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Taking Stock

Tony Crowell

Blue Chips Signal Rally Ahead

 

 

The stock market remains unusually erratic. It went up five straight days, then dropped four straight days, losing 6% in one week. That was its worst week since the dark days of the financial crisis three years ago. With the third quarter almost over, market averages are down almost 10% for the first nine months of 2011.

In most cases, the companies whose stocks make up these averages have continued to increase earnings. Some in stronger sectors like technology are reporting record earnings. Others, especially the banks, continue to struggle. The economic recovery continues although its pace is slow and its strength has become a subject of partisan political debate.

This is unfortunate as the resulting damage to business and investor confidence hurts everyone. Investors will do well to try to ignore the prevailing hysteria and focus on more reliable factors. One group of objective indicators will begin emerging in a few weeks with the newest round of quarterly earnings reports. These are likely to show further earnings gains in most cases, quite possibly fuelling a market surge.

Stock price action of individual stocks often provides direction. In the most recent selling frenzy, just about everything went down, even gold, as speculators sold whatever they could to meet margin calls. Larger blue chips only grudgingly gave up ground, a reminder of their importance as the core of stock portfolios.

Apple (AAPL-$400), our largest position, made a new high on September 10, then was pushed down below $400 during the carnage but pushed back nicely. (It began the year at $325.) I expect it to hit $500, probably by the end of the year, assuming its September quarter earnings do not disappoint. Unlike politicians, Apple rarely disappoints.

Current earnings estimates range from $6.05 to $8.22 with an average of $7.10. Apple’s fiscal year ends in September and the average estimate for its full year is $27.55. That’s up from $15.15 a year ago, emphasizing both its remarkable growth and its reasonable valuation on traditional metrics.

IBM (IBM-$172) has paralleled Apple’s price action. It began the year at $147 and made a new high of $185 in August before backing up recently. These two stocks make the news regularly but Bristol-Myers (BMY-$31) is a more surprising member of this set. It began the year at $26 after flat stock price performance for the past ten years, then popped to new highs in the last ten weeks. Its earnings growth is not as flashy as these technological leaders but it offers a 4% yield.

Unfortunately, similar solid earnings progress by industrial companies is meeting only nervous selling. Both DuPont (DD-$41) and 3M (MMM-$75) are trading near their 52-week lows despite rising earnings, 3% dividend yields and bargain valuations. New reports will show further increases for both companies, probably followed by overdue investor buying as fears recede of a dreaded backsliding into another recession.

With gold prices battered along with everything else, Barrick Gold (ABX-$46) and Goldcorp (GG-$45) are attractive values. Both will soon report increased earnings from their extensive operations. Gold fanatics disdain mining stocks but the best investment for such goldbugs is psychotherapy as these stocks offer 1% dividend yields in addition to attractive valuations.

Energy stocks provide higher yields, a bit larger since their stock prices backed off with recent market jitters. The current fear in this sector is that a renewed global recession put the brakes on energy demand. This ignores accelerating demand from China, India and other developing economies.

Oil prices are traditionally volatile and the big international oil companies continue to demonstrate their abilities to keep growing sales, earnings and dividends despite all the agitating crises that provide fodder for the news media. ExxonMobil (XOM-$70), still the leader, swapped assets with Russia’s state-owned oil company in a deal that will give Exxon unprecedented access to the Russian Arctic as it opens for drilling.

Exxon yields 2.7% from its current dividend, which it has increased for 28 straight years. It is currently trading for only eight times its projected earnings for the full year. Like the other stocks mentioned above, Exxon will be reporting increased earnings in a few weeks, which will probably rally stock prices.

The debt crises in Europe and the U.S. this summer frightened investors, who sent stocks plunging. Ironically, U.S. government bonds, which had just been downgraded, seemed to be the only securities anyone wanted. This panicked buying drove yields down to record lows. As recent price performance of these substantial blue chip stocks indicates, investors are carefully returning to the higher returns available from stocks.

 

Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1993. [email protected] 949.494.1376/

800.697.2622 www.crowellroberts.com

 

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