Europe is doing better

European crises is over and the actions from countries in Europe to cut their budgets so far have impressed the market. The credit spreads have narrowed between Germany and Spain. Germany is doing extremly well. Its economy probably is the best among developed countries. The low and stable Euro helped German exports. The better European economy has reduced the risk of global slow down. That's why stock market refused to go down despite worse economic data from U.S.

Why earnings are diverging from economices

The earnings so far are very good. But the macro economy is not performing at par. There are some reasons behind the earning surge.
1. The deep recession and tight credit have reduced the number of competitors and increased the barrier of new entries.
2. Cost cutting has made corporations lean and more profitable.
3. Many companies are more rationalized and they took out extra capacities. The margin is high. The best example is airline industry.
4. Overall inputs have stabilized and commodity prices did not jump.

Some of these factors are more permanent and some are temporary. Pay attention to the turn.

earnings and economy

The earnings overall are positive but economy data is worsening. So what's going to happen next? My sense is that the earning upsides are most coming from global operations. However, given the high cash level of corporations, a double dip is unlikely. That's why I purchased BAC and CSCO. However, I do not believe the overall market is cheap. The era of 15X multiple is over.

One bright spot is that M&A activities will heat up given the high cash level and cheap credity. Most companies have to look cost savings to increase earning. One way is to merge to take out competitors and realize cost savings.

Big U.S banks

The market is disappointed on most big U.S. banks earnings. But I look at the positives. The earning quality is much higher because the strict loan requirements. I will expect the loan reserve will come down and this is more important than short term profitability. I will put an order in for 200 Bank of America for 13.38.

bought CSCO

Just bought 200 CSCO @22.20. Given the cash CSCO has and the dominant position it has in the router market, the stock is undervalued. My target is 26 in six months

flat yield curve

Bank of Canada has increased interest rate to .75%. The yield curve in Canada has flattened, which is negative for banks. I would be very cautious on Canadian banks.

The weather is very hot for North America and Europe. It has a negative impact on crops. It may surprise people on food inflation over next few months.

IBM and texas Instrument results

Just as I wrote a few days ago about Intel's results, you can not project INTC's result to other tech companies. There are lots of competitions in PC, notebook, and computer software. The competition in service which IBM is in has been increased gradually. That's why IBM still enjoys a high margin. Most companies do not change their service provider regularly and it gives IBM a stable revenue. IBM is a mature company should trade 10-12 multiple which is 115-130. I will be very comfortable to buy IBM around 115.
TXN is another story. I would not touch it until it drops to 20 or below. There are too many variables in mobile semiconductor space and I do not know who will be dominant player yet.

BP STOPS THE OIL FLOW

It is very good news for BP and environment. BP stock has jumped over 30% in last two weeks in anticipation of this news. Now the slow pain starts for BP. There will be thousands of claims and lawsuits, record fines from the government and billions of clean up cost. In addition, the revenue side has also been hit. The energy trading business is in trouble. Deep sea drilling is slowing. my guess BP stock will not perform for years to come.

Intel

Intel's results are great. I have been bullish on Intel for a long time for the following reasons:
1. Computers are becoming necessities, not discretion items anymore. Most families have two or three computers.
2. Emerging market are catching up quickly. Most households in China have computers.
3. The data and videos on Internet have exploded. More servers are needed.
4. Intel is enjoying almost monopoly status which keeps its profit margin very high.

Will the good results from Intel spread to HWP or Dell? Not necessary. The reason is simple. The competitions in PC manufacturing are fierce and margins are low. One worrying sign is semiconductor companies in Taiwan are slowing down.

My target on Intel is $24. However, I will sell around 23.5.

summary for July 13, 2010

Intel has reported very good earnings. I will discusse more on intel tomorrow.

Closing value
Portfolio 1 (U$):113118, up 3%
Portfolio 2 (C$): 82,738, up 3.3%.

prepare to take profit

Just as I wrote a week and half ago that there were some positives in the market when S&P was down to 1000. Today, I would like to remind people that all the worries are still there. Chines property market is cooling down, government stimulus is running out, and inventory restoration is almost done. I do not believe that S&P should trade over 1120. If INTC's results are good today, I will take profits tomorrow.

Anything changed?

The market went down 5% two weeks ago and up 5% last week. Did anything changed during last two weeks? not really. Basically, the market is trading around by traders and they are very comfortable with a range of 1000-1100 for S&P 500.

I believe the tight credit market is good for large blue chip companies because the barriers for new entries have been set up unreasonably high. Especially high tech companies. I already owned INTC and interested to purchase some CSCO around $21. The commodity companies, especially base metal companies are in trouble in short term because of the fiscal tightening. I am neutral on energy companies.

The improvement in loan quality probably bodes well for commercial and retail banking but not very positive for investment banking. I like Bank of America around $14 and CITI.

fair value for S&P500

You have heard some experts saying the sky is falling down and S&P 500 is going to crash to 500 while others suggested that current valuation is the best in a generation. What is the fair value for S&P 500?

Given risk-free 10-year bond is around 3%, the required return for S&P should be around 7-10%. (most single A and BBB bonds are trading around 5-7, stock is riskier than bonds so it requires a higher return). A P/E between 10-14 will be justified for a required return of 7-10%. If I take the consensus earning estimates for 2010, which is 80 and discount it by 10% because of the unfounded pension liabilities (most pension plan assume a 8% return which is way off base over last 10 years), a fair value of 720-1080 is derived. Consider how accommodating the Fed and other central banks have been, the market is probably biased at the high end (900-1080).

Is RIM doomed?

Research in motion is in trouble. the stock is down over 50% from its high. I have been bearish on RIMM for a long long time. My rational was and continues to be that a mature high tech company does not deserve a premium valuation because competitions would come. Surely it did. (Same thing can be said for Amazon, priceline.com and even Apple). However, at price around U$50, RIMM is probably fair valued. There are some advantages in Blackberry. 1. It uses much less bandwidth than IPhone or Google phones. Everyone is complaining about AT&T but I see this is a Apple problem. The highway is limited and you cannot put bigger and bigger trucks onto it. 2. Privacy. RIMM has the best security among all smart phones. I do not see corporations and governments to switch to IPhone any time soon. It may become an attractive target for Microsoft or Nokia.

vacation

I have been on vacation over last few days. The market is weak. I still expect the market will trade in a range 1000-1100 for S&P 500 and 10500-11800 for TSX. There are some risks that the market may break down lower. I have been bearish for a while. But today I would like to write some positives:
1. Interest rates will stay low for longer than expected.
2. energy and commodity prices are stable or lower. It is good for cost control.
3. Labour has no leverage to demand higher wages, except in China
4. No capital for new businesses which is good for established ones.
5. Governments around world start to be serious about deficits control, which is a long term positive.