Financial markets have found out the answer to important questions in the last week. While there have alternatively been both positive and negative reactions, the net result is lower interest rates and higher stock prices.
As the charts above illustrate, the Dow Jones Industrial Average gained about one-half of a percent last week, while the NASDAQ Composite moved higher by 1.4%.
The Markets & Economy
The big news last week was the combination of knowing that Larry Summers would not be the next Federal Reserve Board Chairman and that Federal Reserve monetary policy would remain hyper expansionary. By that I mean that all the “taper” talk since last May was for naught because the economy is not doing well enough to absorb a tightening move at the present time. Fed members must have been reading these Monday morning blogs.
For my part, I have been consistent that economic growth continues to hover around 2% and that the recent upturn in interest rates would serve to hurt growth in the future. That notwithstanding, I did think the Fed, after prepping the financial markets for three months, would pull the trigger if only to preserve their credibility.
That they did not tells you just how concerned they are about the future of the global economy. It also tells you something about who the future Fed Chairman is likely to be. That would be someone who is very dovish and possibly even more suspect to pressure from the President and Congress than the outgoing Chairman Bernanke (and he has become rather political).
Thus, the initial reaction was very positive for bonds, stocks and commodities. Friday the market pulled back because some other Fed official hinted that policy could be tightened in October. To that I say, fool me once - shame on you. Fool me twice then shame on me.
The Fed now has signaled that a zero interest rate policy and quantitative easing will be here for long into the future. Just talking about changing this policy mix produced a huge overreaction. I also call into question all the happy talk about the economy. The proof is in the pudding. This economy is too weak to stress it out and this concern was confirmed again this morning by the President of the New York Federal Reserve Board who himself is now a candidate to lead the Fed.
It is astonishing to note that the Fed is citing the payroll participation rate falling as a major cause for their concern. We have highlighted this for you for months while the financial and national press ignored the issue. Now it has reached the highest level of importance to policy makers.
What this means is that until nominal growth in the economy starts to move higher and people start to move back into the labor force, it is very likely that monetary policy will remain much as it is. This is very bullish for the stock prices. Higher dividends (see our comments below on Microsoft), share buybacks and merger activity will continue on. This means higher share prices even as the economy stumbles along. The dichotomy between social classes will continue due to the mix of tax policies being anti-growth, while monetary policy raises asset prices. We will continue to take advantage of this for as long as the outlook remains as indicated.
What to Expect This Week
Already this morning, more weak economic data was released (see charts next page). Data on manufacturing and new orders have been falling and there is no indication of that trend reversing anytime soon.
The weekly report from the Economic Cycle Research Institute (see chart below) also shows the economy continues to be in a holding pattern. Is it any wonder why then the Fed took a pass. The media is shocked to learn just how awful this economy is based upon the fact the so-called recovery is in its 5th year.
An additional uncertainty concerning the national government’s finances will dominate the news this week. As most of you know there is no budget for the new fiscal year starting in one week. Consequently, either the President and Congress reach an agreement or there will be a shutdown. Obama has said he will not negotiate, and most political analysts think he wants a shutdown in order to improve his political ratings. The uncertainty is likely to play havoc with the day-to-day action in financial markets.
SYMBOL: MSFT
Microsoft hosted its annual analyst meeting at corporate headquarters last week and focused investors on its simplified business model and its robust financial strength. The Company will now report its results in a new structure that should make it easier for investors to see the value the Companyiscreating. These new changes will be highlighted further on a conference call this week, as well as several new product launches, most notably the new Surface tablet.
While the new reporting structure will help investors, we are more encouraged by the Company raising its dividend and share repurchase plan. The management team raised its quarterly dividend by 22 percent to $0.28 per share, which was 2cents higher than Wall Street’s estimates. Also Microsoft is replacing an expiring five–year-old $40 billion share buyback, with a new $40 billion share repurchase plan. We expect management to be very aggressive with this share buyback, given the current price.
Shares of Microsoft didn’t move much following the meeting, but we see several positive catalysts for shareholders in the near future. We think the new reporting structure is a sign that management is open to splitting up the Company, and would not be surprised if that was announced in the near future. Also, the Company will be naming a new CEO sooner than later, which is a move that will be cheered by all investors. We believe that higher dividends and the aggressive share repurchase plan will keep the shares trending higher until these further changes are announced. We expect the shares of Microsoft are worth at least $40 per share if the Company was split up.
SYMBOL: BRCD
Brocade will be hosting its annual Analyst and Technology Day for investors on September 25. The management team will focus investors’ attention to new products and strategic relationships that should drive growth in the coming quarters. Shares of Brocade have been moving higher in anticipation of this meeting, and several of its competitors have been reporting improving business conditions during the last several weeks. We expect this meeting will be a positive for shareholders and likely move the shares into a new trading range. We are raising our 1-year price target for shares of Brocade to $12, due to improving business conditions in the telecom equipment sector.
© McIntyre, Freedman & Flynn
