Weight rating on the sector, as the risk/reward outlook improves.
Our recommendation is to tread lightly and cover your risk. While we recommend the XLF to minimize headline risk, names we do like for the longer-term investors include Goldman Sachs (GS), Merrill Lynch (MER), Lehman Bros (LEH), US Bancorp (USB), Bank of America (BAC) and JPMorgan (JPM). There remains a great deal of risk out there in the near-term including deteriorating capital positions, default risks, counter-party risk, deleveraging, net charge offs, and asset deflation. We anticipate the headlines will remain filled with casualties of the subprime fallout, but incrementally the picture should start to brighten. The S&P 500 Financial sector trades at a trailing multiple of 17.3x and 1.3x price/book.
The Financial sector comprises ~17.64% of the S&P 500.
ArchiveHealth Care typically holds up during an economic slowdown due to the sector's inherent defensive characteristics. This hasn't been the case this year until just recently. Health Care tumbled nearly 18% from January to June as costs mounted, growth slowed, and concerns over the impending change in Washington took hold. Just recently, however, Health Care has been a primary benefactor of the rotation out of commodities and energy. The S&P 500 Health Care sector has rallied nearly 10% from the end of June.
The Market Weight rating reflects enduring challenges facing large-cap pharmaceutical companies of slowing pipelines, drug price deflation, and rising patent expirations. Other areas of concern include rising health care costs and potential managed care reimbursement policies with a new administration. There are some industries that we continue to think offer compelling growth opportunities including Biotechs, which have robust pipelines and are in the midst of a M&A cycle, and Medical Equipment. Managed Care companies have also finally gotten a better handle on pricing and costs. Some names we like include JNJ, AET, ESRX, ALXN, CELG, SQNM, and THOR.
Archive As the economy recovers, interest rates will rise and investors will start to seek more competitive yields outside this dividend sector. The sector has already seen this occur, falling from multi-year highs at the end of 2007. We see further downside risk ahead and recommend investors start paring back positions. ArchiveThe Consumer Discretionary sector was the second-best performing sector over the past week
The perils of the discretionary sector are well known and, we would argue, fully discounted into valuations. A housing market recession, consumer credit concerns, and high food and fuel costs have pushed the discretionary sector to 2003 lows.
There is no doubt the American consumer is facing challenging economic times. That being said, valuations have been steeply discounted and the U.S. economy is poised for a recovery. Lower interest rates and the fiscal stimulus (roughly 25%) have started to filter through the economy.
And as history has proved time and again, betting against the U.S. consumer has proved to deteriminal every time the "death of the consumer" is pronounced.
Briefing.com is forecasting a 3% increase in third quarter GDP. That is, if the inventory adjustment does not interfere once again as it did in Q2. The fact remains consumer spending continues to trend higher and the full impact from the fiscal stimulus is far from over. Falling home prices and high gas prices have yet to stem consumer spending. And we don't see this trend changing.
Specific industries we like include media, general merchandise stores, casinos and gaming, department stores, and education services.
ArchiveThe Technology sector was the best performing sector over the past week.
The Technology sector is down 4.6% compared to the S&P 500. Peaking back in the fall ahead of the critical holiday selling season, technology continued to loose ground on recession worries and consumer health concerns. After trading in a tight range for the last couple weeks, we saw a significant upward move post-Easter with notable gains in Comm/Network Equipment, PC Hardware, and Semis segments. Tech heavyweights, Intel (INTC), Cisco (CSCO), Apple (AAPL), Hewlett-Packard (HPQ) and RIMM (RIMM) seeing strong gains.
Given the fact that the consumer segment accounts for more than 50% of total semiconductor consumption, consumer spending trends, fads, and fancies influence the entire sector from the memory producers to the foundries, assembly and testing, and semi cap equipment. The semiconductor industry is coming off a challenging year in 2007 hurt by a memory chip supply glut, ASP pricing war, chip inventory build ('06/07), and a tightening capital spending environment. The good news is this environment has sparked wide spread restructuring, supply chain management, increased level of outsource manufacturing, M&A activity, and joint ventures aimed to reduce fixed and R&D costs.
And while the situation remain tenuous on macro headwinds, the outlook brightens in the second half helped by fiscal and monetary stimulus. Further, typically consumer electronics enjoy a boost in sales during years with elections and/or Olympic games, which are being held this summer in Beijing. The memory markets meanwhile remain a major overhang as supply outpaces demand. There is a great deal of variance in opinion on Wall Street whether this situation will improve or not this year.
Just take a look at the share price of memory maker Micron (MU) and the situation is clear. Its stock price has fallen precipitously over the last two years, topping out of $18 in September 2006, to below $6 per share. Competitive pressures, once again, weighed heavily on January sales despite modest unit growth. We think the supply/demand picture should improve this year driven by capex control and seasonal demand resulting in greater pricing stability. Memory will remain the wild card for the industry this year. Excluding memory products, semiconductor sales rose 8.1% in January. For the year, the SIA is predicting 12% PC and 12-15% cellular handset unit growth.
More and more, we are finding value across the technology sector. The S&P Tech sector trades at 19.7x trailing and 16.5x forward earnings and 1.8x price to sales. Comparatively, the S&P 500 trades at 20.3x and 14.0x, respectively. Outside SML holdings, CSCO and AAPL, we are becoming more constructive on graphics giant, NVIDIA (NVDA) below $20. The stock is trading at 12.1x forward earnings and a PEG of just 0.6. Notable earnings results in the next couple weeks include Best Buy (BBY) 4/02 ; Micron 4/02; and Research In Motion 4/02.
The Technology sector comprises ~16.73% of the S&P 500.
ArchiveThe global commodity complex is in a corrective mode that started with a break in crude oil prices. The supercycle was due for a correction and it's clear prices had reached a tipping point. The catalyst for the sell-off has been a mix of several factors, but mainly it's the renewed focus on slowing economic growth dampening demand. The "short the dollar, long commodities" trade is essentially over. Slower global economic growth is now taking the spotlight and fears of a global slowdown will continue to put downside pressure on commodity prices and related industries.
We have been long-term commodity bulls over the last few years, but in recent months we had become increasingly concerned over the dollar's influence on commodity prices. Crude was essentially trading as a dollar proxy. Factors outside supply/demand had taken hold of the crude markets like never before due to the sheer amount of speculative money in this market. As such, given the dollar premium built into all commodities, we feared real downside risk from a reversal of fortune in the greenback. From our vantage point, we saw a "prevalence in recent months of onesided views on many commodities, which has, in the past, forecast a near-term top." Now that the dollar has finally found its footing, coupled with increasing concerns over slowing global growth, commodities are correcting and it's likely only just beginning.
At this point, the demand side of the equation is also being clouded by the impact the Olympics are having on China's buying patterns of raw materials from metals to steel. It remains to be seen whether after the games if the buyers will step back in. For now, sentiment remains negative with the bears in full control.
Our underweight position reflects concerns over falling commodity prices over the next few months, a stronger dollar, and slower international growth. The combination of these factors likely results in underperformance. The sector rotation out of Materials and commodities has caused significant selling pressure in producers globally. We do, however, continue to hold positive views on several markets including coal, steel and aluminum where the markets are in deficit position due to secular changes taking place.
ArchiveThe Overweight rating in the Industrial sector reflects the international infrastructure build out taking place globally, as well as improving economic growth in the U.S. Economic growth, urbanization, industrialization, and rising purchasing power are fueling a massive global power infrastructure boom, which is why "The Global Power Play" ranks No. 1 of Briefing's Next Big Thing themes.
This upcycle has bifurcated globally into two distinct trends. Fast growth rates in the emerging markets have resulted in the rapid development, expansion and distribution of basic and reliable power generation. In the developed markets, countries are in need of a massive upgrade of their aging electrical infrastructure. Power, water, ports, airports, and beyond, building is consuming rising amounts of capital that is expected to amass to over $20 trillion over the next decade.
We think that while the Q2 came in below expectations, due entirely to an inventory devaluation, the third quarter outlook is quite good. The market now seems content with the Fed's neutral stance, which is the only valid position at this point in the economic cycle. If energy and industrial commodities continue to trend downward helping to anchor inflation concerns, which looks to already be taking place, this increases the odds substantially that the next move would be a rate cut.
Preferred industries include rails, construction & engineering, logistics, and construction equipment.
ArchiveThe Consumer Staples sector is the second best performing index to date -- behind Health Care -- having gained over 8%. The performance over the last 52-weeks is even more impressive, rising nearly 20%. And while the staples continue to offer defensive qualities and a safe haven appeal in this manic market environment, our Market Weight rating reflects this outperformance, full valuations and the reversal in the dollar.
Staples heavyweights like General Mills (GIS), Kellogg (K), and HJ Heinz (HNZ) have faced considerable challenges this year from declining consumer spending to ramping raw material costs. To date, producers have been able to pass through cost inflation through pricing gains. A 20x trailing earnings multiple reflects the group's performance as many industries suffer from a lack of pricing power.
Mutinationals have also benefitted from a weak dollar, strong export demand, and an expanding global footprint. Some of our favored names in this category include globally diversified producers with strong brand equity. These include Coca-Cola (KO), Pepsico (PEP), Wal-Mart (WMT), General Mills (GIS), Procter & Gamble (PG), and Avon Products (AVP). These companies continue to capitalize on enduring growth with the global economy, particularly the emerging markets where companies are experiencing rapid growth rates and market share gains.
But while global market share gains will continue, the greenback will no longer provide the tailwind it has over the last few years. Furthermore, staples stocks are traditionally less cyclical and generate steady earnings growth. And as the economy eventually improves, money is likely to flow out in favor of sectors more sensitive to the ebb and flow of the economic cycle.
ArchiveLooking across the Energy sector, the destruction is far reaching as plummeting oil and natural gas prices have severed stock prices in half in a just over a month's time. What concerns us is commentary coming out of Wall Street and the popular press suggesting now is the time to buy Energy companies given the attractive valuations. For one, energy stocks have always been relatively cheap given their cyclical status. Two, one can't value an energy stock until a new price deck has been reached.
We've been recommending investors reduce exposure to energy since the end of June on fears the dollar's turn and real demand destruction would end its run. This is exactly what has happened with dampening demand expectations, coupled with a resurgence in the dollar has taken crude below the $117 per barrel. What is unknown at this point, is where oil will stop. Our forecast over the last month have been for a range of $115-$125 per barrel. Crude is already at the lower end of that range and we think, given the dollar's gains, could push crude even lower.
The key for buying energy stocks is not the price level in oil, but the trend. As long as the trend is down, equities will continue to face downside pressure. The key is stabilization. Once the trend changes and a new deck is established, energy stocks can be more accurately valued. Market participants are sure to try to bet ahead of this stabilization, but it's a risky endeavor, particularly given the sheer mass of money coming out of Energy and into other sectors like Health Care.
We continue to recommend not to fight the trend. At this point whether the new price deck is $120, $100, or $80 per barrel is anyone's guess. As we've long argued, this trade had become so one-sided (long crude, short the dollar) that its going to take time to unwind. The X factor here is geopolitical events and supply stoppages (i.e. recent events in Georgia, Iran, Nigeria, pipeline disruptions et al). For now, however, the bears are in full control.
Archive Incredibly, despite its defensive appeal, the Telecom sector ranks only second behind Financials in terms of worst performers to date as a confluence of issues cloud stocks. The cumulative 22.4% YTD decline in the S&P Telecom Services sector has been driven by the major carriers (Qwest -45%, Sprint -30%, AT&T -24%, and Verizon -20%), all of which have suffered severe selling pressure on concerns over competition, lagging DSL growth (possible broadband reaching saturation?), profitability, regulatory environment concerns, and constricting balance sheets. We think these issues have obscured growth prospects, which coupled with attractive shareholder value and growing demand for bundled services (driving revenues and margins), is why we are raising Telecom to an Overweight ranking. We would also point out a rebounding dollar has heightened investor interest in domestic sectors/industries like Telecom and networking services.There are a lot of cross currents within the telecom sector that have led to some confusion and investor disenchantment. There is little doubt consumers are tightening their purse strings, reducing demand for carrier services. Cost savings has further magnified the trend toward land line disconnections as consumers switch from a fixed to an all wireless home environment. This trend will continue for the foreseeable future.
Competition remains a primary concern, as well. Some companies are clearly better positioned than others. Cable companies, which we continue to argue will lose out in the end given their technological disadvantage (copper wire vs. fiber for the final connection), have been ramping their a la carte service packages to the detriment of the incumbents. Cable market share gains (Comcast CMCSA, Time Warner Cable TWC, and Cablevision CVC) could be behind slowing DSL growth rates. Both AT&T and Verizon reported diminutive broadband net subscriber additions in the second quarter. The other possibility provides little relief -- namely the fact broadband is reaching saturation. Through 2004-2007, broadband growth rose 22% per annum. The rate is expected to slow to 5% annually through 2011, according to Goldman Sachs.
Finally, one of the greatest reasons behind investor disillusionment is the current and future regulatory environment. There are many issues in play from spectrum allocation, frequency coordination, net neutrality, telephone rates, and interference. Foremost of which is the broadband spectrum, which will see a major change this February when television broadcasting switches from analog to digital. Also, this fall the two big bell companies, along with other telecom players, are expected to ask the FCC to simplify and/or cut intercarrier compensation payments. There are significant issues at stake and in an election year with looming commissioner changes, there is a lot of uncertainty which makes market participants very nervous.
Quite a considerable list of headwinds, but from our vantage point, we think the downside risk has been priced in. As such, we rate the sector as Overweight based on attractive valuations, growing demand for data transmissions from consumer devices, coupled with long-term growth from the ongoing rollout of bundled fiber-based broadband service offerings. AT&T and Verizon continue to roll out respective fiber networks, U-Verse and FiOS, with great success, particularly in Verizon's case. The primary issue, however, is the fact the vast majority of consumers still do not have access to the fastest broadband options. Therefore, cable companies are winning by default.
This competitive advantage will be short-lived. Cable companies will be left with second rate networks unable to compete with fiber networks built for services not even offered yet. Consider this: we've seen some estimates that predict current offered FiOS services only consume some 10-15% of the total network capacity. And while some contend with Verizon's large capex plans, they fail to see the bigger picture. Verizon is building out a network for next generation services. Forget the triple play, Verizon will deliver any content at any time (the basis for The Next Big Thing premise - Telecom Convergence) -- that's a strategic competitive shift that continue to allude investors focused in the near-term. Verizon, offering a dividend of 5% and earnings growth of 11%, trades at 13.6x trailing earnings -- a 47% discount to the market multiple. AT&T's dividend is 5.2%, which compares to an average 3.4% for the entire utility sector, and trades at 10.5x. We'd be scaling into positions (eyeing VZ in the low $30 range, T in the mid $20s.). As for Sprint, the company is at a significant competitive disadvantage and will eventually be acquired. Potential buyers include Google (GOOG), Comcast (CMCSA), SK Telecom (SKM).
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