The Fear of Default Contagion is Rage'n – The AIA Advocate Newsletter

In This Issue:

The Fear Of Default Contagion Is Rage’n

The Debt Ceiling Deadline Also Worries Investors

Growth Is Weak, But The Second Half Should Be Stronger

Energy Stocks Should Lead A Market Rebound

Blue Chip Tech Stocks Should Also Do Well

The Bottom Line This Month

Stocks continued the slide they began in late April. For all the wailing and gnashing of teeth by investors we might think the market is in freefall. In fact, the Dow and the Nasdaq are only down 4.3% and 4.6% respectively for the two months. Such modest declines don’t even qualify as a correction, much less a bout with the bear.

The stock market numbers for the past 30 days are even less alarming: the two indices eased back 1.1% and 1.5%. The slowdown in the slowdown suggests to us that the slide may be running out of steam.

The Fear Of Default Contagion Is Rage’n

The biggest problem that’s bothering investors is the financial version of a Greek tragedy. This time around, the drama isn’t nearly as interesting as those penned by Homer and Sophocles, but the final has more punch.

The plot of the story revolves around the inability of the Greek government to pay its considerable bills. When Greece dropped the drachma and adopted the much richer euro, the country went on a spending spree. Unfortunately, the money wasn’t used to increase the country’s output of goods and services. Instead, the public sector ranks swelled, wages and pensions were plumped up, and welfare programs went viral. Now the bills are coming due, and Athens doesn’t have the money.

If Greece defaults on a batch of bonds that will mature in mid July, the banks that issued them will be in serious trouble. Since the European banks are all linked together in a giant debt furball, the pain will be spread widely. A series of bank failures could occur.

But that’s not the worst of it. If Greece skips out on its debt it is likely that Portugal and Ireland will do the same. In that case, the toxic relay could spread to Spain whose debts are even larger. Such a chain reaction meltdown would have global repercussions.

Because the stakes are so high, we think Greece will get the loans it needs to get through the next few months. Of course, that won’t do more than kick the can down the road. In theory at least, putting the judgment day off will give Europe time to come up with a more permanent solution to the debt problem. We shall see.

The Debt Ceiling Deadline Also Worries Investors

Never one to be outdone, especially by the Greeks, the U.S. created debt problems of its own, and they are positively Herculean. The most immediate concern is Congress’ failure to raise the government’s debt ceiling which must be done by August 2. If not, federal checks may start to bounce.

Failing to get its financial house in order by the deadline would also bring into question the near sanctity of U.S. Treasury bonds. Currently Uncle Sam’s bonds carry the highest AAA rating, which is one of the reasons they can pay such little interest. If the rating should fall even a smidgeon to AA+, the bonds would no longer look attractive to many buyers until yields go up. Of course, high rates would retard economic growth, which would be bad for stocks.

As with the Greek problem, however, the outcome of a U.S. spending freeze would be so catastrophic, we are confident it won’t be allowed to happen.

Growth Is Weak, But The Second Half Should Be Stronger

The last big item in the worry department is U.S. economic growth, or more specifically the lack of it. The first quarter tally was an abysmal 1.8% (or 1.9% as revised), which is a lot closer to zero than is comfortable.

Second quarter growth was expected to be close to 3%, but it now looks as if the number could be as low as 2.1%. If so, some stock prices may be too high, which is why investors are allowing them to slide.

Unlike the situation with debt that can be put off, a slow economy isn’t quite so easy to fix. Just ask Mr. Bernanke at the Fed who has been trying to goose the economy for three years and doesn’t quite seem to have the hang of it. Nevertheless, hope springs eternal on Wall Street as everywhere else. Several respected economists think the economy will start to pick up in the third quarter. We think they are correct although we don’t expect to see a barnburner.

Energy Stocks Should Lead A Market Rebound

Putting it all together makes us think the stock market is likely to have a rebound within a few months. Besides improving the debt problems and seeing the economy tick up a bit, many stocks are just plain too cheap. In fact, many of the world’s leading blue chips are back to levels last seen 20 years ago.

The leading energy stocks look especially attractive to us because oil prices have dropped in recent weeks. Part of the decline is due to the government’s decision to open the Strategic Petroleum Reserve (SPR) to help bring gasoline prices down for the summer driving season, not to mention the start of the federal election season.

However, oil seems likely to recover once the SPR boost ends. Ditto if we are correct about having better economic growth this fall. The world’s appetite for energy is also in a long term upswing. All in all, we think energy stocks will be excellent performers once they get through this soft patch.

Our top energy recommendation remains ExxonMobil (XOM), the world’s largest and best managed energy company. The stock dropped from $87.98 on April 29 to just $80.25 on June 29, an 8.8% decline. That put the forward P/E at just 8.7, which looks cheap to us.

The stock’s 2.4% yield isn’t earthshaking, but it’s better than 3-year CDs are paying. Exxon’s dividend has also been paid every year since 1911, a century record that few stocks can match. Moreover, on a split-adjusted scale, the company has not decreased its dividend since 1956.

If you are looking for reliable income plus the prospect of good capital gains, we think ExxonMobil is a stock to have.

We also like the outlook for Arch Coal (ACI) America's second largest coal producer with about 15% of the total supply. The company specializes in low-sulfur coal that creates less pollution and lowers clean-up costs. As a result, the company’s coal sells for a premium.

We also like the outlook for Arch because its main competitor, the shale gas industry, is under fire for creating water pollution problems that are almost impossible to clean up. Natural gas prices are also expected to rise and reduce the advantage it currently has over coal.

Also in Arch’s favor is the nuclear disaster in Japan that has turned the public in many countries against that power source. The result can only be more coal-fired electric plants. U.S. electrical companies plan to increase their coal-fired capacity by 30% over the next five to eight years.

The fundamentals for Arch are also favorable. The price fell from $34.17 on April 29 to just $25.81 yesterday, a 24.5% drop. Investors are nervous about the slow economy having an impact on volatile coal prices and about the company’s decision to buy International Coal Group (ICO) for $3.4 billion. As a result, the forward P/E is a low 6.5. The yield is only 1.70% but Arch Coal is primarily a capital gains play.

Blue Chip Tech Stocks Should Also Do Well

Tech stocks also look very good to us. Not only is the low dollar boosting exports, many businesses are upgrading their IT networks this year. Nevertheless, the broad sell off on Wall Street brought already-cheap tech giants even lower.

We continue to think that Intel (INTC) is the leader of the pack because its proprietary chips power so many devices.

Throughout most of the 1980s and 1990s Intel was priced out of reach. Now it is back down to earth at $21.39, a 6.9% decline from $22.97 on April 29. The forward P/E is only 9, vs a five year average of 17.8. That’s remarkable since earnings have been growing 11.1% of late, vs a 5 year average of 7.5%. The yield is 3.40%. The company has a strong balance sheet.

Intel even has a good track record during poor economic times. During the tough 2008-2009 period, the company had an impressive $10 billion in positive cash from operations. If you have been looking for an opportunity to add this blue chip tech giant to your portfolio, we think this is it.

The Bottom Line This Month

Stock prices continued to slide last month, although the pace of the decline slowed. We think the trend will reverse once the European debt crisis has been put on hold and the U.S. government’s debt ceiling has been raised.

Dozens of excellent stocks look very attractive to us. Our favorites continue to be the multinational blue chips that help create, not just participate in, the global economy.

Looking especially good right now are ExxonMobil and Arch Coal that have been hit by falling energy prices in addition to the declining stock market. Tech giant Intel also looks attractive and should perform well in long-term portfolios.

Until Next Month

The AIA "Advocate For Absolute Returns," a publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next time...


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Posted 06-30-2011 11:08 AM by Research & Editorial Staff