13 Aug 2004 Market Pessimism Creates Opportunities for Investors
Rising oil prices continue to drain optimism from the equity markets and from corporate managers. Over 80% ofU.S.companies have reported their earnings now and on average they are up 40% over last year, according to the Wall Street Journal. Advanced Industrial Equipment (1,974%), Coal (1,532%), Internet Services (946%), and Communications Technology (588%) are the leaders so far. But while the latest earnings reports are generally good, managers such as Cisco’s John Chambers appear less certain about the future. They say that their customers seem less enthused than they were earlier in the year. The so-called energy tax appears to be having some degree of economic impact.
According to the Wall Street Journal, energy analysts said the risk premium could be as much as $8 a barrel or 20% of the price. Continuing insurgency in U.S.-occupiedIraq, suspicions terrorists could again strikeSaudi Arabia’s production facilities, and unrest elsewhere contribute to that uncertainty. Oil prices have risen 3.5% over the past week, pushing to new highs; the latest was reached yesterday at $45.50.
The graph below shows not only the persistent rise in oil prices over the past two years, but also the recent volatility. On June 1st (red arrow) prices rose dramatically on supply concerns to a record high when 22 oil workers were killed inSaudi Arabia. A day later OPEC announced they would increase production beyond their agreed upon quotas. Prices declined 16% in the following month (green arrow). Since then numerous threats to supply including the possible bankruptcy of Yukos, the huge Russian oil concern, have caused prices to spiral 28% to new highs.
Experts assert that recent moves are trader driven and seem to ignore the fundamentals. Note the huge increase in volume in the lower section of the chart. On Wednesday,Europe’s International Energy Agency described the recent run-up in oil prices as “irrational exuberance” and cited a host of reasons for oil-supply worries to ease. The agency said while the world oil markets are indeed tight and uncertain, it questioned whether soaring prices were justified while supply still exceeds demand according to the Wall Street Journal.
The S&P 500 is down 8.6% from its peak reached on March 5, 2004, in spite of good economic and corporate earnings news. During that period the best performing industries have been Internet Software and Services, Tire and Rubber, and Steel, up 25%, 20%, and 14%, respectively. The bottom ten S&P 500 industry performers during the Index’s decline from peak were down an average of 27%. The decliners represent a broad swath of the economy from Advertising to Health Care and from Investment Banking to Semiconductors.
Our best performers during the decline of the S&P 500 have been Ebay (11.2%), L-3 Communicaitons (8.5%), QualComm (8.3%) and Coopers (7.6%). Our most disappointing positions have been in the communications, technology, and medical areas including Nortel, EMC, and the NASDAQ Biotech index (IBB). The high degree of global uncertainly has kept these growth industries’ stocks at very low levels. The fact that they represent compelling values relative to historical norms is argued by only a few, but just how long it will take for sufficient confidence to return them to improved valuations remains a guess.
As was earlier mentioned, the economics reports of late have been largely positive. While the pace of improvements has slowed, the reports continue to show economic strength. The Federal Reserve raised its benchmark rate by .25% on Tuesday as was almost universally expected, but kept their pledge to continue doing so at a “measured” pace to suppress inflation without choking growth. Some expected them to drop that phrase amid slowing consumer spending and hiring.
Those two recent negative forces appear to have had an impact on consumers in August. For the first time in three months theU.S.consumer confidence index fell to 94 from 96.7 in June. A measure to current conditions rose while consumer expectations for the economy going forward fell, according to Bloomberg.
The spate of negative news of late has undoubtedly had an impact on business managers as well. Hiring is not growing at the pace it was earlier and orders are not coming in as fast. Cisco is seeing less confidence at the enterprise level and Hewlett Packard surprised Wall Street yesterday with a lower than expected earnings release. The company blamed most of its shortfall on server and storage systems sold to big businesses. But Dell, which is likely taking share from HP sees the future as brighter. The company’s CEO said he was “bullish” on the rest of the year from personal PC’s to big servers.
We think the value style of investing will perform better for the next few months as uncertainty continues. Attractively valued companies that generally grow slower, but steadier than average and that pay an attractive dividend from their earnings will likely outperform the faster growers such as technology, medical research, and communications companies. Investors need to feel more confident about the future before they assign higher valuations to companies that must prove themselves long-term. Pessimism shortens investment horizons. But, when confidence improves, and it certainly will some day, there are huge opportunities among high quality growth companies just waiting for “value” conscious buyers.