Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
November 19, 2012
Stocks continued their post-election selloff. The usual concerns about future tax increases and retrenchment by both consumers and business weighed heavily upon investor sentiment.
As the charts above illustrate, both the
Dow Jones Industrial Average and the NASDAQ Composite fell by around 1.8% last week.
The Markets & Economy
Today’s Wall Street Journal front page summarized the current state of the economy. Businesses have been and continue to reduce plans for expansion and capital expenditures as tax policy confusion in Washington DC has sapped them of their confidence.
The impending tax increases associated with Obamacare are forcing a change in hiring plans as full-time jobs are pared while part time help is growing. This is being done to avoid the expense of having to pay for healthcare benefits for full-time employees as defined in the law.
In addition, next year’s income and corporate tax rates are unknown, and the unknown is the economy’s enemy. This morning’s article hinted at the same thing we mentioned last Monday. Large public corporations will likely focus on returning money to shareholders rather than invest in an uncertain future. Look for special and large dividends to be announced by year end to avoid the higher tax climate in 2013.
While this is not bad news at least in the short-run for equities, the longer-term is not so bright. You cannot run a successful economy with punitive tax rates. Thus look for the economy to show a growth rate of only 1% in the fourth quarter of this year, and next year will be a disappointment as well.
Even the Federal Reserve Board is now talking about keeping interest rates near zero until the year 2016. Does that sound like they are bullish on the economy? Frankly, the deficits in this Country have now grown so large, with no serious attempt to rein them in, that the FED will eventually be forced to keep rates low forever. The USA will lose its ability to service its soon to be $20 trillion debt. Printing money will be possible only as long as the dollar remains the reserve currency. This concept is critical and most people do not understand this for even one second.
The best thing to say is that the dollar is the top of a bad lot, and hence we should remain in control of our finances for some time. Equities, by their nature of ownership in real businesses or assets, are in fact a better asset class than most in such an environment. Government bonds are risky today and will get more so as time goes on.
What to Expect This Week
President Obama is in Asia so talks about the current domestic crisis are on the back burner. Also, of course, Thanksgiving comes early this year on Thursday, which will further give a shortened feel to the week.
Accordingly, the fundamental outlook is not likely to move much this week. The current view of the economy is one that is slowing down as evidenced by the weekly review of the Economic Cycle Research Institute’s weekly leading index (see graph below).
Still growing - but this is going to be a tough retail holiday season and businesses are looking to cut inventory and plan for a bleak winter.
With the market closed Thursday, and only a shortened session on Friday, the next update will be two weeks from today. I bet you we will still not have a deal on the so-called fiscal cliff, and it will still be the dominant concern of Wall Street.
Shares of Boeing have outperformed the market during this recent downturn as production increases and a large dividend increase have been rumored the last two weeks. We still believe that airlines have to upgrade their aging fleets to take advantage of the fuel efficiency of these newer jets. We expect that we are in the early stages of this upgrade cycle and think that this cycle should last through 2015.
Boeing has seen a sharp uptick in its free cash flow since the development and completion of the 787 and revamped 737 aircrafts. Now the Company is focused much more on production of these planes, which is driving free cash flow higher. During the third quarter the Company generated $1.17 billion, compared to just $69 million in the previous year. This cash flow will likely be returned to shareholders through dividend increases and/or share repurchases. Many on Wall Street expect a 10 percent dividend increase before the end of this year.
The Company also indicated it needs to ramp up production on the 737, due to strong demand around the world for this plane. Currently the Company is producing forty-two 737 aircrafts per month, and we expect that number to jump by 20 percent by the end of this year. We anticipate this upgrade cycle will continue for several years.
With higher dividends, increased production and possible share buyback, we believe the shares are poised for a nice multi-year run. A higher dividend payout rate will attract new investors into the Company. We still believe that shares of Boeing will reach $100 within the next 12 months.
(c) McIntyre, Freedman & Flynn