A Capitalist Pig View on Swine Flu

I just could not resist posting such a title!

The fact that markets more or less ignored swine flu news is encouraging.  When equities stop declining in the face of obviously bad news, it is often a sign that there are few sellers left.

There are, however, certain sectors that have suffered as a result of this outbreak, most notably Mexican airport operators, such as Grupo Aeroportuario del Pacifico (PAC), Grupo Aeroportuario del Centro Norte (OMAB) and Grupo Aeroportuario del Sureste (ASR).  These stocks already suffered from loss of traffic due to economic situation, as well as fears from continuing Mexican drug wars.  And now this.  But it is exactly situations like these that can present good long-term opportunities.

Remember the fears around the brid flu a few years ago which did not amount to much? Of course, no one can predict how many people will be affected by the swine flu.  Still, it pays to not feel like a chicken and instead to take advantage of market inefficiencies like a capitalist pig should!

Earnings Season Update

The earnings season is in full swing; about half the companies issued their reports.  On the absolute scale, the results are quite terrible, as expected; however, in comparison to expectations they can be called respectable.   More importantly, forward earnings guidance, when provided, are also better than expected.  Here are some examples of positive surprises for selected companies from various industries:

– Banks and financials: Wells Fargo, Goldman Sachs, Bank of America
– Technology companies: Intel, EBay, Amazon, Netflix, IBM, Apple
– Restaurants: P.F. Chang, Chipotle Mexican Grill
– Retailers: J.C. Penney, TJX, Wal-Mart

There also a number of encouraging signs in overall economy and the state of the markets, such as:

– Successful IPO of Rosetta Stone and acquisition of Sun Microsystems by Oracle point to increasing confidence of investors.
– Seven banks have already paid back their TARP money.
– Increasing sales activity in real estate; some markets in California experience multiple offers again (albeit at much lower prices).
– The tone of media reports is changing.  While a typical news story a few months ago would describe how newly unemployed make ends meet, now we are seeing discussions of how to prepare for a coming recovery.
– Consumer confidence is up (although still rather low on absolute scale).  While this measure is psychological, it is clear that consumer optimism at some point will translate into consumer spending.
– This last point is corroborated by anecdotal evidence from my flying club: it has become increasingly difficult to reserve a popular model, especially on weekends.  That wasn’t the case just several weeks ago.

Of course, this doesn’t mean that we have clear skies ahead.  There is still plenty of bad news to go around: unemployment is still rising, home sales are still dropping.  Economy is still contracting, although at a slower pace than before.  Nevertheless, the fact that we do have some positive news is encouraging — just a short time ago, vast majority of reports were negative.  In the months ahead, we are certain to hear of more disappointments.  However, emerging signs of future recovery listed above could indicate that we have already seen the lows of this bear market.

More on Market Valuation

I wrote earlier about comparing total stock market capitalization with Gross National Product.  This article from GuruFocus.com computes the ratio of market capitalization to GNP for the last 40 years.  It contends that currently, stocks are modestly undervalued, and are likely to return 11% per year for the next 8 years.  At this rate, it will take 5 years to return to previous highs.  Still, this forecast is positive and is certainly better what we had to endure for the last year and a half!

Are the Happy Days Here Again?

One could certainly think so, given the huge rally we have experienced off March lows, with S&P gaining over 25% in a month. A number of  positive economic reports helped to fuel that rise.  Sales activity in real estate is picking up.  Consumer confidence is up.  Many retailers performed better than expected.  Walls Fargo and Goldman Sachs indicated that their earnings are much better than expected.  Even President Obama said that he sees “glimmers of economic hope”.

However, we’ve been in a similar situation before and saw comparable gains in the market in December and January only to witness them to evaporate.  Is this also a bear market rally?  The next several weeks will be crucial to answer this question, as the first quarter earnings season unfolds.   The fact that the earnings will be terrible is well-known, and it is baked into the market already.  The key is going to be outlooks for the rest of the year.  If we see positive (or, rather, not so negative) estimates, then we can hope that we have already seen the bottom of this market.  On the other hand, fasten your seatbelts in case of poor or lack of outlooks…

George Soros Interview

Today, George Soros gave an interview in which he stated that, in his view, the banking system is being kept on life support.   He also likened banks to zombies.  While he thinks that the danger of the crisis has already passed, he doesn’t see a quick V-shaped recovery ahead.  Instead, he believes that we’ll have (or already had) a short bounce, followed by a flat period afterward.

If he is correct, we may face a situation similar to 1970’s, when the market regained two thirds of its losses in less than a year and then went through a consolidation stage for the next five years before 1980’s bull market started.  In any event, Soros’ comments contributed to the decline today.  The markets are already nervous after the four week rally and in anticipation of poor first quarter earnings reports.  While bad earnings are already largely baked into the prices, the key will be outlooks for the rest of the year.