Earnings have recovered to their pre-recessionary postings with margins near record levels. While higher productively, work them 'longer and harder' and low-to-stable labor costs have all helped, the key to the earnings recovery was the reduction in work force initiatives, or as The Donald would have said 'you're fired' (do I need to give equal time if he runs?). Earnings, however, cannot achieve their expected new record highs over the second half of 2011 without an increase in sales. There are just too few cuts left (although some surveys do show that cuts continue, with low pay increases) and if you want to grow the bottom line, you are going to have to grow the top line. Putting aside what could be a contagious M&A; bout, not that I have anything against buying sales, that means companies will need to generate sales the old fashion way - getting customers to spend. The major spender has, and remains, consumers. On one hand they have paid down their credit cards slightly but are always ready to charge to the occasion, few homeowners are burdened with new home equity draw downs (guess the old ones are enough), there was that 2% social security tax reduction, and if we're only reading headlines, the unemployment rate has dropped again. On the other hand, it appears that some of those consumers may be realigning their spending priorities yet again, something about wanting to eat and having to drive (not to worry, we've been told it's not inflationary). The bottom line for them is that there are limited expectations for large increases in consumer expenditures, with potential shifts from Discretionary to Staples. The other spender - which we are hoping will be the big spender, is corporate spending. Earnings, as noted, are near record levels, cash has set its ninth consecutive quarterly high, cash-flow for 2010 was a beautiful thing and our business friendly representatives in Washington (which is still open at this writing; April 18 starts a 2 week recess either way) were nice enough to pass a full (100%) first year tax depreciation schedule, with few strings attached. I wouldn't put a cash bet on them being as friendly on Repatriation. First quarter earnings reports will start Monday (as of last night the S&P; 500 already has 27 issues reported; 4.5%, file attached), with over 70% expected by month-end. I expect to read that companies were spending in Q1, and doing so at a rate that will produce a double-digit sales increase. Specifically, I calculated that that over 30% of issues are expected to report double-digit sales gains, and for the S&P; 500 to show its first double-digit gain in year-over-year quarterly sales since March 2006. The index did manage to post four consecutive double-digit changes in Q4,'09 through Q3,'09, but those were double-digit declines. Financials sales are expected to lead the quarter in growth (25.6% over Q1,'10), but it's still a story of recovery from the bottom. Energy (24.7%) is partially a percentage pass-along from the price of oil; which brings me to Information Technology (13.5%), the largest sector in the index (18.0%; Financials are 16.0%, and Energy is 13.2%), and therefore, the one with the most impact. IT has become (for some, and me) a forward indicator for company spending. The logic is that you cannot expand without it, so their backorders, similar to manufacturing orders, tell a story. We've seen IT sales post double-digit gains for most of last year, which given their 2009 numbers was least they could have done (similar to the high current Financial gains), but now the easy comparisons are gone, and the growth rate has declined. The sales gains in IT are broad, with almost 30% of issues expected to post a 20% sales increase (year-over-year). The implication is that spending is starting to pick up past the recovery level lows to where eventually new jobs might be created - and without jobs the recovery cannot proceed. There are few signs of massive production or plant expansion (in the U.S.), and I've seen few major product launches (outside of Apple; my teenage daughter still loves them, even if the NASD loves them 40 less: from 20.49% to 12.33%; note the 100 adjustment should reduce volatility, but increase the cost of strategy plays against the 100 index), so I hold out little hope for quick hiring. However, as sales increase, and at this point 2011 looks like a double-digit gain, companies will commit to producing more, adding a few hours, then maybe a shift, and at some point eventually hiring. Then with more jobs, more people will spend, companies will produce more.... then the cycle will truly start turning up. Of course, when companies start hiring, spending more money, and investing more, we can all complain about their dwindling margins - but that will be something nice to complain about.
Recently, Warren Buffett stated that his "trigger finger is itchy" to make acquisitions, then he pulled the trigger with a US$ 9 billion cash offer for S&P; MidCap 400 specialty chemical maker, Lubrizol Corp (LZ), which gained 27.7% for the day. AT&T; decided that a quick way to improve its cell lines was through a US$ 39 billion acquisition of T-Mobile from Deutsche Telecom, of which $25 billion is in cash; Deutsche closed up 11% that day (and may end up holding 8% of AT&T; in the deal). And eBay just announced a US$ 2.4 billion cash offer for GSI Commerce (the issue closed at $19.38, hasn't opened yet, and the offer is for $29.25). It would appear to me that S&P; 500 companies are equally as 'itchy', not just for M&A;, but to spend, and spend big, since they've been on spending diet for over two-year. Spend on CapX, spend on R&D;, spend on buybacks, and even spend on dividends; note I didn't say spend on hiring. So what's holding them back, I believe, is concern over the economy, and the fact that things, specifically earnings and cash-flow, are doing so well - why take the chance? Cash, shock and dismay, has set a ninth consecutive quarterly record, and now stands at 10% of market value. Preliminary cash-flow numbers for 2010 may set a record high, and are 125% of expected 2011 operating income, and exceed 2010 dividends, buybacks, and CapX combined. Market-to-cash flow is now at 10, and with low interest rates, discounted cash-flow models are showing a lot of attractive issues.
So far this year, six breakups within the S&P; 500 have been announced, which, when combined with the one executed, and the one scheduled from last year, puts the 2011 spin-off count higher than the historical average of less than seven a year, and it's still Q1. These spinoffs were not a spur-of-the-moment item, nor were Mr. Buffett's acquisition, or the Ma Bell buildup, or eBay's bid. They have been talked about, studied, and planned for years, with the only open decision being "when, and for how much." Given the events in Japan and in the Middle East, the" when" may not be today for many, but soon, and, when it comes, it will be big. All that built-up planning, combined with significant cash and common shares sitting in treasury accounts from the buyback bonanza, and the desire to grow quickly, translates into M&A; activity.
So how long can companies sit on their massive assets, nervous about the market? Not that they aren't justified in being nervous, but they can't keep building cash reserves, content with past cost-cutting to support future growth. All those companies, with all that money, all coming from the same B school, all using the same charts, and all deciding to spend it at the same time - do I need to be a supply-sider to know what that will do initially to stock prices. This is America, and for Corporate America, its build it or leave it. Can Monday Morning Merger Mania be far off?
Dividends are back in the game, but it's going to be a long game. The Fed action allowing most banks (BAC not) to increase their dividends is a start, but it is going to be years until we see them paying out at the levels of 2007. I remain very positive on dividends, and it's a good start, but it's only the first inning.
See file for details Amazing progress for slow moving dividends but it's only the first inning.doc
Indicated dividend rate up 7.0% from year-end, that's a 7% rise in your annual pay 15.0% over last year, but still 12.9% lower than the Jun,'08 high
Expect we won't return to 2008 high until early 2013 for the S&P; 500, and later in 2013 for the rest of the U.S. domestic market
10 initiations - it's a movement
Expect 15% actual Mar,'11 payment increase over Mar,'10, with quarter at +13%+$16.2B Q1-to-date dividend rate increase vs. +$5.1B for Q1,'10 vs. decrease of $38.7B for Q1,'09 (see attached chart)
Financials back in the game, but its going to be a long game
5 fundamental reasons I am positive on dividends Corporate earnings have significantly rebounded from their recession levels, and are now approaching record levels
Low interest rates
Corporate cash on hand stands at an all time high
Payouts remain low, partly due to the speed of earnings improvement and the slower rate of dividend increases
Coverage rates, earnings divided by dividends are very high
The headline news is that S&P; 500 companies spent $299 billion on stock buybacks in 2010, up $161 billion or 117% from the $138 billion they spent in the 2009 - both the percentage and dollar value increase are record highs. The details explains the reason for the headline is because of the 76.5% decline in buybacks (2009 from 2007, down $451B), with the 117% or $161 billion bounce back resulting in the year-over-year record. We remain, however, at half of the 2007 $589B level.
The attached reports give the details, along with charts, tables, and some issue level for where we have been. To see the report click here Buybacks_20110323.doc
For the first quarter of 2011 (no reporting yet), I believe companies continued to be cautious and, in general, purchased more shares than needed for options, enhancing Q1 EPS.
For the remainder of 2011, subject to market conditions (no major crisis), it appears investors are once again (slightly) positive on buybacks, with companies willing to use their vast cash reserves to support stock prices and push EPS up.
If investors get on board the buyback wagon, meaning they buy issues of companies that increase buybacks and do SCR, and bid them up based on their higher EPS, then companies will increase their programs and we may well be in for round two of the buyback bonanza.
However, if strong investor reaction does not materialize, I believe companies will continue to protect their earnings, as well as to purchase small amounts of additional shares, helping their earnings per share to grow - under the radar scope of the headline news.
Next week will mark the two-year anniversary of the bear market low on March 9, 2009. The quick 17-month 56.78% steep decline from the market high on October 9, 2007 (1565.15) to its low on March 9, 2009 (676.53) was the product of a liquidity crunch, a housing bubble with unsustainable prices, and unemployment, which resulted in a recession. The financial sector declined 82.62% during that period (more than Information Technology did in the Tech bust of 2000-2), as major institutions failed and major government assistance programs were implemented to prevent others companies from failing. From the market low, the index is up 95.28%, with 287 of the S&P; 500 issues having doubled in price, and 405 having increased at least 50%. However, from the market high in 2007, the market remains 15.59% down, with 283 still trading lower than they were at back then (12 have doubled and 49 are up at least 50%). The market recovery started two years ago, as initial government supports took hold, and an economic balance between risk and reward met, albeit at a much lower level. Prices for products, housing and wages also realigned to the new economy. Corporate cost cutting (job reductions) has permitted companies to increase profits to the pre-recessionary level, with estimates now calling for new record levels of earnings in the second half of this year. It is this level of earnings which I believe supports the market at its current level, and permits it to trade through Middle East and US$ 100 oil prices. However, oil remains a major factor in earnings, and any escalation could jeopardize earnings, therefore pulling market support. At this point, the prospect of continuing improvement in the economy via higher employment outweighs the expected Q1 impact of higher oil, given the prevailing belief is that oil prices will not escalate. However, that belief is being tested as oil has now closed above US$ 104, a level not seen since September 2008, and the month that Lehman Brothers declared bankruptcy. Oils higher price has already been felt by consumers at the pumps, and by companies via materials (petroleum based products) and transportation costs. I would expect next week to see companies update their guidance and comment on the short-term (Q1) impact of oil, even if they are less specific about the longer-term oil level. I also expect to see Equity analysts adjusting their estimates, regardless of company guidance.
For issue and sector level data file and tables, click heresp500_20110304.doc
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