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Home , Great Recession

July Capital Investment Counsel OBSERVER 2010

socked away $1.84 trillion in cash and other liquid assets as The 2010 year started off with a nice continuation of the of the end of March, up 26% from a year earlier and the strong market of late 2009, but faded into a whimper as the largest-ever increase in records going back to 1952. Cash second quarter unfolded to finish with a nasty sell-off over made up about 7% of all company assets, including factories the May – June timeframe. The major domestic averages all and financial investments, the highest level since 1963.i All ended the quarter down about 6 to 7 ½% year-to-date. Since this cash has allowed companies to get back into the habit of quarter end, a string of strong earnings reports from a number raising dividends and also buying back stock as ways to re- of companies has helped to erase some of the sell-off. ward stockholders. According to Standard and Poor’s there have been over 130 dividend increases in the S&P 500 so far Earnings Releases – Stronger than Some May Realize this year and only two dividend cuts.ii This is very upbeat news after the major dividend cuts of 2007 and ’08. Some of the earnings news has been quite impressive. Intel for instance announced the best earnings in company history, What are Investors Doing in this Environment? for the second quarter in a row. Intel earned 51 cents per share for the quarter on revenue that was up 34% from the Several factors have led to skepticism and apathy amongst year ago quarter. The current year consensus earnings esti- individual investors. Ten years of a very difficult invest- mate stands at $2.05 and the stock is barely over $20. So ment environment including the Great capped off INTC is trading for less than 10 times current year earnings by the Flash Crash in early May and the BP oil spill fiasco with a dividend yield over 3%. seems to have made the average retail investor want to take her marbles and go home. Another example of strong earnings news in the past few days is General Electric which posted a profit of 30 cents per Bonds vs. Stocks share, a 14% increase over the year ago quarter, on a 4% drop in revenue. The consensus estimate for 2010 stands at $1.32 Let’s take a look at some of the factors we believe are driv- per share so at 14 ½ GE is trading for barely more than ten ing investor sentiment. Bonds have done quite well in rela- times current earnings with a dividend of about 2.7%. tion to equities over the past decade and particularly in the very recent past. Many investors are chasing what they The market seems to be shrugging off solid fundamental think are relatively safe returns in bonds and bond funds. news and focusing on whatever negatives it can find. July’s The flight to perceived safety is compounded by the strong University of consumer sentiment survey was re- recent performance of bonds as interest rates have moved to leased on Friday July 16th and marked one of the largest one ultra-low levels. All else being equal, bonds rise in value as month declines in the history of the measure sending the S&P interest rates fall. The yield on 30 year Treasury bonds has 500 down more than 2.5% on the day. Consumers are wor- fallen from about 4.8% to 4% since April of this year and ried and with where it is we can understand spent time over 5% in 2006 and 2007. This has created a why. However, consumer sentiment and unemployment are tail-wind for bond returns. Many investors, after seeing the both lagging indicators. In order to effectively manage in- recent pumped up returns of bonds, are asking themselves, vestment assets, we need to look forward. “Why do I want to own equities when bonds have done bet- ter and are supposedly a safer investment?” Corporate Cash In fact, according to Investment Company Institute, a mutual fund trade group, from 2007 through 2009, investors with- A major positive for corporate America is the vast hoard of drew more money than they deposited to funds invested in cash many companies have piled up over the past several U.S. stocks. This is the first time since the 1979-1981 time years. Corporate America has been concerned about what the frame we’ve seen net withdrawals from stock funds for three future holds and has chosen, in many cases, to build up cash consecutive years. So far this year stock funds have experi- reserves as a defensive management practice. The Federal enced net inflows in January, March and April only to see Reserve recently reported that nonfinancial companies had net withdrawals resume in May.iii

iWall Street Journal “U.S. Firms Build Up Record Cash Piles” June 10, 2010 iiArgus Research “Market Watch” June 21, 2010 iiiWall Street Journal “Small Investors Flee Stocks” July 12, we find the current market environment to be promising. Ex- treme caution is more suitable for times when the average The Flash Crash in May served to be the final straw for some investor is full of confidence rather than full of doubt. As al- individual investors. The Dow Jones Industrial Average ex- ways, if you have any questions, please contact your invest- perienced an intra-day move of over 1,000 points or about ment representative. 10% of its value. The move was highlighted by extreme sell- offs of 80%-90% or more in some individual stocks. Reports suggest high frequency program trading was the primary cul- prit. In a nutshell, there are a number of different exchanges A Publication of Capital Investment Counsel trading many of the same stocks and these exchanges had no www.capinvestco.com system in place to initiate a short-term halt of a particular 17 Glenwood Avenue, Raleigh, North Carolina 27603 stock if it became apparent that price discovery was not tak- (919) 831-2370 ing place. Price discovery is the ability for investors to be- come aware of where pricing is and react to it. In other words, if someone had called you and said you could buy Procter and Gamble for $5 a share you and most sane people would have asked, “How much can I buy?” Since the sell-off happened so quickly, investors did not have time to discover where pricing was and react. A short-term halt allows price discovery to return to the market. The SEC has put in place a pilot program to allow for an orchestrated halt amongst the Disclosures: various exchanges if or when a stock appears to be lacking in Past performance is not indicative of future results. This material is price discovery. Even though the Flash Crash was a market not financial advice or an offer to sell any product. The actual char- structure issue that could be remedied via rule changes many acteristics with respect to any particular client account will vary investors considered it the last straw and headed or the exits. based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment. Capital Where do we go from here? Investment Counsel reserves the right to modify its current invest- ment strategies and techniques based on changing market dynam- In our opinion, stocks are fundamentally cheap. Earnings are ics or client needs. The information provided in this report should not looking pretty strong in most industries and valuations have be considered a recommendation to purchase or sell any particular . There is no assurance that any securities discussed herein contracted for the past decade leaving us with a lot of very will remain in an account's portfolio at the time you receive this re- high quality companies trading at the lowest valuations we’ve port or that securities sold have not been repurchased. The securi- seen in a couple of decades. In addition, companies have ties discussed may not represent an account's entire portfolio and in built up cash hoards and are starting to become more aggres- the aggregate may represent only a small percentage of an ac- sive with stock buy-backs and dividend increases. In many count's portfolio holdings. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will cases the dividends on high-quality stocks are greater than prove to be profitable, or that the investment recommendations or yields available in the bond market. Unlike bonds, dividends decisions we make in the future will be profitable or will equal the can grow over time. We’ve never seen a company raise the investment performance of the securities discussed herein. All rec- coupon on a bond. ommendations within preceding 12 months or applicable period are available upon request. Capital Investment Counsel is a registered So why are stocks so cheap? Is the market discounting or investment advisor. More information about the about the advisor predicting a double-dip recession? Are the sovereign debt including its investment strategies and objectives can be obtained by issues of the PIGS (, , and ) and the visiting www.capital-invest.com. ever rising debt of the going to force us into CIC-10-18 another recession or worse? Or, has the exit of many individ- ual investors caused valuations to contract to the current lev- els? We are aware of the debt issue, as U.S. sovereign debt approaches the 100% of GDP level, but feel it will not cause but rather should hinder moving forward. Maybe the recovery underway will be muted compared to recoveries past. However, when compa- nies are selling as cheaply as we perceive them to be at this point, we may not need 3-4% GDP growth for stocks to do well. Maybe 1-2% will suffice. Being contrarian by nature,