Is the earnings rally starting to lose steam? Big surprises are moving stocks less

As earnings rallies drive along–and we’re sure in one now–investors gradually start to expect good news. More and more earnings surprises are anticipated by stock prices that start to climb before the results are reported. Part way through the earnings season a big surprise doesnt move a stock much any more since the news has been baked into stock prices in advance. And finally, the rally reaches the stage where prices actually fall on great news since even the great has been anticipated by rising prices and investors now sell the news.

I don’t think we’ve reached that last stage yet. But I can see the middle stage starting to unfold. Read more

Qualcomm to manufacture Kindle in UK

According to Electronista.com, Amazon is almost ready to set a UK release date for the Kindle.  ”Manufacturing responsibilities for a UK Kindle are said to be going to Qualcomm, who is also allegedly responsible for finding a regional cellular carrier.”

Buy Qualcomm QCOM

Buy Qualcomm (QCOM).  In the current stock market and economy you want to own stocks in the sectors of the market that are outperforming rather than lagging and you want to own companies that can grow even when the economy isn’t. I think cell phone chip-maker Qualcomm fits the bill on both accounts.

First, technology has been one of the strongest sectors this year. Witness the 16% return for the technology-heavy NASDAQ Composite Index in the first six months of 2009 versus the 1.8% gain for the Standard & Poor’s 500 stock index. Qualcomm shares have done even better, climbing 27% from the beginning of the year through June 30.  In a market like this you want to buy relative strength. (The shares have dipped about 10% in the current correction creating a decent buying opportunity.)

Second, Qualcomm has recently raised estimates for the fiscal year that ends in September 2009 and looks likely to outgrow both the U.S. and the global economy over the next 12 to 18 months. With next generation 3G wireless phone systems rolling out around the world, Qualcomm’s handset volume is projected to climb by 10% in the June quarter from that same quarter in 2008. A lot of that growth is coming from the world’s emerging economies—in Brazil, for example, the shift to 3G smart phones is just gaining momentum. Networks built on 3G technology use some flavor of the CDMA standard where Qualcomm’s patent position is strongest. The current market leading GSM standard now controls about 60% of the market so Qualcomm will see its global market share grow as the rollout of 3G technology moves market share toward CDMA.

That should make up for any slowdown in the U.S. market. Thanks to its patents Qualcomm collects a royalty on phones sold by Motorola, LG, Samsung, and other companies. Royalties and license feels make up about 40% of company revenues and come with an operating profit margin of near 90%. The other 60% of the company’s revenue comes from its chip-making business. Most of those chips go into the wireless phone sector but  Qualcomm is also moving into a new business. Its chips, built on the low-energy platform from ARM Holdings (ARMH), are on the march from cell phones to smart phones to net book computers, where they look like a winner against Intel’s (INTC) current generation of low-power Atom chips. That’s a whole new growth business for Qualcomm. The company is set to report earnings on July 22. As of July 15, I’m adding these shares to Jubak’s Picks with a target price of $55 by March 2010. (Full disclosure: I own shares of Qualcomm in my personal portfolio. I will be adding more three days after this note is posted. As is the rule for Jubak’s Picks, I won’t sell my personal position until three days after I’ve posted a sell on this blog.)

Why Rallies Fail

Has the rally that began in March run out of gas? Sure looks that way. After climbing by 40% from the March 9 bottom through June 12, the Standard & Poor’s 500 Stock Index has gone precisely nowhere. Well, maybe even a little short of nowhere. From June 12^th through July 13 the index lost 5%.

Which seems strange, doesn’t it? After all, even after the March rally, by June 12 the Standard & Poor’s 500 Stock Index was still 40% below its October 2007 high.

And it’s not like there isn’t plenty of fuel stored on the sidelines. The total deposited in money market mutual funds hit $3.71 trillion for the week ended June 19, according to the Investment Company Institute.

With stocks still so far below the 2007 high and with all this money sitting on the sidelines, readily available for buying stocks, why didn’t the stock market just keep on running?

Three reasons.

1. Supply of stock is soaring. U.S. companies raised $259 billion by selling new shares in the second quarter of 2009, according to Dealogic. That’s three times the amount of new stock sold in the first quarter of the year. U.S. banks led the way, raising $89 billion by selling stock in the quarter. The 92 deals in Q1 were the most ever done in a 3 month period and the dollars raised were the most in a year. Also:  corporate America isn’t done deleveraging so investors can expect more supply to flow into the stock market whenever higher stock prices convince company CFOs that it’s a good time to raise cheap capital.
2. Demand fell as stock prices rose. The best lack all conviction. And the rest just want to take profits. Company insiders, who in theory know more about the real prospects for their companies than outside investors, started to sell as prices climbed. Citing filings of Form 4 with the Securities and Exchange Commission, TrimTabs Investment Research reports that insiders sold $2.9 billion in June.  That’s almost 10 times more than the $300 million they bought. Insider selling in June was the highest since November 2008. In the last 60 days, TrimTab calculates, insiders bought just $1 billion in stock. That’s the lowest level of insider buying since November 2004. You didn’t have to be an insider to take money out of the market in June, however. The amount in money market mutual funds stocks climbed by $34 billion in the week ended June 19 from the prior week. You could vividly see the waning of enthusiasm in the volume figures too. For a rally to have legs, more investors need to buy, driven by the desire not to miss out on gains, as stock prices rise. When volumes fall as prices go up, it’s a clear sign that the rally is running short on buyers. In April and again in May daily trading volume on the S&P 500 index was always above 40 million and would occasionally brush 80 million. Starting in June, however, volume dropped until it was almost always less than 40 million and the biggest day was a mere 53 million.
3. Economic data didn’t turn more positive to support the rally. The ambiguous economic forecast that was positive enough to get investors buying when the S&P 500 stood at 677 on March 9 stayed just as ambiguous while stocks climbed to 946. Let me just take a single day, July 2. A reader perusing the headlines in the Financial Times over breakfast that day read “Data show evidence of global recovery.” At 8:30 that morning, however, the U.S. Bureau of Labor Statistics released its report showing that non-farm payrolls have fallen by another 467,000 in June. That was well above forecasts for a decline of just 367,000. Adding to the gloom, average weekly hours worked by those still employed fell to 33.0 from 33.1. Not surprisingly the S&P 500 dropped 2.8% that day to 897.

So where do we go from here?

Sideways most likely.

All that cash sitting on the sidelines is still looking to get in—at lower prices. A lot of investors weren’t in stocks for the 40% rally from March 9 through June 12. They kept waiting for the correction that never came before buying. A 10% correction in July—and as of July 13 the S&P 500 was about half way there with a 5% decline from the June 12 high—would bring some of this cash into stocks. Think of that $3.7 trillion in cash as an insurance policy against a big drop in stocks.

But stocks aren’t likely to go a whole lot higher than the peak they reached on June 12 without some resolution to the uncertainty that surrounds the economy.

Look, if we’re going to have a V-shaped recovery, as Christine Romer, head of the Obama administration’s Council of Economic Advisors said recently, where economic growth takes off like a rocket from the bottom and never looks  back, then stocks at 15.6 times projected 2009 earnings and just 12.2 times projected 2010 earnings are cheap. Back up the truck and load it up.

But if we’re headed for a W-shaped recovery with a big drop in economic growth in 2011 when the current stimulus package is no longer stimulating anything, then stocks as a whole aren’t especially cheap. At past bottoms investors could pick up stocks for just 10 times earnings or even less.

And, of course, there’s still the possibility that we’re not headed for any kind of a real recovery at all and that, instead, the economy is going to simply bump along the recent bottom.

What do you do? What am I going to advise you to do in the months ahead—that is in the short term–on this blog?

While we wait for the economy as a whole to declare its intentions in unambiguous language I’m going to focus on finding a few individual companies—and stocks—that have unambiguously turned the corner. Call them early bloomers. Or special situations. Whatever. These companies do business in privileged niches where demand has remained strong or is clearly coming back after a catastrophic drop-off. These are the companies that have been best at plotting a safe strategy through the Great Recession or who have been most aggressive in changing course when past strategies no longer worked.

You’ll find an entry on one of these stocks, Qualcomm (QCOM) and my “buy” recommendation later today on this page.