Even if you’re a roller coaster aficionado, the market’s recent ups and downs may have turned you a little green around the gills. Since our last newsletter in June, the S&P 500 has risen as high as 1,353 in July (only 10 points off of the yearly high set in April) and fallen to a new yearly low of 1,119 on August 8, reflecting a 21% decline. For 2011, the S&P has recovered from the August lows but is down 7% as the markets have continued to move sideways.
The triggers for this decline have remained much the same as in the past. As we mentioned in the last issue, the Q2 earnings cycle, inflation, and commodity prices have largely cooperated. But the political climate, unemployment, and the instability in European markets, have proved challenging.
The slide in the U.S. markets began in July as politicians became deadlocked over raising the debt ceiling. While the measure received the inevitable approval of Congress, investors, consumers, and business leaders, confidence was damaged in the process and there is still no real solution to the U.S.’s sizable debt burden. In addition, the failure of Republicans and Democrats to compromise serves as the "canary in the coal mine" as we enter the 2012 election season. As neither party will want to yield an advantage, proposals going forward are more likely to serve as the commencement of the 2012 campaign rather than grounds for compromise legislation.
Both the unemployment and underemployment rate - after improving somewhat earlier in the year - increased to 9.1% and 16.1% respectively. Most of the recent jobs cuts have come from the public sector as federal, state, and local governments struggle with increasing deficits. While the private sector improved modestly, recent mass layoff announcements by Bank of America and others represent more clouds on the horizon. Another important indicator - weekly jobless claims - has remained above the key 400,000 level since April of this year excluding one week in August. In order to see improvement in the unemployment rate, jobless claims must mark consistently below this level. While Republicans and Democrats introduce competing jobs bills to address the issue, enacted legislation is unlikely to have any impact until 2012.
Concern about U.S. exposure to the sovereign debt of Greece, Ireland, Portugal, Italy and Spain hasn’t subsided as the European Commission and the European Central Bank have been challenged to find solutions. The increasingly sluggish economic growth within the European Union has heightened the problem as the measures introduced have had minimal impact. Greece, once again, is at the forefront of the crisis as concerns intensify that it will default on its obligations, leading to a cascading "Lehman" effect for the rest of the world’s economies.
Despite these issues (as well as other lingering ones such as the poor housing market) the economy should continue to grow, although more slowly than forecasted at a 1.5% to 2.0% rate through the end of the year. Second-quarter operating earnings for the S&P 500 Index companies showed double-digit percentage gains on a year-over-year basis with over 70% of companies exceeding analyst estimates. That said, companies have reduced forward earnings expectations, while CEOs and analysts remain optimistic that the U.S. will avoid a "double dip" recession. In addition, cheap credit markets should continue to benefit companies looking to make investments, acquisitions and/or reduce their overall cost of capital.
The Maven Wave IT Spending Index also demonstrated strong performance in the second quarter, increasing 6% versus a predicted 3% and thereby signaling that businesses are investing in information technology in order to streamline operations and to offset rising raw material costs as well as to facilitate revenue growth and improve earnings. This continues to be a positive sign going forward, as in the past recession, companies cut IT spending dramatically in front of the downturn.
For these reasons we remain cautious, but optimistic, about the low probability of the U.S. entering another recession. As the U.S. economy continues to be in a delicate state, any additional changes in the factors outlined here could have a significant impact in months ahead.
1 – Index Components
Transportation: CH Robinson Worldwide Inc. (NasdaqGS:CHRW), Expeditors International of Washington Inc. (NasdaqGS:EXPD), FedEx Corporation (NYSE:FDX), Southwest Airlines Co. (NYSE:LUV), Union Pacific Corp. (NYSE:UNP), CSX Corp. (NYSE:CSX), Delta Air Lines Inc. (NYSE:DAL), United Parcel Service, Inc. (NYSE:UPS), and Norfolk Southern Corp.(NYSE:NSC).
Retail: 99 Cents Only Stores (NYSE:NDN), Dollar Tree Inc. (NasdaqGS:DLTR), Family Dollar Stores Inc. (NYSE:FDO), J.C. Penney Company, Inc. (NYSE:JCP), Kohl's Corp. (NYSE:KSS), Nordstrom Inc.(NYSE:JWN), Big Lots Inc. (NYSE:BIG), Target Corp. (NYSE:TGT), Sears Holdings Corporation (NasdaqGS:SHLD), and Macy's, Inc. (NYSE:M).
Healthcare: Amgen Inc. (NasdaqGS:AMGN), Eli Lilly & Co. (NYSE:LLY), Gilead Sciences Inc.(NasdaqGS:GILD), Johnson & Johnson (NYSE:JNJ), Abbott Laboratories (NYSE:ABT), Bristol-Myers Squibb Co. (NYSE:BMY), Merck & Co. Inc. (NYSE:MRK), Pfizer Inc. (NYSE:PFE), and Schering-Plough Corp. (NYSE:SGP).
Telecom: CenturyLink (NYSE:CTL), SBA Communications Corp. (NasdaqGS:SBAC), Verizon　Communications Inc. (NYSE:VZ), AT&T, Inc. (NYSE:T), Sprint Nextel Corp. (NYSE:S), Windstream Corporation (NYSE:WIN), MetroPCS Communications Inc. (NYSE:PCS), and Crown Castle International Corp. (NYSE:CCI).
Financial Services: American Express Company (NYSE:AXP), Bank of America Corporation (NYSE:BAC), Berkshire Hathaway Inc. (NYSE:BRK.A), JP Morgan Chase & Co. (NYSE:JPM), The Bank of New York Mellon Corporation (NYSE:BK), Goldman Sachs Group Inc. (NYSE:GS), Morgan Stanley (NYSE:MS), US Bancorp (NYSE:USB), and Wells Fargo & Company (NYSE:WFC).
2 – Enterprise Value equals market capitalization plus net debt (long-term debt plus short term debt less cash and cash equivalents.
3 – TTM: Trailing Twelve Months
4 – EBITDA: Earnings before interest, taxes, depreciation and amortization
5 – BV: Book Value
6 – M&A comparables over the past trailing twelve months. Includes all transactions as reported by Capital IQ over the selected period and industry.