Here Comes June, Here Comes The Economy
The economy contracted during the first quarter. The Atlanta Federal Reserve Bank, which accurately predicted this disappointing first quarter, just updated its forecast for the current second quarter to a 1.1% increase in GDP. This doesn’t sound like much but the update was up from 0.8% only two days earlier.
That update followed a new report that the U.S. trade deficit narrowed sharply in April from the March report that had ballooned on the strike in West Coast ports. This was one of the factors that had pummeled the first quarter together with another harsh winter, the slump in oil prices and the adverse effect on U.S. exports of a strong dollar. The strikers were back at work in March, while oil prices and the dollar’s exchange ratios seem stabilized, at least for the moment.
Our current economic expansion is six years old, above the post-war average. The 2007-2008 crisis was the most acute drop since 1929, which required fifteen years for recovery; six years is probably only a partial recovery. The Federal Reserve has agreed with its last rate increase in June 2006.
Its next “Open Market” meeting is on June 17. Stocks will behave nervously until then. An unlikely increase would cause a sell-off. The more likely postponement of an actual increase until the fall would pave the way for a benign summer in the stock markets. The employment report due June 5 will give guidance. There are hints of a deal in the Eurozone of a deal for Greece debt, which would give the markets a significant boost.
The combination of an improving economy and a future rate increase is a fertile environment for mergers and acquisitions. Deals are popping in the semiconductor sector, like the recent announcement of a buyout of Broadcom (BRCM-$54) by Avago Technologies (AVGO-$140). The founders of Broadcom, who own almost half its stock, have agreed to vote for the buyout, thus the only obstacle is regulatory approval.
The companies announced they expect the transaction to close in the first quarter of 2016, a conservative estimate, undoubtedly anticipating some regulatory issues. Avago is based in Singapore where favorable taxation may create political risks in the U.S. as an election year approaches. Should regulators block the deal, Broadcom stock would dip but its rising earnings and its value to alternative suitors make the merger arbitrage risk acceptable.
This buyout was followed by an announcement of a definitive agreement through which Intel (INTC-$32) would acquire Altera (ALTR-$51.60) for $54 in cash. As this indicates, the semiconductor industry is maturing with pressure on profit margins encouraging mergers. Their product lines are complementary and both are based in the U.S., removing one complication.
Regulatory approval, always the biggest potential obstacle, will take 3-4 months and Altera shareholders will need to approve the deal. The deal got mixed reactions from Wall Street analysts, possibly a reason Altera stock is trading over 4% less than the prospective merger price. If the deal takes six months to close, that equates to an 8% annualized yield sweetened by a couple of Altera dividends during the wait.
The prospect of higher rates is already causing bond prices to soften with the 10-year Treasury bond touching 2.40 percent, highest since November. Stock prices of debt-dependent companies like most utilities and many REIT’s are weakening and should be avoided.
Regardless of the constant parading by financial commentators of sundry reasons to worry, market averages remain in an overall uptrend. Concentrating on stocks of quality companies with growing earnings remains a winning strategy. Among recent buys, Aetna (AET-$115) and CVS (CVS-$100) are particularly attractive.
This is graduation season, a good time to suggest to those heading for new careers of the merits of starting investment programs as early as possible. Automated contributions are helpful as is staying away from malls and enjoying our summer. As Oscar Hammerstein wrote:
“May was full of promises/But she didn’t keep ’em quickly enough for some And the crowd of doubtin’ Thomases /Was predictin’ that the summer’d never come . . .”
Well, here comes June and here comes the economy.
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 1995. [email protected] 949.494.1376/800.697.2622
www.crowellroberts.com
