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Gaining on the Edge? MoneyNews
Dear MoneyNews Reader, Let's take a look at two pieces of news that emerged to become driving factors in this first trading week of the year. Equity markets started 2006 on a solid footing, delivering gains of 2.5% on the S&P 500 index and 3.8% on the tech-laden Nasdaq index. Globally, technology shares shone as investors' risk appetite grew to start 2006.
The week began with the release of the minutes of the December FOMC meeting at which the Federal Reserve voted unanimously to lift the Fed Funds lending rate to 4.25%.
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The Fed acknowledged that the number of future rate increases needed to keep inflation in check would "probably not be large." When the Dec. 13 rate increase was announced, the Fed also withdrew use of the term "accommodative" to describe its monetary stance. The Fed also acknowledged that their past actions to boost rates from 1.5% to their current 4.25% might not yet have been felt. For that reason alone, they may need to back off for a while - at least until the full impact on the economy is apparent. The news was bullish for both stocks and bonds. The Dow jumped 129 points in direct response. Bond yields fell and began to challenge the arrival of the inverted yield curve. Readers might remember that last week I rattled on about this very subject and concluded that, since traders had arrived at the same conclusion, perhaps it was time to jump ship. And that's precisely what we witnessed during the week. Rather than seeing a rush into 10-year government notes, money poured into two-year maturities sending yields down 10 basis points (1% equals 100 basis points). Investors' rationale seemed to be that if the Fed admits it's close to ending its policy of raising rates, then the best value would be at the front of the curve. The result was that the curve got back to its normal self to close the week. I also proposed in last week's letter that this yield curve inversion might presage an end to the strengthening of the dollar. Take a look at the dollar index chart below. As you can see, it looks like a train wreck due to the contents of the Fed minutes. The light at the end of the tunnel on that front indeed took away the leg of support for holding dollars that I had warned about. The dollar index slid 2.2% on the week. Losses against the euro saw the dollar's value fall from 1.1849 to 1.2164 and from $1.7230 against the British pound to $1.7708. By the way, I see the pound as quite vulnerable here against the dollar since the Bank of England will likely cut rates in the first half of the year.
The second driving piece of news to end the week was the December employment report. The jobless count came in at 4.9%, down 0.1% as the U.S. economy created 108,000 new jobs for the month. The economy has now generated more than two million jobs in each of the past two years. While Friday's news was sharply below the forecast, there was a significant revision to November's data, which was bumped up to 305,000 additional jobs from 215,000. Average hourly earnings remained in check, rising just 0.3%. Retailers and banks added 96,000 service-related jobs in December after having gained 252,000 in November. Manufacturers added the most jobs since August 2004 as they tacked on 18,000 jobs in December. Thanks to the summer hurricanes, the fourth quarter was the weakest of the year. We ought to see a strong start to job creation to start 2006 as workers displaced by the storms return to payrolls.
Additionally, we expect to see further construction-related employment in those areas affected by the devastation. The strength and continued good prospects for employment should be enough to keep the stock markets rising. Despite the fact that earnings growth is likely to be lower in 2006, stocks are hardly overvalued on a PE ratio of 18 times trailing earnings and 16.5 times projected earnings. Standard & Poor's estimates earnings-per-share growth of 11.5% for 2006, compared to 15.5% for last year. It seems as though we should expect to see a fresh share price target for mammoth Internet search engine Google almost each week. It was no surprise to see Goldman Sachs raise their target to $500 this week, but what did surprise me was the outlandish prediction from a boutique analyst company calling for Google's shares to rise as far as $2,000 each!
Analsyst Mark Stahlman at New York-based Caris & Co. Inc, made sure to clarify his view that this was no short-term bet on the stock's surge. Google has had revenues of $5.2 billion over the last four quarters, yet Stahlman suggests that the expansionist policies might one day see Google reach $100 billion in sales. In an interview with Bloomberg television - which left me trying to pick my jaw up off the floor - Stahlman used a multiple of enterprise value to come up with a valuation of $2,000 per share for Google. Enterprise value adds market capitalization, preferred equity and debt - but it subtracts cash from the equation. Stahlman used the conservative 6.2-times multiple that applies to the same method of evaluating Microsoft. With Google shares trading at $461 on Friday, upgrades from Bear Stearns and Piper Jaffray projecting $550 and $600 per share respectively are quite achievable. But $2,000? I'm afraid that's still a little far-fetched for my liking. Have a great week!
Andrew Wilkinson
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Wilkinson's Edge
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