Earnings And Guidance At Odds With Economic Data For Yield Hungry Investors Bristol Myers May Have The Cure

Grand Street Advisors

Market Snapshot

July 2010



The market and economy seem to have collectively limped into quarter end and the half way mark on the calendar. The recovery remains in tact, albeit the strength and durability have come into question. The main culprits causing this bout of agita remain the same, housing and employment. With the home buyers tax credit having expired we witnessed a thirty percent drop off in sales. Obviously, the credit had pulled forward some future sales. Unemployment, as captured by the non-farm payroll numbers dropped by 125,000 and the unemployment rate dropped to 9 ½%. These figures were nothing to smile about. However, viewed in context and with a wider lens, on a three month basis, we see job growth trending higher. As well, using that same lens we can see a bottoming of the home sales numbers and stabilization in the rate of home price declines. Looking at these numbers on this basis makes sense since in a recovery, history suggests and it is playing out right now, any recovery will be uneven. Now, should the weakness in both indices carry forward, this obviously would be worrisome and bears watching closely. For, now market participants are taking this current market weakness to begin snapping up oversold equities. The flight to safety, or the fear trade which drove ten year treasury yields to 2.95% and 30 years bond yields down to 3.87%, is beginning to unwind with both popping up above 3% and 4% respectively.



The Artificial Intelligence(AI, not Allen Iverson you basketball fans) amongst the financial community continues to proclaim short term rates as controlled by or influenced by the Federal Reserve as artificially low or depressed. It is coming close to the point in time to concede this hypothesis as flawed. Fed funds at zero appear to be exactly where they need to be, for an “exaggeratedly extended period of time” (new phrase to look for at next FOMC meeting). Propping up the economy with free money may be necessary throughout 2010 and into 2011 and beyond. Thus far the Federal Reserve has helped reliquify and recapitalize the banking system by allowing them to borrow at virtually zero (think about your CD’s, checking and savings accounts) and lend out at 4 ½% at a minimum ( mortgage rates). While the costs to borrow for consumers are at generational lows, borrowing has not been as brisk as one would anticipate. One solution, collapse spreads further (Rates charged - Cost of acquisition) now that bank balance sheets are healthier and well capitalized. While 4 1/2 % on a 30 year mortgage appears and is, inexpensive by historical standards what effect would 4% or 3 ½ % rates for the housing industry let alone small business have? Why can’t rates drop there? Can this happen? Of course. I offer it should happen and now. A bit of prodding by the Federal Reserve Chairman could get us there tomorrow. Washington has its hands tied now with an election year amid mounting pressure for debt reduction and not another round of spending, excuse me stimulus. The economy is in a process of coming about. Finally. It will take a while, but it certainly has begun. It requires a bit of priming the pump. Targeted tax cuts would go a long way, but there is no consensus on this front. Once again, during this crisis it may fall on the shoulders of Chairman Bernanke to do the heavy lifting. Spreads need to collapse from the bare minimum four percent closer to two, two and a half. With the cost of funds so cheap we may once again spur small business lending and accelerate consumption along the way. Banks will need to revert back to prudent lending standards, which has already begun. These lower costs of funding should encourage home buyers to get off the sidelines and soak up some of the current bloated inventories of unsold homes. This would further help to stem the deflationary tide dragging down asset valuations and the ensuing negative wealth effect on consumers.



Looking forward we must keep a global perspective. The US market was held hostage by the near collapse of the Eurodollar and questions surrounding the capital reserves of large European financial institutions. The recently announced bank stress tests should help alleviate some of these concerns and promote a round of capital raising for financial institutions in need. The results of those tests will be made public later on this month. We may experience some market jitters as those results are anticipated and/or leaked. The US expansion is not alone as China and India economies continue to expand at rates in excess of 7%. Recently released data show job growth gaining traction in Korea, Australia and our neighbor to the north Canada. Being that a good part of our economic recovery game plan is based upon an effort to double our exports this is very positive news.



In closing investors still scarred from the 2008 near collapse of all markets had their band-aids ripped off along with a bit of the scab by the flash crash. A sell first ask questions later mentality re-emerged. Valuations currently look very attractive, but there was some technical damage inflicted upon the charts so caution prevails. This earnings season, about to kick off next week, most likely will determine the direction of the markets for the remainder of the summer. Revenues and earnings should once again beat estimates handily. This time it will be all about the guidance. CEO’s may need to walk the tightrope here. Overly cautious or pessimistic guidance and stocks will get pole axed. However, investors will want and expect a true assessment of the current business environment and end user demand. My sense, based upon conference calls and independent research reports, is we’ll get a modestly positive outlook, which, due to the selloff in June, should be enough to introduce a positive bias to value and income seeking investors. However, I must note there is some concern brewing in the divergent paths CEO guidance has taken relative to recent economic releases. Guidance has, thus far been quite favorable for the most part, while economic data point to the economy heading towards a stall.



We’ll continue to monitor copper, charts, markets and economic releases for a clear signal to either become more defensive or to more fully engage the markets.



For investors seeking an alternative to treasuries, we look to Bristol Myers and the attractive 5% yield it currently sports. The company has a robust pipeline that should help eleviate some of the pain of existing drugs coming off patent protection. The dividend is well covered with cash flows and patient investors can collect the income while awaiting the pipeline to mature.