It won't be long now before college football is in the (soon) slightly cooler air, but first we have to work through those rituals that mark the waning days of summer: families returning home from their last vacations, kids going back to school, and the thousands of Elvis fans who will make their way to still-sweltering Memphis and Graceland to pay homage to The King. As part of our own tribute to The King this week, we'll offer up a bit of Elvis-inspired investment analysis, made to fit the occasion with some only slightly tongue-in-cheek observations. Let's get started.
Don't Be Cruel
With apologies to T.S. Eliot, it is August, not April, that serves as the cruelest month for fans of The King, as it was during that time in the summer of 1977 that Elvis shuffled off this mortal coil and went to that great Jungle Room in the sky. I like to think of Elvis up there right now, sharing a fried peanut butter and banana sandwich with Buddy Holly and Michael Jackson--maybe getting ready to party with Janis Joplin and Jimi Hendrix.
When it comes to being cruel in this temporal world, the market has plenty of cruelty to dish out to investors, and nowhere is that on display more than when companies report financial results that disappoint the market. The concerns over the European crisis, slowing growth in China, and how all of that will hurt the U.S. economy--a global slowdown, in other words--have investment analysts especially focused on the forward guidance offered by companies when they report their quarterly earnings. The quarter posted by Priceline (PCLN, $563) recently, where earnings per share clocked in at $7.85 versus the $7.37 estimate, was immediately overshadowed by the below-consensus guidance that the company issued for the remainder of the year--guidance that explicitly cited Europe as a major factor. Adding to this gathering storm are worries about the tax increases and automatic government spending cuts slated for the first of next year. The government needs to get control of its spending, but taking such a massive chunk out of aggregate demand right now could paralyze an already limping economy. Put all of this together, and the recent strength we have seen in the market is even more astounding (a little Suspicious Minds music would be in order here). The market seems ready to move up at even the slightest hint of better economic news, or at the mere notion that some of these problems might be resolved. My own sense is that we will not see Congress deal with the so-called "fiscal cliff" until after the election, if then.
The historically low interest rates we are seeing visit another form of cruelty on savers. Make no mistake about it, these low rates are good for the economy overall--they pave the way for increased business investment (what the economy needs most), make mortgages more affordable, and make it possible for consumers to refinance their debt burdens. Those savers who need interest income in retirement are about the only ones who get left out of the party. How can low interest rates persist in the face of our government's staggering borrowing needs? Or, to put it another way, why are investors willing to accept such meager yields on bonds? Part of the answer is that many of the investors buying bonds are not investors at all--they're central bankers. While the oxymoronic combination of low rates and huge deficits seems to violate the basic laws of economics, the condition may very well continue as long as the Fed is buying bonds to keep rates low and liquidity flowing into the economy. Mr. Bernanke is not buying those Treasury bonds for retirement income.
Viva Las Vegas
If Elvis were performing this song in 2012, he might have to call it "Viva Macau," that being the region in China where Vegas now resides, not in terms of literal geography but in terms of concept. Just like the hopes of many gamblers, the promises of Macau have been dashed, at least for now, with the slowing growth in China, or at least the perception thereof. That has meant broken dreams for shares of Las Vegas Sands (LVS, $39), where growth seems to be slowing. Also, as we cautioned before when we looked at LVS, the combination of a highly regulated industry and a foreign government can add up to some high-stakes shenanigans, either real or perceived. LVS has been in the headlines lately with more such unpleasant allegations. The stock is down, and a recovery will require some patience. However, I still believe in the allure of gaming for people all over the world, and I especially like a business where the house always wins.
Heartbreak Hotel
In a world where economic growth is slowing and recession is threatening, the hotel industry is typically not one of the places where you would want to invest. More broadly speaking, what is most puzzling about this market is that some of the industrial stocks have been relatively strong--at least their price behavior is not forecasting an economic apocalypse. Emerson Electric (EMR, $51) and General Electric (GE, $21) are within striking distance of 52-week highs; oil service stocks such as Schlumberger (SLB, $75) and National Oilwell Varco (NOV, $77) have rallied well off of their lows. The market is always telling us something, and that may not always be the same as what the news media are telling us. The market is giving us a mystery, wrapped in a conundrum and cloaked in an enigma. In the hotel sector, Starwood Hotels and Resorts Worldwide (HOT, $54) now trades about 10% off of its 52-week high; it has actually been stuck in a range about 10% either side of its current level all of this year. I like the company because it manages, rather than owns, a number of the hotels that bear its flagship brands (St. Regis, W, Westin, Sheraton). The market seems to be taking some former high-flying stocks to the woodshed (Priceline), while sparing the rod on those stocks that have not had such massive gains. Taking all of this into account, I have to think that the market is either ignoring a looming disaster, or that there is no disaster looming.
Return to Sender
Part of successful investing, at least as I see it, involves understanding the big picture (the macro picture) of emerging and prevailing trends and finding individual companies (the micro picture) where those trends are manifest in robust financial results and stock prices. This has been the case with the discount retailers, where the stock movements both signaled and confirmed both the beginning of a trend and its persistence. It makes sense to consider whether other companies might benefit from what are now some well-established aspects of our "Tale of Two Cities" economy. Today we'll nominate Rent-a-Center (RCII, $35) as a stock that should fit like a glove, but has yet to prove conclusively that we have a matching pair. What we can say is that the rent-to-own concept makes sense for a lot of people in this wobbly economic recovery. The company's latest earnings came in above expectations, but revenues were below forecast. That is shaping up as something of a pattern for stocks in this economy, because companies have done a remarkable job of cutting costs and strengthening their profit margins--so we'll see those companies that beat their earnings estimates but miss on their top line revenue. This one bears watching, but true growth investments can't rely on expense reductions alone without solid top line growth.
Burning Love
It may not be the type of burning that Elvis felt for Priscilla, but you have got to love it when companies report stellar financial results and surprise the market in a positive way. One of the more prominent surprises of this earnings season came from Mellanox Technologies (MLNX, $112), the Israel-based designer and supplier of connectivity solutions that optimize data center performance. The shares rose about 40% after the report in July, and since then have added yet another 20%. Probably what investors cheered most was the company's guidance for projected revenues at some 50% above analysts' expectations. Investment firms have been increasing their earnings estimates and price targets on the stock, with one share price target as high as $150 per share. The big concern right now is that the slowdown in economic growth around the world will hurt corporate earnings. Analysts are especially focused on the guidance comments that companies make when they report earnings and are listening for any indications that estimates of future earnings are too high. If those estimates have to come down, then stock prices will likely decline also. That is exactly what we saw with Priceline. So, when a company like MLNX, which is benefiting from the "big data" trend, says that their business is booming, there is this huge relief that at least some sectors and companies are not being affected by the slowdown. Investors bid up the prices of these stocks, and the fact is that there are fewer and fewer of such stocks today--and they are getting harder and harder to find. Of course, investing can be a lot of fun when earnings overall are growing strongly and the market is surging, but I think that is the equivalent of going big game hunting at the zoo. What is more challenging--and ultimately more rewarding--is finding those companies that are doing well in spite of the economic headwinds.
Are You Lonesome Tonight?
I suspect that I am not the only person who once looked at the idea of online dating as a mild form of pornography, the revealing of oneself to strangers (which is what porn really is) without taking one's clothes off. However, matchmaking Internet style has now gone mainstream and converted quite a few of the skeptics. It is no longer seen as the domain of the desperate, but rather as a convenient shopping ground for people too busy to check out potential mates the old-fashioned way. That brings us to Match.com, one of a number of Websites owned by IAC/Interactive (IACI, $52). IACI also owns Ask.com and a total of more than 50 Internet businesses in more than 30 countries. Another company whose business is built on a collection of media brands is Scripps Networks Interactive (SNI, $60), which owns Home and Garden Television (HGTV), the Food Network, and the Travel Channel, all of which offer Websites to supplement their television content. I like companies that have built strong brand franchises, and I especially like to find the ones with Internet exposure that have not been over-hyped. IACI and SNI offer plenty of content to keep you occupied on those otherwise lonesome nights.
To all of the Elvis fans who will be "touching down in the land of the Delta Blues" this week, I wish for you a safe and enjoyable stay in our city. Goodnight, Elvis. May you continue to rest in peace.
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of PCLN, LVS, SLB, NOV, IACI, SNI, and MLNX. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security. Stock prices are as of Friday afternoon, August 10th, 2012.
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