The Bank Plays On
The Federal Reserve is calling the dances for Wall Street at the moment. Janet Yellen, its Choreographer-in-Chief, announced Wednesday that it plans to keep interest rates near zero for a “considerable time” after the previously announced wrap next month of its bond-buying program. The Fed also reduced its 2015 forecast for economic growth to a range of 2.6%-3.0%, down from 3.0%-3.2% forecast in June.
Stocks had become fitful since the summer with their uptrend they re-established in August coming under pressure. The Fed’s announcement eased some immediate fretting and the Dow Jones Industrials inched up to a new record, closing at 17,265. Another report showed consumer prices falling for the first time in a year and a half while underlying inflation pressures remained mute, strengthening the Fed’s rationale for keeping rates low.
Although still modest, the economic recovery in the U.S. leads most of the world; in fact, the Fed is the only central bank even suggesting higher rates next year. If the U.S. does raise rates first, this would probably strengthen the dollar, further favoring U.S. stock markets over most others.
I can also imagine disturbances to overseas markets if the “Yes” vote prevails in the Scottish election. These could become aggravated with the pending independence election in Catalonia and also with political strains in Belgium from Flemish separatists.
The Fed continues to report steady improvement in the U.S. economy. It is still hard for jobseekers and others in less resurgent sectors but overall corporate profits are still setting new records. The stock market, measured by the S&P 500, is up almost 9% this year. Most stocks are keeping pace, thus their valuations, although perhaps high, do not appear strained. Earnings reports for the September quarter will appear in a few weeks, giving further direction.
Pending such guidance, fitful market action prompts emphasizing stronger stocks in better behaving sectors. Tech and biotech are traditional overachievers in response to their (usually) higher earnings rates. Apple (AAPL-$101), Intel (INTC-$35), Illumina (ILMN-$177) and Thermo Electron (TMO-$124) will post higher earnings. So will Amgen (AMGN-$142), Biogen (BIIB-$329), Celgene (CELG-$93) and Jazz (JAZZ-$163).
Irish-based Shire Plc (SHPG-$260) remains on track to be acquired by Chicago’s AbbVie ($59), which fought hard to make this deal. If completed, it would form one of the world’s 50 largest companies by market cap. Dependent on regulatory approvals, the buyout will probably close in 3-4 months, a most attractive potential return as the combination of cash and AbbVie stock currently presents a 10%-11% merger arbitrage spread.
Both companies reported solid earnings growth last quarter. The biggest risk probably lies in the U.S. Congress, which has been producing press releases without legislative progress that moan about potentially lost taxes through mergers with overseas-based companies like Shire. I doubt if the Congress can muster enough unity to block this merger and, even if they do, Shire negotiated a $1.6 billion breakup fee from AbbVie. If Congress wanted to accomplish something, they should lower the U.S. corporate tax rate, which is among the world’s highest.
Meanwhile, back at the malls, the American consumer is returning. Retail sales were up 0.6% in August and the consumer confidence index hit a post-crisis high. This prompts a new buy recommendation for Simon Property Group (SPG-$166), a global leader in retail real estate with operations across North America, Europe and Asia. Current estimates are for 3% overall sales growth this year and 5% in 2015 and for over $9.00 earnings per share for 2014. Simon is back on track after battering by the financial crisis and its stock yields 3% with increases for the last three years.
All in all, stocks are giving a good account of themselves among turbulent world conditions. Sticking with stocks of proven, growing larger companies will continue to be rewarding.
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
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