Category Archives: Strategy

thinking about 2013

May 31, 2012 By in Strategy, Current Market Thoughts, Constructing a Portfolio, Portfolio management, securities markets, stock market Tags: , , , , , , , , , Leave a comment

looking ahead

Today is the last day of May.  In a normal stock market year (let’s define “normal” as a time when investors are neither euphoric nor ready to jump out windows on high floors in tall buildings), this is the time when equity investors begin to ponder what the following calendar year will bring.

Why so early?  No extremely compelling reason.  It’s just the way it typically works.  Equity markets are futures markets, after all.  And by this time participants will have already discounted much of what the current year is likely to bring and are asking “What’s next?”.

not normal everywhere, but definitely normal in the US

Conditions are by no means normal all around the world.  Europeans are scared out of their wits by the politics/economics of the EU.  Pacific Basin markets are keeping a close eye on China, while hoping the battering they’re taking from European selling will soon end.  In the US, in contrast, the economy is entering its fourth year of recovery.  Employment is stable-plus, compensation for regular employees (as opposed to CEOs, who always pay themselves well) is beginning to rise, and the housing market–a key source of wealth–is showing its first signs of life since 2007.  While daily price volatility may be high and the shrill noises from talking heads may be particularly bearish, I think 2012 is a normal year.

therefore, time for pondering 2013 to begin

(You may argue that pondering season has already started, and point to the 8% decline in the S&P since its intraday high on April 2nd as evidence.  I don’t interpret the data that way, but you may be right.  If so, you should be more bullish than I am, since you think Wall Street has been factoring bad news into prices for longer than I do.)

a few numbers

Let’s begin with a back-of-the-envelope (which is the best you’ll get from me) calculation.  According to Factset, Wall Street is estimating earnings of around $105 for 2012, up from $97 in 2011.

Let’s say S&P 500 eps will reach $110-$115 in 2013, which is roughly the consensus.

based on 2012 eps

If the market could trade at 14x earnings, a target for the S&P based on estimated earnings would be 1470.

The 1422 high of two months ago was about 3% below that, giving new money absolutely no motivation to buy stocks.  That also meant short-term traders had a reason to bet against a further rise.

Yesterday’s close was about 12% below 1470, suggesting the US stock market may be on more stable ground.

…and based on 2013 eps

The same calculation gives a target range of 1540-1610 for the S&P based on my guess about next year’s eps.  Potential appreciation from yesterday’s close would be +17% to +23%.

If you want to say that the US stock market continues to trade at the current multiple of 13x eps instead of 14x, then potential appreciation would be +9% to +14%.

In a world of 1.6%-yielding ten-year Treasuries, and 2.7% thirty-years, either case looks pretty good.

clouds on the horizon

I can see three, all of them the obvious ones:

1.  slowdown in China   For what it’s worth, as macroeconomics I think this is old news.  Policy is already beginning to move in a stimulative direction.  However, it will take some time for the new policy direction to take effect.  This probably means weaker prices for industrial commodities–and for commodity-dependent stocks–as well as for negative earnings surprises for firms whose profits are strongly linked to Chinese customers.  So China does have stock market implications.  But they’re stock selection ones rather than market-moving ones.

2.  ”fiscal cliff” in the US    On January 1, 2013, the temporary federal payroll tax cut is set to expire.  So, too, is the extension of Bush-era income tax reductions.  Large mandatory cuts in federal government spending, triggered by Washington’s failure to come up with an overall plan for deficit reduction, are supposed to happen as well.

This combination is enough to send the domestic economy beck into recession.

The consensus view is that after the election, the lame-duck Congress will do something to soften the blow.  My guess is the consensus will prove correct, although an accident is always possible.

3.  implosion in the EU    This is the main concern of global stock markets.

To recap:

–The crisis has been going on for almost three years.

–Worries have been discounted in waves of selling over that time, the worst of which (I think) have been the one currently in progress and the previous one last summer.

–The general parameters of a solution have been well-understood for a long time.

–I think Greece being in the EU or out is a big deal for that country but for no one else.

–The end game is unlikely to be a Japan-like fading of the EU into irrelevance, which would be bad for Europeans but ok for world equity markets.  Unaddressed, an outcome more like the 1996-98 crisis in smaller Asian markets is more probable.

timing?

Evidence to date to the contrary, I tend to think that the worst won’t happen.  I’d feel better about markets if I thought I were in the minority.  But if I were, I think global equity prices would easily be 10% lower than they are now.

If I’m correct, the main imponderable is the timing of a solution.  What little I know (or think I know) about politics says that when resolving a difficult issue involves sacrifice, the problem must be seen as so bad that solving it–no matter what the cost–can be presented to voters as a victory.

Are we at that point yet with the EU?  I don’t know.  Martin Wolf, chief economist with the Financial Times, has a good summary of the state of play.

Were the EU to show it finally has the resolve needed to adequately address its financial woes, however, I’m confident that the higher S&P targets for 2013 mentioned above would quickly become Wall Street’s game plan.  And a mini-version of last year’s autumn rally would likely occur.

In the meantime, markets will likely drift.

a quick look at DIS

May 15, 2012 By in earnings conference calls, economics, Stock ideas, Strategy Tags: , , , , , Leave a comment

a little history

I became reacquainted with DIS in late 2009 when the company bid for Marvel Entertainment, which I had been a shareholder of for a couple of years.  Several things struck me about DIS that made the investment case more compelling than I expected:

1.  A new chairman, Bob Iger, was steadily reenergizing a company that had suffered for years under complacent and bureaucratic management, as happens with many mature firms.

2.  Although the price being paid, $4 billion, seemed pretty full to me, I knew Marvel would benefit from DIS’s stronger distribution.  And I also saw that Mr. Iger wanted to build the attractiveness of the Disney brand to boys, so Marvel had an “extra” value to DIS.

3.  The theme parks were suffering from the Great Recession.  I thought results would gradually improve as the economy recovered, first through an increase in foreign tourists, then through a return of US vacationers.

4.  Wall Street didn’t like the Marvel deal, which made DIS even cheaper.  So I bought some more.

I ended up selling most of my DIS stock about a year ago, soon after it popped above $40 a share.  Two reasons:  the stock was up a lot, and I worried that possible strikes by the NFL and/or NBA players would dent the profits of ESPN, which is DIS’s dominant business.

I’ve still kept my eye on DIS, which has been a market outperformer even after my sale.  The media reports of strong theme park business in 2Q12 (ended March 31st) when the company reported results last week caught my eye.  So I thought I’d take a closer look.

Here’s what I found.

DIS’s 2Q12 results

Excluding unusual items, earning per share were up 18% year on year, at $.58 vs. $.49 in 2Q11.

parks and resorts

Disney cruise line bookings were up 30% yoy.

Domestic theme park attendance was up 7% yoy, with spending per person up 5% in addition.

Occupancy in park hotels was up 2% yoy at 82%.  Room rates were up by about 5% as well.

Disneyland set a new 2Q attendance record.

The strength in the domestic theme park business comes from two sources:

–foreign tourists, especially from Latin America and Asia, and

–reviving interest from in-state residents in California and Florida.

Out of state domestic visitation to the parks was about flat, yoy.

Operating income from the worldwide Parks and Resorts business was up 53% yoy at $222 million.  The comparison is skewed by the closing of Tokyo Disneyland last year after the mid-March nuclear reactor accident in Japan, combined with a $15 million business interruption insurance payment made in the current quarter.  Ex these factors, the theme park business was probably up a bit over 20%.

To me, the most encouraging news is that residents of two of the areas hardest hit by the domestic housing crisis–southern California and Florida–are starting to come back to the Disney parks.

studio entertainment

Currently, this business is a tale of two movies.  John Carter, which may have made a $100 million loss, is certainly the main reason Studio Entertainment operating results dipped into the red by $84 million in 2Q12.  The other is The Avengers, which reportedly cost $220 million to make but which has had box office of over $1 billion in the first three weeks.  So 3Q12′s results in this segment will doubtless be eye-popping.

consumer products

Avengers-related merchandise sales are going much better than DIS had planned for.  A change of actors appears to have even breathed back life into the Hulk.

media networks

This segment is two-thirds of DIS’s operating income and is driven mostly by ESPN.  Changes in affiliate contracts and the differences in  timing/number of sporting events make year-on-year comparisons particularly hard for an outsider to interpret.  The reported you gain in operating income is 13%.  DIS says an apples-to-apples comparison would be more like half of that.

my thoughts

I find the implications for the US economy in DIS’s results to be encouraging–and consistent with what other companies who appeal to a broad range of Americans are saying.

DIS shares aren’t expensive.  They’re trading at 15x the Wall Street earnings consensus of $3.00 a share for fiscal 2012.  Trend growth is probably around 15% a year.  My guess is that they’ll be mild outperformers over the year ahead, with their best relative showing coming in uncertain days like these.

 


 

 

the April 2012 Employment Situation report

May 7, 2012 By in economics, employment, Employment Situation report, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , Leave a comment

the report–+115,000 net new jobs

Before the opening of stock trading on Wall Street last Friday, the Bureau of Labor Statistics of the Labor Department released its monthly Employment Situation report for April 2012.  According to the ES, the US economy added 115,000 new jobs last month.  That was made up of +130,000 net new positions in the private sector, offset by -15,000 layoffs by state and local governments.

While a reasonable performance, the figure was substantially weaker than both the median estimate of domestic economists (which was for a gain of around 160,000 new jobs) and the stellar performance of the winter months, whose gains comfortably exceeded 200,000 each.

revisions were positive

Job additions for February were initially reported as +227,000 (+233,000 for the private sector, -6,000 for the public).  That figure was revised up in the March report to +240,000 (+233,000 private, +7,000 public).  The final numbers, reported in the April ES, were revised up again–to +259,000 (+254,000 private, +5,000 public).

Job gains for March were initially reported last month as +120,000 (+121,000 private, -1,000 public).  The April revision boosted that figure to +154,000 (+166,000 private, -12,000 public).

Taking February and March together, April revisions boosted the number of net job additions during those months by 53,000 (+66,000 in the private sector, -13,000 in the public).

Wall Street was disappointed

Investors had been hoping that the April ES would reestablish the more favorable job gain trend of last winter, or at least show that the low reading in March was a fluke.  Arguably, the +34,000 upward revision of the initial March figures did that.  But all eyes–or at least those of short-term traders–appear to have been focused entirely on the current month figures instead.

As a result, the S&P 500 declined by 1.6% for the day.

why the slowdown in job growth?

Three explanations appear to be on offer:

1.  The US economy is doing the same thing it did in 2010 and 2011, lurching into a “seasonal” deceleration in economic growth.

2.  The unusually warm winter weather in normally cold regions of the US allowed an early start to what’s normally springtime work. Construction or home renovation, for instance.  This shifted job creation ordinarily seen in March or April into January and February.  If so, what we’re seeing now is temporary payback.  The real job growth trend is +160,000/+180,000 new positions a month.

3.  A third possibility comes from a Goldman report I’ve only read about in a Gavyn Davies blog for the FT. The idea comes from Okun’s “Law,” the suggestion that changes in the workforce move in line with the rise and fall of GDP.  In the Great Recession, argues Zach Pandl of Goldman argues, layoffs were much heavier than the fall in GDP warranted.  Similarly, during the recovery, job gains have been a lot greater than a tepid economy would justify.  However, we’ve recently reached the point where all the “extra” workers shed by companies during the downturn have been rehired.  Therefore, from this point on job gains will again move in lockstep with rises in GDP.  In other words, they won’t be much to write home about.

does it matter for investors?

For what it’s worth, I think there’s a small effect from warm winter weather in the ES data but the rest of the apparent weakness in March and April is a fluke–probably having to do with the seasonal adjustments Labor Department economists make to the raw data.

That’s not the important investment issue, though.  We all have to ask ourselves how much difference having the correct explanation for the April jobs figures makes for our equity investment strategy.  After all, we’re back to record-high levels of real GDP in the US even with a high level of unemployment.  The long-term unemployed are a political and social problem.  They aren’t necessarily a stock market one.

I can think of two ways in which interpretation of the ES results makes a difference:

–in the (unlikely, to me) case that the US economy is beginning to stall, or even to shrink a bit, a defensive stance is called for

–if there’s going to be negligible job growth in the US from this point on, then the strategy of 2009-2010 of emphasizing emerging markets and domestic firms that cater to the global affluent will likely be the right way to go.

Otherwise, the pattern of market action over the past eight months or so is going to continue–slow but steady outperformance by IT and by consumer discretionary firms that appeal to the broadest spectrum of domestic customers.

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