Thursday, October 27, 2011

Happy Days

Third quarter GDP came in at +2.5%.  That was +2.5% higher than Benjamin Bernanke's prediction as he launched "Operation Twist," his latest brainchild for rescuing the economy.  The figure would have been even higher except for an inventory contraction, which might have stemmed from the Fed Chairman's view itself.  If inventories had stayed unchanged the September quarter GDP gain would have been +3.6%.  The data are preliminary and could be revised.  The basic message is unlikely to change, though.  Modest expansion probably will persist into the December quarter, fueled by solid retail spending and the seasonal holiday push.  Inventory re-stocking may provide additional impetus.  Whether the uptrend will prove sustainable, or at least sustainable enough to justify the recent burst higher by the equity market, that's less certain.

Most economists now have dismissed the possibility of a Double Dip recession.  Their complacency could be premature.  Economic activity in the U.S. may have improved a little over the summer.  But serious structural problems remain.  Productivity has suddenly taken a turn for the worse.  Output per worker rose sharply after the recession originally struck in 2008.  For whatever reason the rate of improvement has hit the wall of late.  If the trend keeps up that will put pressure on profits or wages, maybe both.  Much of the latest improvement in consumer spending came from savings, not expanding income.  External inflation is turning higher, as well.  Petroleum supplies grew tight after the Energy Department ended its program of releasing strategic supplies into the market.  And while the industry would love to expand drilling a thicket of government roadblocks remain in the way.  Foreign producers scaled back over the summer as the government supplies flooded the market.  The vaccuum is being filled but prices remain 20% higher.  A wide range of other commodities are selling at elevated heights, too.  For the moment investors may leave those markets alone and focus on stocks and bonds.  Speculative money could shift over to commodities, though, amplifying the uptrend.

The combination of rising prices, lower personal income, and government austerity measures could stall the recovery all over again.  Unemployment stands at 9.1% and threatens to increase.  The Administration is attempting to pass a Jobs Bill to offset the spending cutbacks likely to emerge from the Super Committee later this month.  That proposal resembles the "Single Wing Offense" that once ruled the day in the NFL but grew obsolete decades ago.  Even if it were pass it wouldn't move the ball in today's economy.

A more pro-active game plan is needed.  The details are negotiable.  But a number of key elements are essential if 4%-6% GDP growth is going to be reestablished.  That's the rate the country needs to lower the unemployment rate, boost personal incomes, create a more dynamic business environment, narrow if not eliminate the budget deficit, and keep inflationary pressures under control.  Lower marginal taxes, less government regulation, greater personal freedom . . . .  There's quite a list of things that could do the job.  At this point it's largely a matter of competing foolishness in Washington, so gridlock might not be the worst thing in the world.  Let's hope the politicians eventually take a page from the emerging growth companies we focus on here and concentrate their fire on new business formation and growth.

The Dow Jones Industrials are up nearly +15% over the last two months.  We advised a fully invested posture back then, figuring the market's ultimate downside risk was -10% at most.  That target hasn't changed.  So today downside risk is more like -25%.  And the day of reckoning hasn't moved, either.  The basic variables are the same as before.  Europe won't destroy its banking system.  But it probably will slip into a recession as the recent bailout's austerity program kicks in.  China continues to slow.  And while the U.S. did enjoy a burst over the summer it's economy remains out of balance.  Government stimulus is off the table due to the extreme debt load already in place.  And a private sector stimulus isn't likely to happen due to political reasons.

A Double Dip recession could emerge in 2012.  Our advice is to remain invested in core positions.  Take advantage of the recent rally to accumulate a cash reserve to use in the future.

Walter Ramsley
Executive Editor

Saturday, August 13, 2011

Scary Days

The stock market has pulled back sharply over the past few weeks.  Wild up and down trading signals a major division of opinion among investors.  Chances are both sides are right.  The next few weeks is anybody's guess.  But looking a little farther out, where fundamental variables will be able to exert their gravitational pull on stock prices, the picture seems clearer. 

Benjamin Bernanke and most mainstream economists remain way off the mark.  Conventional theories haven't begun to explain what's taken place since 2006 and there's no reason to listen to them now.  The conventional analysis predicts 3%-4% GDP growth in the U.S. over the last six months of 2011 with further gains next year.  That's not going to happen.  But a major disaster isn't in the cards, either.

The European Central Bank is well positioned to prevent a financial meltdown.  Its bond buying and other support measures will impact economic growth, because the price the Bank is extracting is austerity measures.  If Italy, Spain, Ireland, and the others don't achieve the milestones the Bank has set out as a condition for its support, the support will be withdrawn.  So there's a high likelihood of compliance.  But that will bring down economic activity in the short run.  Japan isn't bouncing back in a big way from the earthquakes, either.  So that's not going to pick up the slack.  And while China has maintained momentum to date it's exports are bound to moderate, which could put the brakes on its import growth as well.

In the United States a downturn began in Q1.  Bernanke and crew didn't anticipate that and now say a rebound will emerge in Q3.  In truth, even slower growth is on the horizon.  The budget deficit negotiations are likely to keep a lid on fiscal stimulus.  And the Federal Reserve is out of ammunition when it comes to monetary tricks.  By the first quarter of 2012 GDP growth could slip all the way to zero, sending unemployment up to 10%.  West Texas oil prices could drop another $15 a barrel to $70.  Personal income could flat line.  Corporate earnings probably will contract despite the management heroics which have kept performance intact so far in the recovery.

A decline to 10,000 on the Dow Jones Industrials is possible.  The average might not go that low, considering the cash and other balance sheet assets that are in place.  But investors should be willing to ride out a move to those levels if they want to stay in the game at this point.  The high potential growth stocks we focus on in Growth Stock Insider might be dragged down with the pack.  But their earnings power is likely to continue rising while much of Corporate America slows down, creating even greater investment opportunity.

Downside risk appears manageable at current market levels.  The payoff for staying in the market could come in 2012.  The economy itself probably will take some time to really get rolling.  But there appears to be an excellent chance that lower corporate tax rates will be one result of the deficit commission.  That could be the rocket fuel the economy and market needs.  Once things start moving in a positive direction, moreover, consumer spending should pick up with the lower gasoline prices, cheap interest rates, and a pile of pent-up demand.  Corporate cash reserves will go to work.  A repatriation scheme could amplify capital spending by allowing companies to bring foreign earnings home at little or no tax liability.  And by then it's possible the housing market may start to clear in much of the country, boosting mobility and freeing up a lot of skilled workers who today are stuck where they are.

External factors could disrupt the rebound.  Global warning is getting worse and could cause unpredictable disasters.  Seismic experts are bracing for a major earthquake along the U.S. West Coast.  A war in the Middle East could start, not necessarily including Israel.  Putting that stuff aside, a fantastic buying opportunity could be in the making.  If you want to try and time the market, go ahead.  But it's tough to buy when the headlines scream trouble.  It's never as easy as it sounds.

Our advice is to remain invested in the type of high performance growth stocks we highlight in Growth Stock Insider Plan to start using the cash reserve we built up in the spring.  Valuations already are reasonable.  The long term outlook is tremendous.  The rate of return on technology already is improving and could skyrocket over the next decade.  Most investors today are afraid of the future, and stock prices reflect that.  It would be great time to be an optimist even if prices were high.  Things are going to be great.  The fact you can buy that future at a discount, well, can't beat that with a stick.

Walter Ramsley
Executive Editor


Thursday, July 7, 2011

Lower Corporate Tax Rates

Former President Bill Clinton approved the idea of reducing corporate tax rates to 25% in a televised interview last week.  That cut would be offset by the elimination of special interest tax deductions, leaving the immediate impact on Government revenues unchanged.  The measure actually might be enacted as part of the debt ceiling negotiations that currently are underway.  The deal could be structured so that both political parties could claim victory.  The American economy probably would benefit, too, by the more transparent and equitable system, and the lower marginal tax rate. 

Growth companies promise to be the biggest winners.  Most fast growing corporations pay cash taxes equal to the posted rate.  Larger, slower growing operations typically are the prime beneficiaries of tax dodging maneuvers.  The way things are set up now the Government effectively is draining cash from companies that earn the highest rates of return and subsidizing those with the lowest. 

The new approach, if enacted, would start to reverse that.  It also could provide a stock market jolt to the types of fast growing companies we focus on in Growth Stock Insider.  Earnings could rise 15% right off the bat due to the lower tax rate.  The availability of more cash to re-invest also could accelerate future income gains, perhaps causing P/E multiples to widen.

It remains to be seen if a deal will be made.  Things seem to be moving in that direction, though.  The overall stock market could gain as a result.  Growth stocks have the potential to make the largest moves.

Walter Ramsley
Executive Editor

Saturday, May 21, 2011

Tinkle Down Economics

The United States economy reduced speed in the March quarter.  That was unexpected because the Federal Reserve was in the middle of a gigantic money printing operation ("Quantitative Easing - Part Two") which should have drawn idle resources back into productive use.  It also marked the culmination of two years of fiscal stimulus that drove the Federal budget deficit to $1.6 trillion, an unprecedented 11% of the nation's GDP.  Together those moves should have led to an acceleration in real growth, on the order of 4%-6%.  In reality the Q1 figure came in at 1.8%.  And a full percentage point of that was an inventory build-up that counts in the statistics, but didn't happen on purpose.  GDP growth might be impacted in Q2 as inventories are worked back down to normal levels.

The international economy is cooling off, too.  Benjamin Bernanke's money creation project wound up flooding Communist China with more cash than it could use, despite the fact it was growing at a 10% rate when the program started.  That amplified the Middle Kingdom's inflation rate, which already was climbing due to a free for all real estate market and rapid industrialization.  Interest rates and reserve requirements went up, putting pressure on a lot of marginal borrowers.  The United Kingdom also implemented tighter policies to get its house in order.  The European Union slowed down, as well, due to its uncertain debt situation.

The game plan should have been for the United States to take the lead at this stage.  The rest of the world was due for a breather.  It should be drafting off our recovery.  The stimulus spending and money printing of the past two years should be kicking in, boosting incomes, lifting employment, and driving down the budget deficit.  Regrettably, the Obama Administration squandered its opportunity.  Little of the pump priming cash was invested productively.  Instead of laying a foundation capable of generating recurring revenue and income growth most of the spending went into one shot bailouts, or just completely down the drain.  The Administration is laying the blame on bad weather, temporary inflation spikes, Japan's earthquake, and whatever other special factors it can think of.  Experienced investors know those excuses always are smokescreens for more serious problems.  A downturn is underway.  It remains to be seen if it will affect the stock market.  But a cautious approach is warranted under the circumstances.

Our nickname for the Obama Administration's economic policy is "Tinkle Down Economics."  The U.S. Treasury and the Federal Reserve Board have flooded the capital markets with fresh money, paying face value with cash for securities.  Billions of those securities were impaired, moreover, so the sellers got a huge bailout in the process.  Additional bailouts supported various public and private unions, state and local governments, and huge companies dangling on the edge of bankruptcy.  None of that money went into venture capital, private equity, new business formation, incentives to help genuine growth companies expand faster, or anything that might have generated a high rate of return.  There was lots of big talk about "shovel ready" construction projects.  But in the end few of those got off the ground.  A variety of one size fits all housing market initiatives were implemented.  They didn't work because real estate is a series of local markets, all of which are unique.  The Administration could have spent resources going zip code to zip code in 2009 to stabilize housing, to get the problem under control.  Instead it redesigned the medical industry, boosting its share of GDP to 18% from 16% before.  (Europe has healthier people and pays 9%-12%).

Prices are rising faster than incomes.  All that new money has sent the Consumer Price Index up by 6% since January 2009.  Unfortunately for the average American, it hasn't helped wages.  Incomes are up just 1%.  The standard of living has declined by 5% as a result.  Unemployment still stands at 9.0% compared to 8.2%  when the administration took over.  The CPI hit 4.0% in Q1 (annual rate).  That measure may trend higher in upcoming periods.  No turnaround is on the horizon.

All that liquidity could keep the stock market afloat.  Business conditions won't be as vibrant as they should be.  And marginal companies no doubt will encounter problems, either diminished demand or rising costs.  But a wholesale decline in share prices isn't certain.  Our advice is to remain invested in a diversified portfolio of Special Situation stocks, with a cash reserve to take advantage of future opportunities.  The political scene may be a different story.  It will be interesting to see how long today's 20-30 year olds will accept having their aspirations thwarted.  For that matter, we'll see how long the 50-60 year olds being laid off every day put up with it, either.  At least with Ronald Reagan's "Trickle Down Economics" the rising tide lifted all boats.  With "Tinkle Down" the only things we're getting are higher prices, anxiety, and disillusionment.

Walter Ramsley
Executive Editor

Monday, February 21, 2011

Further Gains Possible

The U.S. stock market has advanced sharply since September 15, 2010, the day we began publishing Growth Stock Insider.  Back then economists were engaged in a lively debate; one side arguing the country was headed into a double dip recession, the other saying it wouldn't be quite that bad.  The experts also predicted doomsday scenarios in Europe, slowdowns in China and Brazil, and an onslaught of tariffs and protectionist measures.  Equity analysts on Wall Street dialed back their earnings and sales estimates to reflect the "New Normal."  Then, people started to realize it wasn't the end of the world after all.  Business was moving along, despite what the computer models said.  Third quarter financial results came in ahead of consensus expectations.  Corporate executives couched their forecasts to acknowledge the academic concerns, and the negative reporting in the media.  But the guidance they issued was positive, often better than the market anticipated.  Interest rates remained low, moreover, and the Government picked up the pace of its money printing operation, pouring liquidity directly into the capital markets with its Quantitative Easing II program.  The supply and demand for stocks almost had to tilt to the bullish side as the Government removed existing securities from circulation and replaced them with hot money.

The Dow Jones Industrials are up 17%.  The S&P 500 has climbed 19%; the Nasdaq Composite, 23%; and the small cap Russell 2000 has led the way, advancing a remarkable 28%.  The Nasdaq and the Russell have regained everything they lost since the last market peak in 2007.  The big cap indexes still have a ways to go.  The stocks that we've presented in Growth Stock Insider have appreciated by an even greater amount.  Assuming an equal Dollar amount was invested in each security, the group's performance is up by almost 50%.  And our average holding period is more like three months than five, since we wrote up the stocks as we went along.

The stock market is in an uptrend and could keep rising for an extended period.  The interest rate and liquidity dynamics remain unusually positive.  Business fundamentals continue to be robust.  And while investor enthusiasm for equities has improved, skepticism still abounds.  Confidence in the future remains a scarce commodity.   And rightfully so, when you get right down to it.  Money printing and borrowing isn't a sustainable strategy.  The flow of funds inevitably will reverse course, exerting pressure on stock prices.  There are bound to be some downs along with the ups in the future.  It needn't be a disaster.  But when the big picture turns south the general market averages are bound to be affected.  That's why we focus on small fast growing Special Situations that can produce exceptional results under all kinds of economic conditions.  Our advice is to stay invested in a diversified portfolio of emerging growth companies and not worry about the general market.

Walter Ramsley
Executive Editor