Note: I'm out of the office until April 3. The next article will be posted on the weekend of April 8.
It was another week of looking ahead to the Fed. Will we have two more interest rate increases, or three? Is a 5% rate right, or is 5.5% warranted by the strong economy? You've seen me and the rest of the investment community wrestling with these questions for the past three months.
Guess what? We're still wrestling.
Fed Chairman Bernanke spoke Monday night at the Economic Club of New York. Some people expected him to mention his thinking about future rate hikes, others thought that there was no way he'd tell a club before telling an official policy meeting. The second group was right.
You may remember seeing calls for a death to the housing market over the past two years. It has so far refused to follow predictions, and this week brought mixed evidence. Housing is central to the economy. The strong real estate market held America together through the technology bubble burst of 2000-2002.
On Thursday, the February existing home sales report registered a rise to a 6.9 million annual rate, up from January and much higher than analysts expected. That got people talking about the Fed again. If the housing market is still strong, the Fed might continue raising rates after May. We could get that third, painful increase after all.
Then on Friday, new home sales for February clocked in at a 10% decline. The market liked that. Two more hikes might be enough.
This Tuesday, Mar. 28, is the Fed's next policy meeting. It will raise rates then, guaranteed, but it will also issue a policy statement. Everybody will read the statement for some sign of future direction. We probably won't find one. Such is the nature of the Fed. The forecast calls for continued cloudy interest rate skies.
Let's take a look back at the week.
Monday The market did almost nothing, but our portfolio advanced smartly. Our computer maker gained 2.3% and our Japan investment gained 3.5%.
Tuesday Call it Tech Tuesday. We had interesting news from Microsoft (MSFT), Dell (DELL), and Google (GOOG). We'll look at all three.
By now, you've surely heard that Microsoft will delay the consumer release of its new Vista operating system until January 2007. We've been steadily building a portfolio around the theme of a second half 2006 PC recovery, partly on the back of Vista's November release. Delaying Vista until the new year means that holiday sales won't happen.
Does this change our investment thesis? Yes. Does it destroy it and invalidate our portfolio? No.
The reason for the delay is that Microsoft decided it needs more security in Vista. Windows is an overwhelmingly popular target for hackers worldwide. Preliminary testing showed that the fresh release might not hold up well with its current set of security features.
Picture that. We, along with the vast majority of computer users, wait with bated breath for the November release. Expectations are high for dazzling Christmas sales that have computers flying out the door with Vista installed. Stock prices rise according to plan. Then, hackers tweak the automatic update feature to release a "Pearl Harbor Virus" that purges the hard drives of 20 million people on Dec. 7. The surging sales fall off a cliff, Microsoft and computer makers are named in a class-action lawsuit, chip inventories builds because computers aren't moving anymore, and stock prices fall.
I'd like to avoid that scenario, and I'm happy to see that Microsoft would, too.
As for the delay itself, I'm not sure that it's going to be so bad. Already, computer makers have said that they might provide holiday buyers with online coupons to get a free Windows upgrade in January. Microsoft is sympathetic to the situation and will undoubtedly set up a robust download center to serve the millions of holiday buyers who come looking for Vista in the new year. Functionally, then, the two-month delay seems nary a trifle.
From our perspective as technology shareholders, this could actually be a boost. The market operates on expectations. The holiday buying season itself creates high expectations every year. It doesn't need the help of one company's new product, even if that company is Microsoft and the product is as visible as Windows. Sans Vista, Christmas will still be Christmas in every mall, on every website, and under every tree.
Had Vista been released on schedule in November, it would have added to the excitement. But adding to excitement is not as exciting as creating excitement. Now, though, with Vista's release happening in January, just after Christmas, we may have an unusual opportunity to extend the holiday happiness beyond its usual end date.
Too, expectation is always more interesting than reality. When computers sell briskly during the holiday season, investors will be happy. In the midst of that ebullient mood, somebody will remark that the good times are bound to keep rolling because, "after all, we haven't even seen the new Windows yet!" Right, and if sales are this good now, just imagine what they'll be like in January.
That mood is what we're looking for in the market. It's what drives prices higher. We may be in for a pleasant surprise from this Vista delay. Most see it as a downer, but we should see it as either a minor blip or a helpful gift. ____________________
Dell chairman Michael Dell said on Tuesday that he expects the company's sales growth to outpace the broader industry this year, aided by rapid expansion in Asia.
He said he was confident of strong demand in Asia, including smaller markets outside of India and China, where Dell is the third-largest PC seller and recently doubled its production capacity.
"If you look at all those markets combined, outside of the big markets like India and China, those markets are very significant and are growing very fast."
In the Asia-Pacific region including Japan, Dell's revenue grew 21% last year as unit sales rose 30%. The region accounted for 12% of total sales.
Anecdotally, I've noticed that Dell is popular here in Japan. When I mentioned to a Japanese business friend that I like Sony's Vaio notebooks, he suggested that I look at Dell instead. "Its products are cheaper, faster, and stronger. Sony's notebooks break too often."
The Asia-Pacific region is known for its high technology. For Dell to be popular in the homeland of Sony, Toshiba, and Fujitsu is pretty impressive. ____________________
Also on Tuesday, Google launched Google Finance at:
I spent some time on the site looking for something to distinguish it from the plethora of offerings already available. To me, there's not much to write home about.
The main page itself is very sparse, nothing at all like the complete landscape presented at Yahoo Finance, MSN Money, or Morningstar. Google says that it offers a way to search for companies easily. Yet, that begs the question, what finance site doesn't offer that?
From the many features listed in the launch, only two strike me as compelling: interactive charts that show where news items occurred, and blog postings tied to companies.
The charts are nice. It's helpful to see news in context so you can tell what actually moved the stock and what was just noise. You can drag the charts to a different time frame and see along the price line exactly the price and volume on specific dates. If you click a news letter icon, the accompanying news summary on the right is highlighted. You can click that for the whole story.
The blog post listing is also nice. Blogs often provide much faster and cleaner information than the ad-laden content from major publishers. My own information is published via Blogger on my website, so I'm partial to blogs. Google owns Blogger, making it a natural fit to tie blogs to finance symbols and make the aggregation. At last, there's a tool that puts commentary in one place. Slick.
However, Yahoo Finance has already said that it has a slate of improvements on deck for later this year. Interactive charting will surely be among them. Blogs, too, don't seem too hard to incorporate because so many of them use universal syndication formats RSS and Atom. Anybody can pick up the syndicated content that way, so Yahoo could easily work with an aggregator like Feedburner to pull in postings from hundreds of thousands of content feeds. As I wrote about the Yahoo vs. Google match up before, catching up with technology is not hard.
From an investment perspective, Google Finance does not change my belief in as a solid investment. From an investment research perspective, Google has given us yet another tool to use when looking for good investment ideas.
Wednesday: After Microsoft's Vista delay, it was a relief to see the stock drop just 2%. ____________________
For the tidbit file, I picked up these nuggets.
In the last four years, revenue has grown 54%, its earnings per share have grown 104%, but its stock price has fallen 3.5%.
In the last four years, revenue has grown 46%, its earnings per share have grown 636%, but its stock price has fallen 35%.
I'm happy to have these two in our portfolio.
Thursday: RBC Capital lowered its estimates for Intel, citing slowing unit growth. The firm said that inventory is still too high and that Intel is still losing market share to AMD. While everybody expects the June quarter to be seasonally slow, RBC says it could be much worse than seasonality. The most ominous sign is that AMD appears to be taking share in notebooks now, Intel's supposedly unassailable stronghold. ____________________
had a jumpy week, falling 3.2% on Thursday alone. It's a volatile stock. We were up some 26% last week. This week, we're up just 18%.
It's still cheap, though. The stock has a P/E of 15, compared with 25 for the Dow Jones U.S. Consumer Finance Index, of which this company is a component.
A lot of people hate the stock. About 23% of shares outstanding are sold short, a 12% increase from last month.
Investors who sell short borrow stock and sell it, betting that the stock's price will fall and they will be able to buy the shares back later at a lower price for return to the lender. They then keep the difference as profit. Instead of buying low, selling high, short sellers hope to sell high, buy low. So, a great number of people believe that this company's shares are headed lower and have shorted nearly a quarter of all shares outstanding.
Professional short sellers point out that just three of the company's customers made up 65% of revenue in 2005. The customers are Bank of America, JPMorgan Chase, and Collegiate Funding Services. If any one of them quit doing business with the company, it would be a serious blow. Even if they don't sever relations, though, they could use their importance to the business as leverage to get price concessions on new contracts.
However, as I've written before, the demographics are compelling. Increased college enrollment rates, rising tuition levels, and a struggling economy helped increase nonfederal student loans to $11.3 billion in the 2003-04 academic year, a rise of 39% in just a year and 147% over three years, according to the College Board. Plus, a full 94% of that came from banks and other private lenders, precisely the kinds of companies that this firm works with.
And, the firm does everything from processing the loan application to collecting payments. But it earns most of its fees from bundling the loans for resale to the capital markets, what's known as securitization. It does not act as the lender or own the loan.
This is a great service to financial firms. They can offer student loans to their customers without having to handle the paperwork that accompany them. They can just offload the work to this firm and keep a small, hassle-free profit.
This convenience has won the company business with 15 of the 20 largest originators of federally guaranteed student loans.
One believer in the stock is Liberty Ridge Capital's chief investment officer, Jerome Heppelmann. He's directed the firm to build a 260,000-share holding, making it the second-largest mid-cap holding in its portfolio.
Mr. Heppelmann says simply, "[This company] has an in-house expertise that can't be matched." If that's so, then there seems little risk of the company losing any of its critical customers.
The company itself recently reiterated its estimate for 2006 of net income growth of 25%-30% over 2005.
Friday: Not much happened, other than the announcement that Google will replace Burlington Resources (BR) on the S&P 500 at the close of trading this Friday, March 31. It's the largest company ever added to the index. Index fund managers will need to buy the stock and it will be much more visible to the investment community. On that news, Google rose 7% and gave a positive bias to much of the technology sector. We, however, saw a significant gain only in our semiconductor equipment maker, which rose 1.9%.
That was the week.
I'll be out of the office next week and will not provide a weekly update. My next update will be posted on the weekend of April 8.
We received good economic news this week, and that sent the S&P 500 and our portfolio up every day.
On Wednesday afternoon, the Fed said that "labor cost pressures were little changed" and that "prices at the retail level increased at only a moderate rate."
Of course, investors are looking for signs of an end to inflation or at least of a leveling off that might stay the Fed's rate-raising hand. Wednesday's report dispensed a drop of hope that maybe there will be just one more rate hike. That hoped lasted all week, as stocks finished solidly positive. It was hard to miss the "Indices At Five-Year Highs" headlines that dominated the week's financial news.
Then, on Thursday, the consumer price index for last month came in at a modest 0.1% rise. It was expected to be 0.2%, so the report was good news. Prices rising more slowly than expected? Hmm, could that mean the end of rate hikes? Just the whiff of such a possibility created a light mood on the street. In fact, the data don't change the situation much yet.
Finally, this morning's industrial production report showed a 0.7% increase in February. That puts production up 3.3% in the last twelve months and into historical highs.
That's a big thumbs-up on the economy. A lot of people think the U.S. has no industrial base anymore, having ceded it to cheaper nations like China and Vietnam. Part of that misconception is that U.S. manufacturing employment doesn't grow anymore. However, that's due to gains in productivity. It simply takes fewer people to make more stuff than it used to. Every year, output goes up while payrolls stay constant.
Production is up 10% from three years ago, and looks set to climb another 3% this year.
We face a classic on-the-one-hand set of data. On the one hand, the economy is strong and that's always positive for business and stocks. On the other hand, if the economy looks too strong, it may bring further rate hikes and that's negative for business and stocks.
Which is why Warren Buffett's approach is generally the best: ignore the greater economic picture, ignore the market, and just focus on your own portfolio. If a stock is cheap and has good prospects, then buy it regardless of what's happening in the bigger picture. In the end, good companies come out on top. Good companies bought at good prices are the mother lode in this business, and they turn up in every economic environment. In fact, The Kelly Letter bought one just today.
Let's take a look back at the week.
Monday We received confirmation that our tech recovery plan is on track when several analysts confirmed our rationale. Reports from last week's Intel Developer Forum were widely circulated and shared this general overview:
Intel (INTC) will narrow or close the current price/performance gap against Advanced Micro Devices (AMD).
New Intel products coupled with Microsoft's (MSFT) new Vista operating system in November will boost PC revenue in the fourth quarter and into next year. PC unit growth will track at 12% this year and climb to 14% next.
While all PC vendors will benefit from the improved performance and lower prices resulting from the Intel/AMD rivalry, Dell (DELL) is likely to see the best incremental improvement. That's due mainly to its heavy reliance on Intel's chips. Dell arch-rival Hewlett-Packard (HPQ) will benefit less because it sells a broader array of AMD chips.
We own . We're firmly at the heart of this story.
Tuesday At last, some stimulating news from our brewer. The stock rose 1.7% after Deutsche Bank and Bear Stearns upgraded it, saying sales and prices appear to be rising.
Wednesday Some bad news for Sony (SNY) was good news for Microsoft.
Sony postponed the release of its PlayStation 3 until November due to delays in its new disk platform. The game console was scheduled for a spring launch. It's currently the dominant brand, controlling around 60% of the market.
Microsoft has been trying for years to gain market share for its Xbox, and this may finally be its chance. The new Xbox 360 debuted last November. Long-time readers may recall my report from Tokyo about the Xbox Cafe and signs outside major train stations. It was an impressive launch here in Japan.
What the Xbox has always lacked is a deep library of games. All developers still focus their efforts on the market share leader, leaving Microsoft and Nintendo behind. Now, though, there should be some shift to making Xbox games on the theory that publishing games that can be played today will provide a lot more revenue than publishing games that will sit in boxes until November.
Thursday Needham recommended overweighting the Internet sector for four reasons:
recent stock performance has not reflected fundamental performance and has been driven by fear
based on historical trading patterns, now is a seasonally good time to build positions in the group
the fundamental outlook remains solid, with key advertising and e-commerce indicators pointing to continued robust growth
valuations generally look attractive, particularly relative to expected growth
The firm says that large-cap stocks such as Yahoo, Google (GOOG), eBay (EBAY), Amazon.com (AMZN), Monster Worldwide (MNST), and IAC/InterActive (IACI) are likely to benefit the most from strong earnings and improving sentiment.
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We're seeing more activity at our electronics retailer. It restructured management by promoting four executives to executive vice president. The company said the move will simplify reporting, narrow accountability, and make for faster decisions.
The company also hired Wal-Mart (WMT) executive Cara Kinzey as senior vice president of information technology. Wal-Mart's inventory management systems are legendary. Maybe Cara Kinzey can infuse some of that magic into our retailer, and improve margins.
Friday The week's upbeat tone continued on lower oil prices and the lingering good mood from good economic reports. For the week, the Dow rose 1.8% while the S&P 500 and Nasdaq each rose 2%.
In the wake of Needham's Thursday report on the Internet, I delivered to subscribers an in-depth look at Yahoo. If you'd like a look at that, along with the rest of my portfolio, please try my one-cent, one-month trial. There's no long form to fill out, and I don't need your credit card number. All you do is enter your email address and your name, then click.
The market is range-bound these days. It doesn't want to go down because it has already corrected much of the excessive happiness of early January. It doesn't want to go up because of rising interest rates and the uncertainty over how high they'll climb.
This past week didn't ease concerns over interest rates. On Friday, the February employment figures were released. They were roughly along expectations. Payrolls were up 243k. After a downward adjustment of 18k to previous months, the net 225k gain was just a tad higher than the anticipated 210k rise. Hourly earnings rose 0.3%, right on target.
The report is good for the economy because solid employment and wage increases fuel growth. However, the report means precisely nothing in the debate over when the Fed will stop raising rates.
The market is anticipating two more increases for sure, and potentially a third. It's that third one that has people wringing their hands for two reasons. First, because they can't get a grasp on the odds of it happening. Second, because if it does happen it will crimp business spending significantly. To now, we've been getting back to normal from a long period of low, free-spending rates. Three more rate increases from here, though, and we will have moved past normal into restrictive.
Another factor to watch is bond yields. Prices and yields move in opposite directions. When a stock or bond drops in price, its yield goes up. Therefore, something with a high yield is seen as a bargain, or at least less risky than something with a low yield or no yield at all.
For the past three weeks, the 10-year U.S. Treasury Note's yield has been rising. Two weeks ago it stood at 4.57%. Last week it rose to 4.68%. This week it rose to 4.76%. If it keeps moving higher, bonds will become more attractive to investors than stocks. Money moving from the stock market to the bond market could push stock prices down. There is no forecast to be drawn yet, but I'll keep an eye on the 10-year note's yield.
Oil poked its head into newspapers again this week after OPEC said it would maintain current production levels. The price of crude slipped under $60 for a moment, but closed the week at $62. That's a dollar less than last week, but solidly in the recent price range.
Let's have a look at some individual investment themes, starting with the company we bought last Wednesday.
Semiconductor Equipment Maker We bought on Wednesday at $18.
Since January, the company has received four analyst upgrades:
Feb 03, Soleil, from Hold to Buy Feb 08, Banc of America, from Sell to Neutral Feb 14, AG Edwards, from Hold to Buy Mar 06, CIBC, from Sector Perform to Sector Outperform
The stock hit a high of $21.06 on Jan. 12 and has a 50-day moving average of $19.16.
Consensus forecasts show sales and earnings improving over the next two quarters. The average one-year price target is $23.74. Getting there from $18 would give us a 32% gain. I expect, however, to get to $27 for a 50% gain.
A month ago, the company beat earnings projections by growing more than 20%. Then, contrary to recent trends, it guided second quarter projections higher. It said that it expects orders to increase by 15-20%, double its previous estimate.
The stock has lagged its industry, but that's going to change. Foundries are increasing their capital expenditures. Both United Microelectronics (UMC) and Taiwan Semiconductor (TSM) reported high revenues and utilization rates last quarter. A 13-page, $6,995 report (no kidding) from Gartner published on Jan. 19 concluded that:
After two consecutive quarters of strong growth, the foundry market will suffer a seasonal dip in the first quarter of 2006. Demand orders are thereafter expected to improve gradually, pushing the industry utilization rates above 90 percent by the fourth quarter of 2006.
That means those foundries will need more and better equipment to make future generations of semiconductors. This company makes, sells, and services that equipment. Sales by geographic region in fiscal year 2005 were as follows: Taiwan 23%, North America 21%, Japan 20%, Korea 14%, Europe 13%, and Asia-Pacific 9%. Asia accounts for some 80% of sales, so positive reports on revenue and utilization, like those above from Taiwanese companies, are positive for this company as well.
Management has done a good job. The company's debt is in line with industry averages and its finances are solid. Cash flow is positive. Demand for its products and services has been strong. Last quarter, sales grew 4.3% to $1.86 billion.
Standard & Poor's maintains a 12-month price target of $26. From its March 6 stock report:
Our recommendation is buy. We expect momentum will continue to build through 2006 and see industry sales increasing 10%. We believe the semiconductor industry experienced demand weakness starting in the second half of calendar 2004. This trend reversed beginning in the second half of 2005. Management has noted that Japan and Taiwan continue to be a strong source of demand. DRAM prices have also started to increase, which is positive. We see as having the technological expertise and economies of scale to benefit from these global trends.
I'm happy to be riding this wave with this company. If you have not bought yet, there's still time. The stock closed the week 1.2% lower than The Kelly Letter paid.
I have fresh updates on Intel, Japan, RadioShack, and the 2nd Half 2006 PC Recovery, for which we're positioned in the top three companies. Only one of those three is substantially higher than the price I paid. That means now is a good time to try The Kelly Letter.
In your welcome notes, you'll see the semiconductor equipment company I just bought and which you can buy 1% cheaper than I paid. Plus, you'll see which three companies I'm betting on to benefit from the PC upgrade cycle later this year. One of them is trading 10.5% lower than I paid and one is a mere 0.3% higher.
This is almost always my approach: patience awaiting deep value. There is no doubt in my mind that the positions we're building now will turn into winners, just like our last four sales. Did you see those listed in the Kelly Command Center at the top left of this page? Here they are again:
Every one of them traded below my initial buy price before eventually rising to excellent gains. I'm repeating the pattern again, and hope that you'll join me before we're halfway to the final profit.
Would you like to have a look? The first month is only a penny, and then just $5.48 per month thereafter. Bet you didn't know leading information could be so affordable. It is here. I hope to welcome you soon.
Today, our order to buy at $18 filled. The stock ended the day at $17.88, so there's still time to buy shares if you didn't have an order in place.
Along with our investments in , this stock should do well for us when the technology sector turns up later this year on new chips and a new Windows operating system from Microsoft (MSFT).
