The first week of the New Year is in the record books.

The result is a gain based upon the outlook for strong corporate profits and an improving, but hardly robust global economy.

 

As the charts above illustrate, the Dow Jones Industrial Average gained .84% while the NASDAQ Composite jumped by nearly 2% to begin the year.

The Markets & Economy

As we noted last week, while the markets performed well in 2010, they did so despite the dismal state of employment growth here in the United States, and the continuing debt problems facing nation states, as well as every level of our own nation’s government.

Last Friday’s report on the employment numbers for December was quite simply disappointing as we had predicted last Monday. While the so-called unemployment rate fell to 9.4% the actual number of jobs created was just over 100,000. This number in theory should not have pushed the unemployment rate lower - and it did not.

Remember the unemployment rate also depends upon who is counted as being unemployed. For some reason our government showed nearly 300,000 people as no longer in the work force. They are still alive and they are still in need of income, but our government found some technical reason to no longer count them. As a result the unemployment rate fell, but it did so because people are giving up looking for jobs. This, of course, is the worst possible reason.

The proof of what I am discussing is shown in the graph below. It shows the percentage of civilians participating in the labor force. It has fallen off the chart. More and more people not only do not have jobs but are no longer even looking. Thus in many cases these people have become permanently beholden to various state and federal assistance programs such as the 43 million Americans who currently receive food stamps.

This is bad news for society and for our government finances.

On the other hand for investors, the news is much better. Strong corporate profits and improving balance sheets are allowing companies to engage in shareholder-friendly activities such as dividend increases, buybacks and merger activity. Thus the gain last week for the stock market despite the disappointment over the jobs number.

The outlook for the future of the economy remains upward. The latest from the Economic Cycle Research Institute shows the highest level of year over year growth rate since last May (see chart below). Consequently, the economy is improving, but not quickly enough to fundamentally lower the unemployment rate.

Accordingly, the New Year is beginning to look like 2010. The global debt problems of the European nations continue to grab headlines and will cause periodic episodes (like this morning) of market weakness, but stock prices are buoyed by low interest rates, strong earnings and a lack of other asset classes to offer serious competition.

What to Look for This Week

Unfortunately, many of the weak link European nations need to do some financing this week, and until their bond offerings are successfully placed, the global markets will be held hostage to fears of the Euro collapsing etc…

On the domestic front, the fourth quarter earnings season will begin this week including some of the bank numbers which could influence market sentiment.

Finally, later in the week, there will be updated reports on inflation, retail sales and industrial production. I don’t expect any of these to outweigh the items mentioned above as having an impact on the financial markets.

 

                                                                                             SYMBOL: DUK

 

Duke Energy agreed to purchase Progress Energy for more than $13 billion in stock this morning, which creates the largest utility company in the United States.  Shareholders of Progress will receive 2.6125 shares of common stock of Duke Energy in exchange for each Progress share.  There is only a slight premium for the shareholders of Progress, and Duke expects the deal will be accretive to earnings once it closes.

This deal makes a lot of sense for both companies for several reasons.  First of all, the combined Company will be able to substantially reduce its cost structure, and we expect numerous layoffs will be announced.  Secondly, this gives Duke a succession plan as current CEO Jim Rogers is expected to retire in two years.  Progress’ CEO Bill Johnson is 10 years younger and is widely respected on Wall Street.  Finally, this gives the Company the size and scale so they will be able to invest in new projects that otherwise they would not.

This isn’t a big surprise to Wall Street as there have been several recent large mergers in the utility space.  The only obstacle to this merger will be regulatory approval, although we believe the deal will be completed even if they have to divest of some of their assets.  The Company believes that they will be able to close the deal by the end of this year.

Duke Energy is a very conservative investment, although we expect this deal positions the Company better for growth in the coming years.  With the shares yielding over 5.5 percent, we believe the risk reward relationship is extremely attractive.  We look forward to hearing more from management as the merger closes, and expect the shares will reach $22 within the next 12 months.

  Three-Month Chart

 

 

                                                                                          SYMBOL:  VZ

Wall Street is abuzz this morning with speculation that Verizon will announce they will begin selling the iPhone tomorrow.  The Company is scheduled to make the announcement tomorrow morning at 11AM in New York City.  This has been rumored for quite some time, but all indications are that Verizon will be selling the iPhone by the end of this month.

Customers and shareholders of Verizon have been waiting for this announcement for quite some time - now this will end the 4-year exclusivity relationship that Apple has had with AT&T.  There is so much pent-up demand from the existing Verizon customer base for the phone that analysts believe the Company can sell up to 13 million phones by the end of this year.  We believe this estimate is conservative by between 10 and 20 percent, as Wall Street has consistently underappreciated the demand for the iPhone since its launch.

Even though Verizon shares are trading at multi-year highs, we believe the Company has never been positioned for such strong growth.  There are several possible positive catalysts that should follow this announcement, plus we would not be surprised if Verizon were to buyout Vodafone’s stake in Verizon Wireless by the end of the year.  We believe that Verizon shares will trade above $40 by the end of the year.

Three-Month Chart

 

(c) McIntyre, Freedman & Flynn

www.mcintyreinvestments.net