Memorial Day weekend market thoughts: Part one

Posted May 25th 2007 5:00PM by Georges Yared
Filed under: Forecasts, Microsoft (MSFT), Cisco Systems (CSCO)

The first five months of 2007 have proven to be volatile, and volatility has been and will always be with us. The US stock market is truly part of the global market and what occurs in China, Asia or Europe has an effect on the US. Late February and March gave testament to that.

The ultimate driver of stock valuations is earnings and the perceived growth of those earnings. The world of corporate earnings exited 2006 on a general upbeat note and this has certainly carried through for the full first quarter of 2007. Companies hit or exceeded expectations for the first quarter and, in general, guidance for the second quarter and the rest of 2007 looks pretty healthy. Certain pockets are struggling and will continue to have a challenging 2007, such as housing and housing-related stocks. But technology, health care, financials, retailers and other consumer cyclicals have shown some definite strength.

The financial sector was rocked by the subprime mortgage issue -- which will also continue through 2007-- but the larger, well-run banks and financial institutions have raised their reserves for bad debts and are aggressively managing the situation. In years gone by, the financial institutions were more in the react-mode, now the new business strategy is to work with those customers -- before it becomes a bigger problem. Doesn't make it perfect, but it certainly helps mitigate the potential losses. Earnings throughout this ordeal have held steady and firm.

The technology sector is buoyed by a good cycle of capital expenditures at the corporate and government levels. Traditional names like Microsoft Corp. (NASDAQ: MSFT), Cisco Systems Inc. (NASDAQ: CSCO) and others are rejuvenated with new products and upgrade cycles. Software sales have been somewhat more robust than expected, as have general hardware sales.

The era of mergers and acquisitions continues from 2006 into 2007. Private equity firms flush with huge amounts of institutional cash are salivating over many different assets. The traditional question: "who is in play?" is now more likely to be: "who is NOT in play?" Any asset generating 5% plus free cash flow is a possible target. Market capitalization of these takeover targets is no longer subject to the wow factor. Anything announced under $10 billion is relegated to page 3!

Share buy-back programs have been another source of supporting valuations in the stock market. Companies flush with excess cash are deploying those dollars to retiring shares and thus propping up earnings with a lesser share count. All in all a healthy sign when a company buys its own shares -- it demonstrates confidence to investors.

The second half of 2007 will of course be volatile. The earnings numbers look strong and healthy. Looks like the Federal Reserve will not act on lowering rates until next year as economic activity, according to them, does not merit this. Get ready for more large takeover activity and please, as intelligent informed investors, keep a portion of your investment portfolio in international stocks or funds.

The markets are truly global.

Part Two will highlight several individual stocks to focus on for the remainder of the year.

Georges Yared is the CIO of Yared Investment Research. For more growth stock ideas please visit the web site.

Tags: cisco, csco, microsoft, msft