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5 reasons the Fed will fumble in 2006
(Page 2) of 2
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Note I'm talking about a drop below the current 3.8% growth to a rate that makes the Fed, Wall Street and Washington politicians (who are facing midterm elections in November 2006) nervous. I'm not talking about a negative quarter and certainly not a recession. A drop below 3% is a certainty if the Fed's interest rate policy overshoots. And somewhere in the range of 1% to 2% growth for a quarter would be a reasonable expectation for a low.
By the time that growth low arrives, the Fed will have stopped cutting rates and is likely to begin sending signals of an ease or two if the growth picture doesn't improve.
To me, this doesn't add up to either economic or investing disaster. More volatility than we've seen even in the last few months? Certainly. Radical shifts of money between sectors as the managers of hot money search for short-term profits? Certainly. Enough worry about rates of interest and growth to cause a flight to safety in assets that range from gold to consumer staples? Certainly.
Looking out over the next six to 12 months, I think shifting portfolios to include more non-U.S. equities makes sense. In the near term, a stronger dollar will increase the sales of overseas companies. In the longer term, a decline in the dollar as the Federal Reserve stops raising interest rates will give investors in non-dollar-denominated assets a decent exchange-rate profit. I also think looking to U.S. consumer companies that represent safety from inflation and strong guarantees of growth is a solid strategy.
With this column, I'm making buys for Jubak's Picks in iShares MSCI Japan (EWJ, news, msgs), an exchange-traded fund focused on big-company Japanese stocks, and Sysco (SYY, news, msgs), the dominant U.S. food distributor. Both should outperform the market if the Federal Reserve does indeed overshoot in 2006.
Updates
Buy Sysco
Sysco looks like it has turned the corner toward lower inflation a year or more ahead of the rest of the economy. Food inflation, which ran at 6% to 8% a year ago, has dropped to just 1% to 2%. Although the company can pass along higher food costs to customers, the lag between when costs go up and when customers pay higher prices made the last 12 months tough for Sysco, as its stock fell 6% in that period. But with food inflation down -- and with the company able to much more readily pass along rising fuel costs in the form of surcharges -- the next 12 months look much brighter. The company's efforts to cut costs, a necessity when food inflation was so high, have resulted in permanent savings in transportation and inventory costs. The rollout of regional distribution centers, for example, where slower-moving items can be held for distribution to local operating units, has cut freight costs and lowered inventory. The company has also geared up its growth plans with a goal of adding 3% to annual revenue through acquisitions in fiscal 2006 and 5% to 6% in organic sales growth from a larger and more-aggressive sales force. It won't hurt the stock, either, that growth in the next 12 months will be compared to the weak results of the last 12 months. Wall Street now projects that earnings growth will climb to 14% in the fiscal year that ends in July 2007 from 5.2% in fiscal 2006. The shares trade at 19.7 times projected fiscal 2006 earnings per share. I've owned this stock in Jubak's Picks before, selling it in October 2003 for a 10% gain and at approximately the same price as today's buy. I'm setting a target price of $37 a share by May 2006. (Full disclosure: I will buy shares for my personal account three days after this column is posted.)
Buy iShares MSCI Japan
I'm using this ETF to add broad exposure to Japan's big company stocks -- Toyota Motor (TM, news, msgs) is, at 5.2%, the largest of the fund's holdings. I think the Japanese economy is finally showing sustained growth -- and even a bit of inflation. The Bank of Japan has raised its projections for economic growth to 2.2% for the fiscal year that ends in March 2006. Inflation, the bank now estimates, will climb 0.1% in fiscal 2006 -- not much but a huge step forward for an economy that has experienced years of falling prices. With the dollar up 14% this year (and trading at a 25-month high) against the yen, I think the big companies in the Morgan Stanley Capital International Japan index, which this fund mirrors, will show strong export growth into 2006. And I'm looking for a kick from the dollar-yen exchange rate as the dollar goes lower to correct against the yen in 2006, when the Federal Reserve stops raising interest rates. I'm adding these shares to Jubak's Picks with a target price of $15 a share by June 2006. (Full disclosure: I will buy shares for my personal account three days after this column is posted.)
New developments on past columns
How the Fed lost the inflation fight
I added ENSCO International (ESV, news, msgs) to Jubak's Picks on Sept. 23 as a hurricane play, pure and simple. "Drilling rigs were in short-supply before the big storms hit the Gulf of Mexico; they're in even shorter supply now," I wrote then. "And short supply means higher day-rates for drilling companies that have rigs to hire. ENSCO International is a buy on the timing of the contracts for its fleet of 43 jack-up rigs. Only 39% of its fleet is under contract through 2006." So far, that logic seems to be working just fine. On Oct. 25 ENSCO International reported third-quarter earnings of 53 cents a share, six cents above Wall Street estimates, on revenues of $277 million. (The company managed to escape serious hurricane damage, taking only a charge of 3 cents a share for damage to its ENSCO 29 platform, which will be declared a total loss.) But the best news was a 37% increase in the average day rate -- to $75,400 on average from $54,900 in the third quarter of 2004 for the company's fleet of jackup rigs. The company also saw a 15% increase in day rates from the second quarter of 2005. That bodes well for increases in day rates for other rigs due to come off contract in the next few quarters. Analysts have now begun to push up their earnings projections for 2006 as it becomes clearer that, with rigs in such short supply, the peak of this cycle could be as far out as 2008. As of Nov., 4 I'm raising my target price to $58 by September 2006. (Full disclosure: I own shares of ENSCO International.)
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: ENSCO International. He does not own short positions in any stock mentioned in this column.
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