PICKING APART THE MARKET
By WSS Research Team
4/14/2010 1:30:09 PM Eastern Time
By: Brian Sozzi, Research Analyst
I must admit that after a year of hearing the phrases "weak top line" and "challenged global end markets" in my meetings with leading CEOs, to now bear witness to indications of economic green shoots morphing into young flowers is tough to comprehend at first blush. Throughout 2009 it was pounded into the brains of investors and those on Main Street that the sky was falling on our economy and that business conditions were severely constrained, so excuse me if I still harness skepticism on our fruitful rebound. As Charles so eloquently put it earlier in the week, conditions on the ground should be even better; we should be clamoring for 1Q10 GDP growth above the 2.5% rate that I hear among industry contacts. After all, consumers are consuming frivolous goods once again and businesses are picking up fixed asset investment, resulting from the stimulus plan and easy money Fed policy. Professionally managed accounts, though worried about a correction in the markets, continue to put money to work in equities on the premise that the earnings recovery and potential for dividend increases and share buybacks will lend way to powerful total portfolio returns.
To commence earnings season, there has been very little indications to believe a sharp correction in the markets is looming around the bend. Aloca's (AA) revenue line did materially fall short of consensus, but management noted pricing power. Pricing power was absent in 2009. Intel (INTC) raised its gross margin outlook, which only happens if demand is outstripping supply thereby underpinning prices. JP Morgan (JPM) acknowledged a better trajectory for charge-off rates, something that is also unfolding at retailer Target (TGT). So although there are many concerns out there that could crystallize and derail this equities rally locomotive, visibility into second half earnings gleaned from the 1Q10 reports suggest the recovery investment thesis remains valid. Please take a moment to read the note I published on our website yesterday (
www.wstreet.com) on investing in the Dow 30; I believe it's a great read following the strong earnings releases from Intel and JP Morgan.
I recommended to our subscriber base last week keep a dutiful eye on the data emerging from China this week, which crescendos with the GDP report later today. According to the National Bureau of Statistics, home prices in 70 Chinese cities surged 11.7% year over year. Nationwide, prices were up 14.2% for new homes. Some of the provinces in the south of China had home price gains in excess of 50.0%; yes you read that correctly.
What is driving this boom, and as I see it bubble, is an influx of rural Chinese to urban areas to find higher paying jobs. Fiscal stimulus efforts by the Chinese government helped to raise fixed asset investment as a percentage of GDP to 46.6% in 2009 from 43.5% in 2008; can't blame human beings for trying to improve their living standards. New data is likely to show a big increase in ROA (return on assets) for new manufacturing faculties in China (11.4% in 2008). Non-performing loans as a percentage of the total for Chinese banks is still low.
Nonetheless, this type of growth is absolutely unsustainable and believe it or not, the Obama Administration's push for a yuan revaluation may cause the eventual bursting (and potentially an increase in our borrowing costs). If the yuan were to regain its peg to the dollar, commodities are likely to become cheaper (check out the charts of gold and silver recently) to companies operating in the country, thereby creating a scenario where more buying is done to support more infrastructure. More workers will get hired. More migration then occurs. Still higher home values ensue. See where I am heading with this rant? At some point all of this new capacity will be excess capacity, resulting in lower ROA metrics for companies, less fixed investment, worker layoffs, and an increase in loan loss reserves by banks. Is this down the line, quite possibly?
Railroads are on the Tracks
By: David Silver, Research Analyst
The railroads are considered a bellwether for the economy as a whole, and if the headlines out of the Association of American Railroads (AAR) are any indication, the economy may finally be turning that corner. Here are the headlines from the past three weekly carload reports:
* March 25, 2010 -
"Fourth Straight Week of Gains Reported on U.S. Freight Railroads
* April 1, 2010 -
"AAR Reports Carloads at Highest Weekly Level Since November ‘08"
* April 8, 2010 -
"AAR Reports Sharp Traffic Gains on U.S. Railroads for Most Recent Week"
This strength was reinforced yesterday after the closing bell when the first freight railroad CSX Corp. (CSX) released operational results for its first quarter of 2010. Volumes increased about 5% and pricing power returned. Automotive shipments increased almost 80% year over year, which shouldn't come as much of a surprise as Chrysler and General Motors were idling plants left and right to try to stave off bankruptcy and the "healthier" automakers such as Ford (F), Toyota (TM), and even Honda (HMC) were slashing production to meet the anemic levels of demand.
One of the most important commodities that the rails ship is coal, and while volumes were down almost 15% year over year, management expects there to be volume growth for 2010. Natural gas prices are extremely low so that could take some of the demand out of the market (as utility companies utilize natural gas in lieu of coal); however, demand from overseas, specifically China (as Brian mentioned above) and India remain extremely strong.
Perhaps the best tidbit we got from the company's conference call was the labor situation. Management indicated that in target areas it's hiring back many of the workers that were laid off over the past year, and some cases even hiring new workers to meet the jump in demand. There are other areas that have remained weak; however, the company expects hiring to increase as a whole for the entire year. So all of this talk about jobs (and the billions of dollars spent to make these) may finally be helping, but management alluded to the fact that it was normal private business action instead of the help of the government. Over the past three years, the rail industry has invested more than $40.0 billion into improving and expanding its infrastructure. Talk about shovel ready jobs.
Holes in the House?
By: David Urani, Research Analyst
There has been some poor housing data recently, and despite the bad news, housing stocks, like the rest of the market, have been fighting through it. Yesterday, Integrated Asset Services (IAS) issued its home price index. Although it doesn't carry the same weight as the Case Shiller index, it comes to us much earlier. The report for February was, once again, weak. Nationwide, prices fell by 0.6% in February according to the report, representing its lowest level since March 2004. Prices in the Midwest and the Northeast actually increased by 0.8% and 0.2%, respectively, while prices declined by 1.4% and 0.9% in the South and West, respectively. Once again, as we have been seeing in the Case Shiller reports lately, prices in California have actually been on the rise, presumably on bulk foreclosure sales. Meanwhile, the likes of Boston, Chicago, Miami, and Washington, D.C. remained in a downtrend. The IAS data is not adjusted like Case Shiller, so it takes into account more immediate price swings. Therefore, it may not be indicative of a trend. However, it's just one more clue that points to the possibility that we are in the middle of another housing dip.
That takes us to this morning's mortgage application report. Applications fell by 9.6% week to week. Purchase applications fell by 10.5% and refinancing fell by 9.0%. The drop is likely related to rising premiums on FHA insurance. The good news from the report is that 30-year mortgage rates actually decreased to 5.17% from 5.31% week to week, despite the Fed's recent withdrawal from mortgage security purchases. Nevertheless, applications have been in a fairly strong downtrend for approximately a month now and give us little optimism.
-In other housing news, WaMu execs were grilled today by the Senate during the first day of their "Wall Street and the financial Crisis" hearings. As you can probably infer from the title of the hearings, the Senate is out to get the fat cat lenders, and not without good reason. The Senate accused WaMu of creating a "mortgage time bomb" with subprime lending and with more wordiness and less directness, the WaMu guys essentially backed up those accusations. Not that we didn't know this already, but this hearing is likely the beginning of the assault on the lending industry and the lead-in to a newly reformed industry. In fact, the top story on WhiteHouse.gov today concerns a new plan for financial reform. By my observation, here's what I think we can expect from the mortgage side of financial reform:
* Consumer protection (a.k.a. regulated mortgage underwriting standards and "plain English mortgages")
* Limits on the pooling and trading of mortgage securities
* Requiring lenders have some of their own money invested into their own products
But most importantly.....
* Government takeover and reform of Fannie Mae and Freddie Mac
Hydrocarbon Gushes
By: Conley Turner, Research Analyst
The price of crude is trading up today as the dollar index is on the decline versus a basket of other international currencies. Crude oil is denominated in dollars and becomes less expensive for foreign investors when the value of the greenback decreases. As a result, demand for oil increases resulting in the rise in its price.
This decline in the dollar today comes on the expectation of improved earnings results for the banking and technology industries. The upbeat expectations for earnings suggest that both the global and domestic economies are improving and will ultimately lead to more increased demand for oil. This sentiment was bolstered by the most recent U.S. statistics which pointed to a 1.6% rise in retail sales in the previous month. As such traders and investors are demonstrating a willingness to sell dollars and acquire riskier assets such as commodities.
In addition, the weekly crude inventory report by the U.S. Department of Energy indicated a 2.2 million barrel decline in crude oil inventories. This is in contrast to the market expectation for a 1.6 million barrel increase. The fact that crude supplies are actually lower than the prior week is acting as a supportive factor for oil prices. Many market participants have felt that the recent rise in oil prices was due largely to technical trading. This latest result suggests that supply/demand factors are beginning to gain traction and would make any rally from here more sustainable.
The SOX have Come Off
By: Carlos Guillen, Research Analyst
Overall all tech shares have been performing well during this morning's trading session. The chip sector, as measured by the Philadelphia Semiconductor Index, has increased 12 units to 394, representing a 3% rise from Tuesday's closing price and reaching a new 12-month high. Some of the companies that are driving the index into the green are Intel, Linear Technology (LLTC), and Kulicke & Soffa (KLIC).
As we had expected, the improving economic backdrop around the world and strong demand for PCs led to a blowout quarter for Intel. First quarter revenue was simply phenomenal. Strong demand drove revenue to $10.3 billion, topping the Street's $9.8 billion estimate and management's $9.3 billion to $10.1 billion guidance range. Revenue was sequentially down 2.6%, but the seasonal pull down should have been about 8%, so the result defied seasonality. On a year over year basis revenue grew by 44.1%; however, this was mostly due to the fact that the year ago quarter revenue represented a trough that was affected by the macroeconomic slowdown. What is very encouraging is that the better than expected revenue was fueled by end-demand, and inventory replenishment only played a smaller role. In fact, channel inventories remained flat and are still lean. Intel's management team is bar none, and it continues to improve cost of goods sold and overall operating expenses, leading to a record high operating income.
Also contributing to the tech sector strength is news from Linear Technology as it reported financial results that blew past the Street's consensus estimates. The company posted earnings per share of $0.44 on revenue of $311.0 million, while the Street was only expecting earnings per share $0.39 on revenue of $279.0 million. Also encouraging was that the company expects to grow revenue sequentially in the June quarter by 7% to 10%, which is very impressive considering the already strong revenue level and the fact that the June quarter is a seasonally down quarter.
Shares of Kulicke & Soffa are up more than 19% as the company announced a top line guidance update that was significantly above the Street's consensus estimate. KLIC raised its revenue guidance to $205.0 million from its prior guidance range of $140.0 million to $150.0 million. The Street was expecting revenue of approximately $146.0 million, way under the new guidance level. Apparently, unprecedented demand for both ball bonders and wedge bonders have led to strong top line growth, and more encouraging is that management expects this trend to continue in the September quarter.
We believe that revenue growth will continue well into 2011 as the company ramps up sales of its heavy-wire wedge bonders (from its Orthodyne acquisition) and die bonders. Demand for power management component, which use heavy-wire wedge bonders, stand to boost revenues for KLIC as power efficiency becomes more and more critical. Longer term, the company also stands to benefit from a replacement cycle of its bonders, which is likely to begin in 2011.
All in all, it is becoming apparent that this earnings season is going to be much better than expected for the tech sector.
