WAVETECH ENTERPRISES, LLC
Private Account Wealth Management Services
Newsletter Issued 05-09-07:
By: John T. Moir
Chief Editor: Clare Mc Kendrick
Position overview . . .
Our previous newsletter, dated April 16th, stated that the recent stock market advance as been in anticipation of lower than expected first quarter earnings. This proved to be the case, as earnings came in averaging around 7.7%, compared with a forecasted level of 3.4%. We projected the DOW to have a trading range for the month between 11,950 and 12,735. The release of stronger than expected first quarter earnings elevated the major stock indices, resulting in an actual DOW trading range for the month between 12,324 and 13,162. The reasons for this extended rally are further addressed later within this month’s newsletter.
The US dollar was anticipated to find some technical support, with a euro fx equivalent trading range for the month between $1.33 and $1.36. We further expected this renewed interest in the US dollar could be purely a technical bounce from an oversold condition. The US dollar produced an actual trading range for the month between euro fx equivalent of $1.3362 and $1.3706, fairly closed to our projected range.
The US treasuries were projected to be price-supported, with a forecasted peak yield for the 10-year Note at 4.75%, as the US economy continues to slow. We saw the 10-year Note have an actual yield range for the month between 4.64% and 4.76%, as further economic data confirmed the slowing of the US economy.
Looking forward . . .
The proof of the continued slowdown in the US economy arrived this past Friday morning in the form of another poor employment report, in which only 88,000 folks were added to non-farm payrolls in April, the fewest in any month since November 2004. The unemployment rate ticked up by 0.1 percentage point, to 4.5%, which actually understates the true overall weakness.
The household survey, the one used to calculate the jobless rate, showed that 892,000 folks were estimated to have dropped out of the workforce. The jobless rate cannot count a person as unemployed, if they are not out actually seeking employment. Therefore, the jobless rate would have been up 0.2 percentage points, to 4.6%, if the non-job seeking unemployed had been counted.
Restaurants and health care continue to account for the bulk of the new jobs. These sectors, over the past year, have represented 16% of the overall employment, and accounted for 37% of new jobs added. Meanwhile, the housing downturn was apparent, with construction jobs falling by 11,000 and finance jobs by nearly the same amount.
The only positive aspect of the employment report was that growth in average hourly earnings has slowed markedly to just a 3.7% annual rate, which could reduce the Federal Reserves continued concerns of inflation, at least for the near-term.
CONCERNS WITH STOCK BUYBACK’S, M & A’S, AND LBO’s CREATING ARTIFICIAL GROWTH:
Investors like when companies buy back their shares of stock, since it indicates that management thinks the stock is cheap, that the company has excess cash, and is reducing the number of shares outstanding — adding to the scarcity or equity shrinkage effect.
American companies have been repurchasing their stock to the tune of $628 billion of US shares, since September 2005. February of this year was particularly active, with $55 billion in share buyback’s.
The current magnitude of equity shrinkage (buyback’s) has not been seen in the past 16 years, which can be construed as a bullish sign. However, stock buyback’s also juice earnings-per-share (EPS) growth artificially.
In 2007, the EPS for the S&P 500 is expected to slow from the fat 16% last year to about 5%. This is well known, but what many investors probably do not realize is that buyback’s make up the bulk of this year’s punier growth.
We would estimate that 3.5 percentage points of that 5% — seventy percent — is due simply to a lower share count, or a lower denominator, not higher profits. Short-term, buyback’s are investor friendly, but is not a commitment to the longer term. Ideally, we would prefer to see this excess cash being used to raise dividends.
A dividend increase better aligns management’s interest with shareholders’. The market knows that EPS increases are declining, but does not realize that the total amount of earnings available for shareholders is decreasing.
This suggest that future profit growth could be minimal, if most of the EPS rise comes from lower share count. Sales gains have been less than impressive, even though there have been a number of positive surprises from the S&P 500 companies reporting their first-quarter earnings.. Companies are “beating” the bottom-line expectations but only “meeting” the top line.
The market knows American companies’ EPS growth is weakening, and has disregarded that or has decided it is simply not that important. The diminishing quality of growth will eventually have to be accepted by American companies, which will lead to the next stock market decline.
In addition to all of those share repurchases, the merger-and-acquisitions (M&A’s) and leverage-buyout (LBO’s) boom of the past few years has taken plenty of stocks out of circulation. Last year, for example, US M&A deals jumped 21% to $1.45 trillion, with about a fifth of those being LBO’s.
The equity was not destroyed, but simply changed into another form. Those LBO firms will have to eventually sell that equity back to the public through initial public offerings (IPO’s), to realize their true investment return.
The current LBO boom will create a subsequent explosion in initial public offerings, pushing lots of new stock from debt-laden companies onto the market. Future returns will inevitably be lower, when investment dollars rush in one direction, in this case toward private equity.
There should be a mountain of new equity coming to market soon, since the M&A boom begun in earnest a couple of years ago, as private equity firms that bought out companies in 2004 and 2005 begin to recoup their investments through IPO’s.
The returns for private equity firms could suffer, if there is no appetite among investors for these newly offered shares in the coming months and years.
There appears to be plenty of appetite and cash for new issues now, but the wall of potential stock issues from heavily debt-laden companies is getting higher and higher every day.
Long-term conclusions and current month expectations . . .
The stock market of late has been powered by too much available money, the global mania, and a huge number of better-than-expected corporate profits, even as the growth of Gross Domestic Product (GDP) has slowed to 1.3% in the first quarter — its worst showing in four years. The money has come from the usual suspects: the private-equity funds, the hedge funds, the banks and the Federal Reserve, not necessarily in that order.
The mania can sometimes feed on itself: The rise in stock prices tends to generate still-higher stock prices, and so on — until one day, the process goes into reverse for reasons as unannounced as those that triggered it in the first place.
First quarter earnings’ reports of the companies that make up the S&P 500 Index are likely to be up by some 7% over last year’s opening three months, or more than double the gain anticipated by the Street.
There is, however, less to that 7% gain than meets the eye. A big chunk — maybe as much as 40% — is contributed by the vagaries of foreign exchange, a gift of the weak US dollar. This weakness within the US dollar may remain for a long time, but at least for the near-term, it could bounce from an oversold condition, resulting in a euro fx equivalent trading range for the month between $1.34 and $1.37.
We think the US economy will slide into recession, as the drag from housing and the burden of unprecedented consumer debt make themselves increasingly felt. The US dollar could continue down the slippery slope, complicating things for the Federal Reserve and inducing stagflation — a slowing US economy with rising interest rates.
The US over-leveraged, overheated, over-hyped market could blow itself out and touch off a chain reaction that could affect globally as well. This could all happen, if not tomorrow, then in the very near future. We are anticipating a DOW trading range for the month between 12,750 and 13,370, as the major stock indices begin returning to proper valuation levels.
The action within the stock market that we have witnessed recently is the exact mirror image of the later part of 2002 and early 2003. The stock market, during that period, just kept declining as the economic data was turning upward. Eventually the stock market followed the US economy and we embarked on a four-year cyclical market advance.
Things have now been turned inversely. Investors, in the winter of 2002 and the spring of 2003, seemed oblivious to such enticing bullish signs of a less than 2% fed funds rate and the nascent recovery in the US economy. Today, they seem oblivious to any number of significant negatives as they bid equities up to new highs, among them: downgraded growth prospects, a newly subdued consumer, the remorseless weakness in housing, and higher oil prices.
The various technical indicators, sentiment, merger and acquisitions, along with liquidity can only advance the stock market so far — especially with margin debt up 32% over a year ago. The US economic backdrop inevitably prevails, as we saw four to five years ago in reverse.
The Federal Reserve met today for their Federal Open Market Committee Meeting (FOMC) and decided to leave the fed funds rate at the prevailing level of 5.25%. They recognize that the US economy is slowing, but remain concerned with the elevated level of inflation, and are not prepared to lower interest rates until they are convinced that it is well-contained.
The conditions for stagflation — a slowing US economy with growing inflation — still persist and could place the Federal Reserve in a very awkward position, at least for the near term. The US treasury 10-year Note could see the yield remain above 4.62%, resulting in lower US treasury prices, due to these continued concerns of growing inflation.
SUGGESTED INVESTMENT ALLOCATIONS:
1. A 75% to 85% allocation of their taxable ordinary funds and/or tax-deferred funds into a conservative as well as flexible investment strategy using various no-load index mutual funds and exchange traded funds (ETF’s) offered through our Wavetech Enterprises’ Private Account Wealth Management Services. The minimum investment criteria are determined after reviewing the investor’s current assets and fund allocations. These services are ideal for individuals, trusts, foundations and privately held corporations that have large stock, bond and/or real estate holdings and are seeking an active management service to generate a long-term average rate of return on investment between 15% to 20% per year (after fees) through either a rising or declining stock, bond or real estate market.
2. A 15% to 25% allocation toward cash, Treasury bills, CDs or money market funds with short maturities which will allow investors to rollover these instruments and obtain a higher level of return as interest rates move higher.
If there are any questions regarding the information discussed within this newsletter, the investment allocations mentioned above or our unique management service, please call the number provided below or e-mail us and we would be happy to provide further clarification.
John T. Moir
Worldwide Investment Manager
Wavetech Enterprises, LLC
Phone: (775) 841-9400
Acknowledgements: Federal Data, David Rosenberg, Economist, Thomson Financial, International Strategy & Investment Group (ISI), Matt McCormick with Bahl & Gaynor, Christopher Zook with CAZ Investments, John Goetz with Pzena Investment Management, Liscio Report.
Note: These newsletters have no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. These newsletters are issued for informational purposes and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. These newsletters are based on information obtained from sources believed to be reliable, but are not guaranteed to be accurate, nor are they a complete statement or summary of the securities, markets or developments referred to in the various newsletters. Recipients should not regard these newsletters as a substitute for the exercise of their own judgment. Any options or opinions expressed in these newsletters are subject to change without any notice and the Wavetech Enterprises, LLC newsletters are not under any obligation to update or keep current the information contained within. Past performance is not necessarily indicative of future results. Wavetech Enterprises, LLC and its newsletters accept no liability for any loss or damage of any kind arising out of the use of any or all parts of these newsletters.