Market Call: Yu-Dee’s Mid-February Notes

Earnings

So far 340 companies in the S&P 500 have reported earnings, and 227, or 67% of those companies have exceeded expectations. The ten-year average is 62%, so it looks like the fourth quarter was a good one in that regard. By sector, we’ve seen an underperformance in the energy and materials sectors, which have had sluggish sales; this is a key indicator in this economic climate. Conversely, financials posted good earnings that took them to five-year highs. We saw plenty of bank insiders and executives take profit on bank stock they owned. We also saw healthcare stocks post good top line performance and profits. So earnings-wise, the stock market is looking pretty good right now.

Rally

Yesterday the S&P 500 Index was trading around 1520, which is up about 12% from the low we made on November 15^th. Since March of 2009, the average market rally has been 12.88%. So just going by averages, this rally could have a little bit left before we see the next market correction. That would put its trading at about 1520. But right now, people are getting bearish on this market. We had an extraordinary rally through the month of January, and people may want to take some profit. Also, generally speaking, February is historically a flat to down month. And the pulse of the market is negative. I have never seen so many people hate a rally like they’ve hated the 12% we’ve gained since mid-November.

Correction

If we look at the S&P 500 Index, from the high of 1465.77 on September 14^th, we declined 7.67% on a closing basis to a low of 1355.33 on November 15^th. This is really interesting because since the market low in March 2009, the market has gone into a correction twelve times. These corrections averaged 7.66%, which was exactly the percentage of the correction we experienced in the fourth quarter of 2012. So I believe we could see a correction in the 5% to 8% range. But it’s important to get ready to buy this market on pullbacks. This Fed-supported market has a lot of room to go to the upside this year. When it’s all said and done, we could be up anywhere from 13% to 17% in 2013.

Apple

Apple is still a good company that makes good products, but they’re losing market share. There is not a lot of perception in the market that it will continue to be a super growth company. Right now there isn’t any momentum or clear visibility in the market.

Apple CEO Tim Cook today argued that the company’s product magic is still deeply at work despite increasing questions over Apple’s next big thing and its growth prospects as the company’s stock has shaved off more than 30% of its value in recent months.

“I’ve never been more bullish on innovation of Apple,” Cook told investors attending the conference at the Palace Hotel in San Francisco. Shares of Apple slid 2% to $471.67 in midday trading after the event appearance. Apple’s stock is down from a 52-week high of $705.07 reached in September. He pointed out that Apple sells more iPads alone than Hewlett-Packard’s entire PC lineup. “The iPad is the poster child of the post-PC revolution.”

Rival Google last year bought Motorola Mobility for $12.5 billion in what many expected was a play for patents and in-house hardware expertise to better go up against iPhones and iPads. Microsoft last year unveiled its Surface tablets in a first home-brewed hardware-and-software move into tablets and a new direction.

Cook faced a number of questions in a bid to gauge his thinking on areas spanning its massive $137 billion cash in use for dividends or acquisition, the company’s growth and its profit margin pressures. “What Apple does is sweat every detail,” he said.

Intel

Intel is past its prime and it doesn’t look like the company can deliver the results it used to. The Ultrabook isn’t meeting expectations, and their plan to make hybrid phone/tablets (phablets) is very skeptical. Intel remains the strongest company in its industry and no one can rival their manufacturing or their ability to make chips. Intel revolutionized personal computers with its chips, but right now it doesn’t have the chips that they can put into smartphones or tablets. As a result they’re lagging in one of the hottest and most profitable industries. Expect low single-digit growth and an above average dividend, the same as an industrial company.

The company announced today that it would be introducing an internet-based TV service box this year.

Intel will be providing the hardware and services directly to consumers, and the box will come with a camera that can detect who is in front of the TV. Intel declined to provide many details — including the service’s name and programming partners – but said the service will let users watch live TV, on demand, and other offerings. Though Intel hopes to revolutionize the TV industry, the service will resemble current cable offerings in some key ways. For one, don’t count on saving money with Intel’s new offering. Intel noted its push isn’t a value play and will not cut a user’s television bill in half. In addition, users won’t be able to pick and choose certain channels but will likely subscribe to bundles curated by Intel’s team.

Intel’s history in the TV industry has been rocky. It was early to push Google TVs and other smart TVs, with its processors powering a Sony Google TV and a Logitech Google TV set-top box. However, such products flopped, and Intel shuttered its TV business in late 2011 after failing to gain much traction.

Financials

The banking industry is still one of the best sectors to invest in. Even though the industry can face extreme highs and lows along the way, many observers believe that the sector is stable compared to investing in alternative markets. Since its downfall in 2009, the banking industry has been rebounding, with investment banks showing impressive growth over the past few years. Also, most of these investment banks believe that there are several good years ahead, with expected U.S economic growth as one of the contributing factors.

Goldman Sachs (GS, S$153.82) did quite well in 2012. Q4′s earnings report showed a net profit increase to $2.9 billion. This increased EPS to $5.60 is a significant improvement from the same quarter in 2011. The earnings for the full year came out to $7.5 billion which showed an increase of over 70%, compared to the $4.4 billion earnings in 2011. It is currently trading at a 52 week high at $153.82.

JP Morgan Chase (JPM $49.21) one of the world’s largest asset management firms, is another strong bank in the financial industry, which is expected to grow further in 2013. After the “London Whale” incident, which resulted in a loss of $6 billion, JPMorgan’s financials still look strong and it seems like if many have already forgotten about the loss after the latest earnings report. The latest report showed that revenues increased by around 10% for the quarter, while full-year profit reached another record at more than $21 billion. Apart from that, the firm’s EPS of $1.40 also beat expectations by nearly 16%. Jamie Dimon, JPMorgan’s chairman and CEO, recently said that all the divisions performed exceptionally well in the quarter, with strong growth expected further in 2013.

Wells Fargo (WFC $35.50) has also been making headlines. Wells Fargo is one of the largest banks in the world and is set for long-term growth for patient investors. Still one of the biggest banks in the world, Wells Fargo is just behind JPMorgan in terms of market capital.

The company’s recent earnings report showed a record quarterly profit of $5.1 billion, which shows an increase of 24% compared to 2011′s last quarter. Also, the total profit for the year showed an increase of 19% to $18.9 billion, compared to the year before. Meanwhile, an EPS of $0.91 also managed to beat the $0.89 expectation of analysts.

Wells Fargo is certainly seen as a brilliant long-term investment opportunity, with the firm expecting further growth over the next couple of years. One of Fargo’s strengths is the recovery in the housing sector, with the company being able to lend smartly, compared to its competitors.

Homebuilders

This leading stock sector has been one of the biggest positive industry groups since October 4, 2011 and they have outperformed the recent rally. Lennar Corp (LEN, $40.00) is up 14% since November 15th, DR Horton (DHI, $24.00) is up 30%, and Ryland Home (RYL, $39.00) is up 27% compared to the S&P 500 Index which is up 12%.

Overall most of the builders reported positive results this quarter. Deutsche Bank research shows that 70% of builders beat expectations while only 20% were in line and just 10% missed expectations. The builders generally performed well in gross margins, which is of huge importance to investors after strong stock performance. And 90% of the builders showed upside on gross margins in their fourth quarter results. Order growth was also generally strong this past quarter, with a median of 35% year-over-year growth, which is higher than the consensus forecasted 29% growth. 90% of the builders were
either in line or above consensus on order growth.

Mortgage rates that continue to be at historical lows, combined with an economy that appears to be slowly but surely improving, should continue to provide a tailwind for the industry. After almost three years since hitting their lows in March of 2009, the homebuilding stocks have been one of Wall St.’s top-performing sectors. The challenge for investors at this point is not only choosing the right name, but picking the right entry point.

China Summary

Overall, China has been putting out some good economic numbers recently. China is posting impressive trade data that indicates its economy is growing and inflation is under control. Critics of these numbers say that China manipulates their numbers and can’t be trusted. But all of the numbers are relative anyway. There is little doubt that China is an important part of the global economy and it seems that their economy is improving.

However, China still needs to reform their economy if they are to become a modern economic superpower that they want to be. They need to create more robust and regulated capital markets, fight corruption, decrease income disparity, and eventually free-float their currency. The new leadership seems willing to reform, but the transition of power is still going on. Also, the Communist party is split between hardliners and reformers.

This week we saw China stand with the rest of the world against the actions of North Korea when they condemned nuclear tests. The question remains whether or not they will impose sanctions on their Communist ally.

Economic Numbers

Trade

Combined total for imports and exports of Chinese goods hits $3.87tn, edging past the US for the first time.

China has become the world’s biggest trading nation in goods, ending the post-war dominance of the US, according to official figures.

China’s customs administration said the combined total for imports and exports in Chinese goods reached $3.87tn (£2.4tn) in 2012, edging past the $3.82tn trade in goods registered by the US commerce department.

For many countries around the world, China is becoming the most important bilateral trade partner.

It is another milestone for China, which became the world’s biggest exporter in 2009, and has been averaging 9.9 per cent growth since the economic reformation of the late 1970s that followed the death of Chairman Mao.

Growth

China’s exports and imports surged last month, far more than expected, its aggregate financing topped analyst expectations and inflation slowed, indicating that the world’s No. 2 economy is set for strong and sustainable growth.

Imports surged nearly 29 percent and exports climbed 25 percent, narrowing China’s trade surplus to $28.2 billion

Financing jumped to 2.54 trillion yuan ($407 billion), and inflation appears under control: It fell in January to 2 percent from December’s 2.5 percent, which was a seven-month high.

Jan exports +25.0 pct y/y vs +17.0 pct forecast

* Jan imports +28.8 pct y/y vs +23.3 pct forecast

* Jan trade surplus $29.2 bln vs $22 bln forecast

Social

Last month, China’s statistical agency said that the nation’s Gini coefficient, a commonly used measure of income inequality, was 0.47 in 2012. That figure ranks China near the United States, but well behind many of the world’s developed economies.

Some analysts contend China’s official statistics understate the magnitude of inequality, and others warn the gap between rich and poor is already wide enough to potentially inspire social unrest in the country.

North Korea

North Korea conducted its third nuclear test on Tuesday in defiance of existing U.N. resolutions, drawing condemnation from around the world, including its only major ally, China, which summoned the North Korean ambassador to protest.

North Korea said the test was an act of self-defense against “U.S. hostility” and threatened further, stronger steps if necessary. China, which has shown signs of increasing exasperation with the recent bellicose tone of its neighbor, summoned the North Korean ambassador in Beijing and protested sternly, the Foreign Ministry said.

Foreign Minister Yang Jiechi said China was “strongly dissatisfied and resolutely opposed” to the test and urged North Korea to “stop any rhetoric or acts that could worsen situations and return to the right course of dialogue and consultation as soon as possible”.

China is a permanent member of the Security Council. The test is hugely insulting to China, which now can be expected to follow through with threats to impose sanctions.

Economic Reform

Income Disparity

Last week the Chinese government released a plan to close the gap between the rich and the poor and to fight corruption. The plan will boost minimum wage in most parts of the country to 40% of the average salary by 2015,  this will increase property taxes, estate taxes, and will limit salaries at government-owned businesses. It will also increase taxes 5% for state-owned enterprises, money that will be used to fund social welfare programs.

Corruption

China’s government has pledged to make corruption a top priority, but a recent wave of scandals involving graft and embezzlement have embarrassed the country’s top leadership.

Account after account of officials and executives who have used their power for personal gain have surfaced in recent months, sparking outrage on social media sites popular in China.

The series of scandals have complicated the handover of power taking place at the highest levels of government. Xi Jinping, already installed as party boss, will assume the presidency in March and has pledged to tackle corruption. He has warned that corruption will lead to “the collapse of the party and downfall of the state.”

Yu-Dee Chang

Founder and President

Chesapeake Investment Services, Inc.

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