We made it! The world didn’t end and we didn’t fall off a cliff. All is well…or is it? Twenty years in the market has taught me that traders, and therefore markets, can be relied on for one thing: they will overreact to news, good or bad. In itself this is neither a good nor bad thing. It’s just a fact. It does, however, present opportunities to those who understand it. To assess whether the relief rally will continue, or fade as quickly as it came, we need to look at the underlying economic climate, not just the headlines.
On the negative side, nothing much has changed. Whoever your politics leads you to blame, this has been a remarkably unproductive Congress. It should be no surprise then that they have basically placed a band-aid over the gaping wound of continuing deficits and debt. The hard work of reducing spending is yet to come. Unemployment, while on the right track, is still stubbornly high. The economy is growing, but growth is anemic at best. There is hope for Europe, but the medium term outlook is still uncertain to say the least. Now that I am thoroughly depressed again, let’s look at the positives.
The housing market, arguably the biggest drag on consumer driven growth over the last few years, is continuing to improve. Despite disappointing holiday sales there are signs that the U.S. consumer is recovering somewhat. Corporate profits are decent. What we saw last year was a small increase in earnings on the S&P, but a significant increase in overall price to earnings ratio. In other words, investors are pretty optimistic about the future. Most of all, the Federal Reserve is still adding liquidity to markets.
I have said before that to me, as an old foreign exchange guy, the continued actions of the Fed tip the balance to the positive. That still holds true, leading me to the conclusion that the rally is real, but limited. I am bullish for U.S. equities in 2013 in general, though, I think there may be better opportunities elsewhere, as I said here. Within the broader US markets, however, some sectors can be expected to outperform.
In general, corporate profits have been pretty good. In the face of uncertainty, those profits have mostly been kept as cash, or returned to shareholders via share buy-backs and increased dividends. I believe that that trend is coming to an end, and growth will once again move to the fore. Continued growth in the economy, albeit slow, should create an environment where businesses begin to spend. I would love to say that this will result in significant progress on jobs, but I feel that before they hire most will look to improve efficiency by technology upgrades. Thus, technology companies that are focused on business sales, rather than consumer, could well be an area of growth.
NetApp (NTAP) is one such company. They are in the business of data storage and management. The stock had a disappointing year in 2012, falling from early year highs over $46 to $26.33 in November before bouncing back above $30. I have seen them mentioned elsewhere as a possible takeover target, but my opinion is based more on general improvement in the sector. As most business tech companies have been hit, NTAP has seen slight growth in revenue, and could be a major beneficiary of more capital expenditure across the board. There are other better known names that could also benefit, such as Cisco (CSCO) and Intel (INTC), but NTAP is more of a pure business to business play.
Salesforce.Com (CRM) is often touted as a company that will benefit hugely from investment in “the cloud.” They well may. They have an excellent product and good branding, but I am naturally loath to recommend a stock that isn’t profitable and trades at a forward P/E of around 85. To me the risk of one so- so quarter triggering a collapse is too high. I would prefer their more boring rival SAP (SAP). They are profitable, have less downside risk, and a 1.8% dividend yield certainly doesn’t hurt.
Businesses have been hoarding cash for a while. As the recovery grinds on, expect them to start spending. Make sure you get your share.