Stocks kicked off the year on the right foot, with all three major averages closing the week in the green on some encouraging employment data. For the week, the Dow gained 1.2%, the S&P 500 added 1.6% while the NASDAQ led after tacking on 2.7%.
Everyone knows that employment remains one of the weakest areas of the economic recovery of the last few years, so any good news on jobs goes a long way to support sentiment. And that’s exactly what we saw this week, with the ADP jobs report showing a gain of 300,000 in December and the government’s non-farm payrolls not far behind at 200,000, both coming in well ahead of expectations.
That sharp turn in hiring could mean that private-sector productivity and margins are finally tapped out, and that companies will now need to hire additional labor resources in order to grow sales and earnings. If that’s the case and the trend sticks, more jobs will go a very long way to support GDP, earnings and equity prices.
Europe Still a Question
Shifting into big picture, the Europe story continues to be relatively quiet in spite of Italy’s bond yields remaining above the critical 7% area. Both Ireland and Portugal required financial assistance when their yields breached 7%, so this is definitely a warning that the Euro story remains well in play behind the scenes. But the relative quiet over Europe has allowed investors to focus on other parts of the global economy that aren’t nearly as gloomy.
Q4 Earnings on Tap
Like earnings, with Q4 earnings season set to kick off on Monday with Alcoa stepping up to the plate. For as bad as employment has been for the last two years, earnings have been equally good, pushing the S&P500 back to peak earnings from 2007. But back then, the index was trading at a 20% premium to its current level, so clearly the valuation picture is fairly compelling right now. Just like jobs growth, if we see another solid quarter of earnings it could set the stage for some nice equity gains.
Looking forward, the market should have plenty to focus on with another full week of economic data on tap.
- Monday-Federal Reserve Consumer Credit
- Tuesday-Wholesale Inventories
- Wednesday-Federal Reserve Beige Book
- Thursday-Initial Claims and December Retail Sales
- Friday-Consumer Sentiment
So as it stands there are actually a few reasons for investors to be feeling good right now. Stocks are off to a good start in 2012, the domestic economy is adding jobs, valuations look compelling and another season of earnings is set to kick off. So as long as we can avoid a wholesale implosion of the Euro zone, we could have the making of a decent year in the market.
We usually highlight about 5 or 6 stocks in the updates section. But this time around and probably more frequently down the line, I wanted to trim that number down and take a more granular look at one specific sector, its stocks and how they have performed compared to the overall market. So for our first incarnation of this format I have chosen energy.
Energy was a huge underperformer in 2011, clocking in as the worst performing sector in the S&P500. That weak performance was predicated on two things; the first was just general concern about the growth of the global economy. The second was more specific; concern about the growth of China, which has been an absolutely massive consumer and importer of natural resources and energy over the last 10 years. So when China shows signs of slowing, which it did in the second half of 2011, natural resource and energy stocks take a beating.
But as an analyst it is my job to be skeptical, so I decided to dig below the surface to see if I could find any material deterioration in the fundamental profile of any of these energy stocks.
So let’s go ahead and take a look.
The company I am going to profile is Baker Hughes, Inc. (BHI), an energy services and drilling company that operates both domestically and internationally with a market cap of $23 billion. So this is a pretty big company.
Baker Hughes had a terrible run in the second half of 2011 (along with the entire sector), falling 30% while the S&P500 gained 5%. You can see that in the chart below, with BHI in green/red and the S&P500 in red.
But the chart only tells half the story, technicals as they are called. The other part is the fundamental story, related to earnings and valuation. This is where the story gets interesting. Below is a chart of earnings projections for Baker Hughes. As you can see, analysts remain bullish on the company, with earnings projections showing almost no deterioration and holding in higher territory.
That has Baker Hughes trading at a historically low valuation, where shares have gotten killed while earnings have held strong. A compelling valuation is by no means a guarantee that shares will rally, but investing is all about probability and mean reversion. So buying a stock like BHI with a current PEG (PE/Growth) ratio of .55 against a 10-year average of 1.2 means that probability is on your side.
- Current PEG ratio: .55
- 10-Year Median: 1.22
So what you have here is a situation where the market has fully priced a recession into energy stocks while the fundamental story remains unchanged. So if you are bullish on the long-term trend in energy it could be an opportunity to reduce your cost basis on existing shares with a historically low valuation.
That’s all for this week, but until next time here is a list of 10 investment ideas for 2012. Enjoy!
Your Investment Partner,