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Beware: Analyst Bulls Continue to Run Over Wall Street

By ndouthat | Published July 21st, 2010

At Ockham, we often like to check in on the prevailing school of thought among Wall Street analysts. Study after study has shown the analyst community to be woefully inaccurate at predicting corporate profits. They are historically an overly bullish group as the a McKinsey report recently observed, over the last quarter-century Wall Street analysts’ earnings estimates have predicted on average nearly 100% too high a growth rate, as the average predicted growth rate of 10% to 12% has clearly overshoot the reality of about 6% annual growth (The Analysts’ Horrendous Track Record Exposed). In that 25-year time span only two times have the analysts been too bearish compared to actual earnings, and this was in the recovery phase of the business cycle after a recession. Of course, analysts come out looking most overly bullish and almost silly when recessions hit or bubbles burst.

To be fair, no one can accurately predict the future, and only a rare few see bubbles for what they are before it is too late. However we found it fitting that the analyst bulls on Wall Street seem to have taken firm control yet again and expectations for the coming years are extremely aggressive. According to Thomson Reuters analysts have predicted 2010 earnings to $82.26 per share, which is clearly phenomenal growth of around 40% from the level of 2009. While this growth is certainly possible, we think it is a lofty expectation and one that may prove to be too much with top-line growth still elusive.

However analysts are even more bullish towards calendar year 2011 as Thomson Reuters now shows the consensus among analysts calling for S&P 500 growing earnings to a new record $96.25. For earnings to come in that strong they would need to grow another 17% on lofty 2010 expectations. Furthermore, this would top the peak earnings levels achieved in 2006 by about 9%. Remember in 2006, a large portion of S&P 500 earnings were produced by the overleveraged, high-flying financial sector as well as ballooning profits from energy companies. The situation has changed dramatically since then and we think it is unreasonable to expect that large a contribution from financial stocks post FinReg.

The analysts would surely argue that firms have aggressively cut costs and have made themselves more profitable, so should revenues really start to rebound there would be a multiplier effect on earnings per share. This is of course all true, but with the analysts’ track record in mind we think it is wise to at least be skeptical as to their abilities and wary of the tendency to exaggerate. I do not need to list a number of pitfalls that have the potential to further drag on the US economy because most are already well known. Instead, we will conclude with a warnings issued in John Hussman’s weekly market comment.

I continue to urge investors to have wide skepticism for valuation metrics built on forward operating earnings and other measures that implicitly require U.S. profit margins to sustain levels about 50% above their historical norms indefinitely. Forward operating earnings are Wall Street’s estimates of next year’s earnings, omitting a whole range of actual charges such as loan losses, bad investments, restructuring charges, and the like. The ratio of forward operating earnings to S&P 500 revenues is now higher than it has ever been. Based on historical data (see August 20, 2007 Long Term Evidence on the Fed Model and Forward Operating P/E Ratios), the profit margin assumptions built into forward operating earnings are well beyond two standard deviations above the long-run norm. This is largely because, as Bill Hester noted in his research article last week, forward operating earnings are heavily determined by extrapolating the most recent year-over-year growth rate for earnings. In the current instance, this is likely to overshoot reality, and in any event, has little to do with the long-term cash flows that investors can actually expect to receive over time.

I can’t emphasize enough that when you hear an analyst say “stocks are cheap based on forward operating earnings” it would be best to replace that phrase in your head with “stocks are cheap based on Wall Street’s extrapolative estimates of a misleading number.” – John Hussman, Ph.D Don’t Take the Bait 7/19/2010

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Ockham in the LA Times

July 16th, 2010

latimes.com

Wesley Bush is steering Northrop Grumman in a new direction

In the six months since Wesley Bush’s first day as CEO, and with this week’s announcement that he may abandon the shipbuilding business, military giant Northrop Grumman has become a very different company.

By W.J. Hennigan, Los Angeles Times

July 16, 2010

latimes.com

Once taking the helm of Northrop Grumman Corp. in January, Wesley G. Bush hasn’t wasted any time shaking up one of the world’s largest military contractors.
On his first day on the job, Bush made a stunning announcement that he was moving Northrop’s headquarters out of Los Angeles — where the company has been since it was founded in 1939 — to the Washington area.

He then pulled Northrop out of the Pentagon’s $35-billion aerial refueling tanker competition, shuffled top executives and this week announced he was looking at abandoning the company’s $6-billion-a-year shipbuilding business.

The moves have analysts wondering whether Bush is dismantling a military juggernaut built up by predecessors Kent Kresa and Ronald Sugar.

“The decision to explore strategic alternatives for shipbuilding should not be interpreted as an indication that we are dismantling the company,” Bush said in an e-mail, adding that he might separate Northrop from the shipbuilding business because it didn’t fit with the rest of the company.

But to Loren Thompson, a military policy analyst for the Lexington Institute in Virginia, “Northrop Grumman is a very different company than it was six months ago. Wes Bush is determined to transform the business and culture of Northrop any way he can,” he said.

Since the mid-1990s, Kresa and then Sugar acquired nearly two dozen companies with interests in virtually every aspect of the U.S. military, including building spy satellites and nuclear submarines, managing websites and protecting computer systems against hackers. Northrop Grumman grew from a billion-dollar company on the verge of bankruptcy to a $34-billion behemoth.

But in a conference call Wednesday, Bush said he was closing its shipyard in Avondale, La., near New Orleans, and that the company could get out of the shipbuilding business altogether.

“Going forward we perceive little synergy between shipbuilding and our other businesses,” he said.

Bush, 49, is moving Northrop away from building traditional military hardware, such as massive warships, to developing more high-tech products, such as cyber security and unmanned systems.

Northrop’s largest sector for cyber security work, Information Systems, hires about 4,000 people a year. The company specializes in encryption technology used by U.S. intelligence agencies that could be applied to protecting valuable data.

“He sees Northrop as a company that will lead the way in cutting-edge electronics and information systems,” Thompson said. “That vision does not include industrial metal-bending in shipyards.”

The move to close the Avondale facility came amid the prospects of a slowdown in Pentagon spending on large weapons systems, such as tanks and warships. Last year, Defense Secretary Robert M. Gates proposed a plan to cut major weapons developments worth as much as $330 billion. And in February, the U.S. Navy canceled the planned purchase of two amphibious ships that were to be built at the Avondale shipyard.

The facility employs about 5,000 people. Production will cease in 2013 and operations will be consolidated with the company’s Pascagoula, Miss., shipyard about 125 miles away.

Northrop currently builds transport and amphibious assault ships at both locations. So consolidating ship construction on the Gulf Coast will reduce costs and increase efficiency, Bush said.

“He’s demonstrated that he’s not afraid to be bold in his leadership,” said Ned Douthat, an analyst at Ockham Research, an equity research firm. “It’s not popular right now to take 5,000 jobs away from the Louisiana coast. But it’s the right move for the company, and it provides the most value to shareholders.”

Since 2008, the company has taken more than $430 million in charges against earnings because of delays caused by Hurricane Katrina and production problems.

Northrop picked up the Gulf Coast shipyards in 2001 as part of the acquisition of Litton Industries Inc. Litton had a considerable military electronics business, which appealed to then-CEO Kresa; the two yards came as part of the deal.

Paul H. Nesbit, an aerospace analyst with JSA Research Inc. in Sarasota, Fla., said the main objective of the Litton deal was to expand the electronics business and to acquire some members of Litton’s management team. Shipbuilding was an afterthought.

“Northrop seemed to fall into shipbuilding,” he said. “It never really fit with the rest of Northrop. It operated like a separate company altogether.”

Later in 2001, Northrop bought Newport News Shipbuilding Inc., which builds nuclear submarines and aircraft carriers, to spoil a bid by rival General Dynamics Corp. to become the nation’s largest military shipbuilder.

The ship business accounted for about 18% of Northrop’s revenue last year, which leaves a sizable hole on balance sheets, said Michael O’Hanlon, a senior fellow at the Brookings Institution.

“Traditionally, shipbuilding is not the type of business that’s going to grow exponentially year over year, but it’s not going to diminish very much either,” he said. “It’s a steady stream of revenue because there aren’t that many big shipbuilders in this country.”

General Dynamics is the only other major competitor in the ship business. If General Dynamics makes a bid to buy the shipbuilding business unit from Northrop, the Pentagon has a dilemma on its hands.

“It’s something we’re going to watch closely,” said Cmdr. Victor Chen, a Navy spokesman. “We want to make sure there’s adequate competition in the marketplace.”

Bush put the government in another precarious position in March when he pulled Northrop out of the race for a $35-billion Pentagon contract to build aerial refueling tankers. At the time, he left Northrop’s rival in the competition, Boeing Co., as the sole bidder for one of the largest military contracts in U.S. history because he said the specifications dramatically favored Boeing.

Northrop had been seeking to win the contract since 2007, when it teamed up with Airbus parent European Aeronautic Defense & Space Co.

Northrop spent about $200 million to capture the contract and won, but the decision was later overturned after the Government Accountability Office found that the U.S. Air Force failed to credit Boeing for some of the plane’s capabilities.

After the Pentagon relaunched the competition earlier this year and laid out new specifications in late February, it took just two weeks before Bush said the company wasn’t going to pursue the contract. To him, it wasn’t worth spending money to go after a contract that seemed all but destined to go to Boeing.

With a series of aggressive moves, Bush has shown a real contrast with the leadership of the past, said Rebecca Grant, president of IRIS Independent Research, a military and aerospace consulting firm. Past chief executive transfers of power at Northrop have been rather customary, she said. But Bush has taken the company in a new direction from the start.

“Wes Bush is not hung up on the Northrop Grumman of the past,” Grant said. “Time will tell about his judgment. But I think you have to give him credit for making the tough moves early on.”

william.hennigan@latimes.com

Housing Starts Drop Drastically Following Stimulus

By ndouthat | Published June 16th, 2010

Housing starts fell 10 percent, the biggest decline since March 2009, to a 593,000 annual rate, from a revised 659,000 pace in April that was less than previously estimated, Commerce Department figures showed today in Washington. Building permits, a sign of future construction, unexpectedly fell to a one-year low. Single-family starts suffered the largest drop since 1991.

Builders focused less on starting new projects and more on completing houses for those seeking to qualify for the tax credit, which required contracts be signed by April 30 and closed by the end of this month. Growth in sales and construction will now depend more on job gains and a drop in foreclosures, which have pushed down prices and created competition for builders. – Bloomberg.com 6/16/2010

Homebuilders are pulling back as they fear the fallout after the expiration of the first time homebuyers’ tax credit, which enticed buyers into the market with an $8,000 tax break for purchasing a home. Starts on single family residences were the hardest hit, dropping by an estimated 17%, the most dramatic collapse in 19 years. The south was the hardest hit region as overall starts fell by more than a fifth in May. Building permits, a leading indicator of housing starts, also declined by about 9.9% almost matching the 10% declines in April. Although the housing market has stabilized over the last half a year, the chorus calling for a double dip in housing is growing louder as data such as this runs counter to a sustainable recovery thesis.

The weakness in housing in the wake of the tax incentives has caused some in Washington to wonder whether the tax credits should be extended yet again. They were set to expire last November, but lawmakers extended them to apply to contracts signed through April 30th. Now, Senate Majority Leader Harry Reid has proposed another extension, this time for three months. One has to wonder; then what? Tax incentives have had the desired effect of generating demand for housing, and once that incentive is withdrawn there will be a lull. We believe it is reasonable to think that the longer the tax break is in effect, the more pronounced the days of reckoning will be. Many have compared the phenomenon to a drug addict just looking for a fix, when in fact it does not really fix anything.

I believe that people are driven to act in their own best interest, and I do not blame anyone for taking advantage of the homebuyers’ tax credit. In fact, I am one of the beneficiaries, but lawmakers must realize that extending the rebates will only kick the can down the road. We saw this same process with cash for clunkers: the program ignited demand for vehicles, it ended and sales sagged for a time, now months removed sales are showing relative strength without rebates or incentives. It is the pull-forward effect of consumer demand, and it has to be pulled (at least to some extent) out of the future.

We do not believe an extension of the tax credit will stave off a double dip, if that is even in the cards, it would only serve to delay it. It is time to simply allow the market to rebalance after the pull-forward. It has worked thus far for cash for clunkers (also extended once) and it will likely be the same story for housing.

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BP: Oil Leak Rivaled by Leaking Valuation

By ndouthat | Published June 9th, 2010

BP’s (BP) Deepwater Horizon rig disaster has dominated headlines for about six weeks now, and there is still an undetermined quantity of oil leaking into the Gulf of Mexico. As the oil seeps into the ocean, investors are faced with a risk/reward proposition that is difficult if not impossible to access. The potential costs of clean up continue to climb, recently crossing $1 billion already spent, yet the market has already docked the company more than $100 billion in market cap from its highest point this year. Their stock has now fallen below $30, the lowest level since 1996.

The drastic fall, including more than 13% decline just today, has even introduced the idea of bankruptcy into the conversation as it would somewhat limit the oil giant’s liability. Noted energy investment banker Matt Simmons interviewed on CNBC’s Fast Money said that he believes BP is increasingly likely to declare bankruptcy “possibly in a matter of months” in the wake of this disaster.

Of course, opinions vary widely as T2 Partners Whitney Tilson discussed why he is actually going long BP stock in this situation for the long term opportunity. He believes the company is earning nearly “$100 million per day” and the negative press and horrendous PR have sunk the stock too far. Furthermore, he believes that the dividend will not be cut at all, and BP will be allowed to payout the nearly $11 billion it plans to pay to shareholders over the next year. Talk about a bold call!

Of course the two opinions expressed above are only a small (if extreme) sampling of the wide range of opinions regarding BP and its future. The reality is likely somewhere in between the sanguine Tilson and the gloom and doom Simmons. At Ockham, we continue to believe the short term risks are simply too great for investment (as opposed to speculation). There is mounting pressure in Washington that the company should not be allowed to pay its shareholders a dividend this quarter. The President is talking tough to BP, and now members of the House are looking to force BP to spend no money on advertising or dividend payouts and devote all its resources to cleanup.

BP selling in the $20’s is sure to pique the interest of opportunistic investors, but for us to recommend the stock we need more clarity into when they can actually stop the leak. Furthermore, it is never a good idea to invest in a company that is drawing increasing attention from the political class. One of the few certainties I see in this situation, US politicians will do everything in their power to make sure BP pays; a pound of flesh will not cut it either.

Disclosure: Some accounts at Ockham Wealth Advisors do have a long position in (BP) as of this post. This disclosure is made as of 6/9/2010 and positions may change at anytime thereafter.

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Two Gold Miners’ Time to Shine

By ndouthat | Published June 8th, 2010

Gold reached another record high today, as investors bid up the price of gold futures to more than $1250. The previous record price for an ounce of gold was achieved almost a month ago, but there is renewed interest in the yellow metal as a hedge against global currencies. With sovereign debt issues in Europe continuing to create widespread concern among investors, gold is benefiting from the resultant flight to safety. Many see gold as a good place to stash cash because it will benefit from further global weakness as a flight to safety, but also stands to benefit from inflationary pressure should markets regain their footing.

That being said, as with everything else in investing, “there is no such thing as a free lunch.” The fact that gold is trading at an all-time high in not necessarily a good thing, as stabilization in Europe could send prices lower. Also, there is rumbling that gold is in a bubble and is vulnerable to dramatic declines as so much of its demand is for investment purposes; we are not ready to join that camp but it is worthy of consideration. However, at the very least, we know that investors are going to have to pay a premium price for an asset that may not be as safe as first thought.

For the reasons above, we think investors may be able to find a more attractive value in some gold mining stocks rather than in the metal itself. Clearly, these stocks would be adversely affected by a decline in gold prices, but at current valuations, they may provide a more conservative approach to investors concerned with conserving capital. Here are some of the stocks that we think have further upside if gold stays flat or continues higher, and according to our methodology, provide a margin of safety in the event of gold deflation.

Newmont Mining (NEM) Our favorite among the large cap gold-miners trades at a price-to-cash earnings multiple of just 11x; well below its ten year historical norms of 18.1x to 32.2x. While they mine more than just gold, gold is clearly NEM’s primary driver producing about four-fifths of net income. The company has seen margins and revenue greatly improve thanks to increasing gold prices (five-fold since 2001). We believe it should be more closely correlated to gold prices, but has performed poorly despite strong growth in both earnings and revenue (five year return of NEM 48% compared to GLD 187%). To us it appears to us to have the most favorable valuation among the major gold miners, possibly due to the swoon in copper prices.

Capital Gold Corp. (CGC) At this time, this junior minor appears to be quite cheap according to our methodology. They announced record production in their last quarter which equated to about 23% growth over the prior year. Management has stated that production at their El Chanate mine (Sonora, Mexico) continues to grow and, “is on track for a 70,000 ounces per year run rate.” The mine is clearly not to that production level yet, but it is an indication of their confidence in this ultra-productive asset. This stock is likely going to be more volatile than the bigger senior miners, but it also has greater growth and appreciation potential. The company has maintained modest but stable profits which can be hard to find in a smaller, volatile mining stock, and we believe that speaks well to competent management. Also of note, the company is seeking shareholder approval for a merger with Nayarit Gold (NYG) that has been in the works with little news since February.

With debt levels at extremely high levels in both Europe and the US, we think every investor should have at least some exposure to precious metals. However, physical gold is obviously more expensive now than it has ever been which makes these two miners look like bargains in comparison. For the amount of revenue and earnings that these companies are producing their prices are reasonable making them a suitable investment for value seekers that do not want to chase gold prices at record levels.

Disclosure: Neither the author nor any managed accounts at Ockham Wealth Advisors held a position in any stocks mentioned in the article. This disclosure is made as of 6/8/2010 but positions may change at anytime thereafter.

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Analysts’ Collective Bullishness: A Return to Normal?

By ndouthat | Published June 1st, 2010

It was just two weeks ago that we blogged about an interesting study done by McKinsey & Co. discussing the overly bullish track record of the Wall Street analyst community dating back decades (The Analysts’ Horrendous Track Record Exposed). In that brief piece we noted that the analysts have–as a whole–underestimated rebounding corporate profits over the last year, but we expected that trend to revert to the more historically normal trend of overestimation of corporate earnings growth. It seems it did not take long for the bullishness to return to the Wall Street analysts, as an article on Bloomberg.com says it all.

“Estimates for companies in the S&P 500 show profits may jump 19 percent in 2010, the most since 1995, and 18 percent in 2011, according to data compiled by Bloomberg. The index trades for 13.4 times 2010 per-share earnings forecasts, compared with an average multiple of 16.4 times reported income since 1954.

Highest Since 2008

Should analysts’ forecasts for a 25 percent gain in the S&P 500 come true, the gauge would climb to 1,361 by next May, the highest level since June 2008.” – Bloomberg.com 6/1/2010

The 25% or more gains for the S&P 500 are based on an accumulation of estimates by more than 2,000 analysts tracked by Bloomberg. This consensus forecast shows that rightly or wrongly bullishness is alive and well in equity research despite the recent global tumult. We have been as impressed as anyone by the strength in corporate earnings performance, but we also have to recognize this was enabled by widespread cost cutting during the recession. While payrolls have been slashed and inventories remain lean, top line growth has been more subdued. Revenue growth is an important gauge of health of a company, as it clearly less manipulated by accounting chicanery than is profit.

To be clear, we are not here to judge the earnings growth projections of analysts; rather we think it is interesting to note this trend of bullishness. It is as yet unaffected by European sovereign debt concerns, leaking oil in the Gulf, terrible equity performance in May or anything else. In general, we tend to agree with the assessment by McKinsey that the analysts are too optimistic about the companies they cover, but that doesn’t mean stocks are overvalued or that earnings won’t grow impressively in the years ahead.

Did they get it right this time or is this just more of the same old song and dance? One thing we know for sure, the bar has been raised and companies will soon discover it is tougher to “beat the Street”.

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Retail Investors Have Taken Profits

By ndouthat | Published May 26th, 2010

Many investors were jolted into action following what has become known as the “flash crash” of May 6th, where the DJIA quickly lost nearly 1000 pts in a matter of minutes before recovering. That was a day that will not soon be forgotten, and despite many pundits blaming such an occurrence on a glitch or a faulty trade the indexes fell to below that panicked level on Tuesday May 25th. It seems there was more to it than just a glitch or faulty trade. The return of stock market volatility after some relatively calm months may be exciting for some traders on Wall Street, but it new data shows that the individual investor is content to take some chips off the table here. No doubt, many investors are still licking their wounds following the market’s meltdown following Lehman Brothers, and capital preservation is a very high priority.

Investors had about 60 percent of their portfolios in stocks, 20 percent in bonds and 20 percent in cash, according to a survey last month by the American Association of Individual Investors, a nonprofit investment education group in Chicago. That compares with an average recommendation of 8 percent allocated to cash from strategists at brokerages compiled by Bloomberg, including Bank of America Corp. and JPMorgan Chase & Co.

…

First Net Withdrawals

Investors pulled an estimated $14 billion from U.S. stock and bond mutual funds in the week ended May 12, the first net withdrawals since March 2009, according to the Investment Company Institute, a trade group in Washington. The Standard & Poor’s 500 Index has declined 5.2 percent this year and has gained 59 percent since the market low in March 2009. – Bloomberg.com 5/26/2010

The reasons for the skepticism are many, but likely the top excuse would be uncertainty surrounding the European debt situation. From our view at Ockham we saw an important breakdown in various investor sentiment metrics recently; after spending the better part of a year at extremely bullish levels, we have seen sentiment fall precipitously in just the last three weeks. One basic proxy we use for investor sentiment is the percentage of NYSE stocks selling above their 30-week moving average. As of last week’s close, only 38% of stocks fit that criterion down from more than twice that level for nearly the entirety of the past year!

As our readers know, were had been calling for a pullback as the market was simply overheated according to our methodology. We like to see the market from a contrarian point of view, and the mass exodus of the retail investor does seem like herd-mentality thinking (even if it is justified). Of course, there are real risks in the current environment with European debt, high unemployment, and other headwinds. However, the underlying fundamentals of the US economy have undoubtedly strengthened considerably over the last year, interest rates remains extremely low, and crude oil prices are falling just in time for summer (a break for consumers budgets). Now with the market seeing a much needed correction, we think that a buying opportunity may not be far off assuming Europe can avoid the worst case scenario.

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The Analysts' Horrendous Track Record Exposed

By ndouthat | Published May 17th, 2010

The analyst community has never been known for their pinpoint accuracy, but no one can reasonably expect them to be able to perfectly forecast a corporations performance down to the penny. However, the latest study on the analyst community by McKinsey & Company (commentary in the McKinsey Quarterly) shows that they have not even been remotely close to the actual results over the last twenty-five years.

As you can see from the graphic above, analysts have forecasted far better earnings growth than was actually the case. This may seem surprising to some as analysts have undershot earnings over the past four quarters, but the longer term view it is undeniable that analysts are too bullish. To be sure, earnings have rebounded nicely since the spring of 2008, but we have warned investors that a quick return to peak earnings levels may be a bit optimistic. After all, we would expect analysts to revert to their clear historical pattern of overestimating rather than underestimating earnings.

Source: McKinsey & Company (h/t The Pragmatic Capitalist)

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Ockham in Information Week

May 14th, 2010

Cisco Stock: 4 Reasons It’s Not Reflecting Blowout Quarter

Posted by Bob Evans on May 14, 2010 10:46 AM

CEO John Chambers says Cisco just had “probably the strongest quarter in our history” and given that storied history, that’s a remarkable perspective. But investors have been pooh-poohing Cisco shares, which have actually even fallen a bit: do they know something CIOs should know? Here are four possible explanations from a great equity-research firm.

Ockham Research has a strong following among traders and I’ve found their analyses of tech-company strengths and weaknesses to be unusually insightful. Ockham has posted a brief analysis of the Cisco disconnect onseekingalpha.com, and I’ve culled out four factors Ockham cites as potential causes for the mismatch between Cisco’s blowout performance and the lousy stock performance since then.

Bear in mind that Ockham is not taking the position that these are in fact the causes for the disconnect; rather, these four points represent their best effort to make some sense out of a situation that seems to make no sense. If it seems that the analysis is stretching a bit thin, that’s more a reflection of the bizarre share performance than it is of Ockham’s analytical capabilities.

1) “Perhaps the earnings whispers are to blame for the sell-off.” Yes, possible—but coming off “the strongest quarter in our history,” Cisco is also predicting huge growth for its next quarter, matching or significantly ahead of analysts’ projections.

2) “[Perhaps] . . . positive earnings surprises from other tech bellwethers made this report just par for the course.” Yes, some other tech companies have shown strong results, but none has matched Cisco’s 27% revenue growth and a comparable spike in profits.

3) “The quarter did include an extra 14th week, a rarity that may provide one possible explanation for the strong results.” Right, except for that equally bullish projection for the next quarter, which has no extra 14th week.

4) “The question investors must ask themselves is, does this best in class company not command a premium?” Perhaps some investors feel it doesn’t—but in a market that’s been desperately seeking growth, Cisco’s performance will be hard for competitors to match let alone exceed.

Ockham’s diligent attempt to find some chinks in the Cisco armor reveals just how strong the company’s performance actually was, and it also sheds some very encouraging light on the still-murky issue of whether CIO-level tech spending is back to encouraging levels.

As Ockham said, “Growth has returned to Cisco and, as its CEO will attest, they are hitting on all cylinders. . . . There is no doubt Cisco is a cash generating machine right now and operations appear only to be getting stronger as they provide the pipes for the Internet.”

Errant Trade Gives the Market an Excuse to Drop

By ndouthat | Published May 6th, 2010

We expect to see the finger pointing continue as to the reasons for the market’s worst sell-off since the Lehman Brothers days, and at this hour speculation has centered around a trading error at Citi (C). Citi has denied the claims, although they are investigating. The NYSE says there were no erroneous trades of Procter & Gamble (PG) or any other shares. Now, is it possible that a “fat-fingered” trader accidentally pushed “B” for billions instead of “M” for millions and dropped the Dow by as much as 1000 points at one time? Sure its possible, but we think that what is more interesting is the market’s rapid reaction.

At our office this afternoon, we huddled around our computers hitting the refresh button and calling out the worsening loses for what seemed like a long time but only lasted a few minutes. It’s down 410…550…700…920! The market was in full-blown panic-mode. I am sure this sort of activity happened in many offices this afternoon, and we all looked at each other looking for answers. Was it the Euro, Greece, Spain, housing, banks, what were we missing?

In short, we came to the conclusion that this has been a long time coming. Market participants had become complacent in the preceding months and being bullish was no only en vogue it was expected. With that said, the stock market has been built upon a vulnerable foundation. Around here we got the sense that that last few months were built upon popsicle sticks, a strong wind could send it tumbling. Make no mistake, the market was oversold in March of last year, but 14-months without so much as a ten percent pull-back? That is simply not sustainable, even if earnings are recovering and handily beating expectations. We had been expecting a pull back for a month or more now, but we didn’t expect it to take place all in one day!

The market’s behavior today seems to make our case for us. The Dow dropped 300 points and believing the rally was finally ending investors rushed to the exits hoping to hang onto as much profit as possible. Trading algorithms with tight stop losses triggered and human beings caved to their own emotions. No one knows when a catalyst will take place, be it a trading error or not, but Mr. Market displayed fear for the first time in a long time today.

Of course, the market did recover somewhat from the huge losses earlier this afternoon. But you can bet that complacency with the perpetually rising market will not be the case any longer. This was a wake up call that valuations are simply too hot. We still expect a further correction or at least a slight pause before a buying opportunity presents itself.

Disclosure: Some accounts at Ockham Wealth Advisors do have a long position in (C) and (PG) as of the time of publication. This disclosure is made as of 5/6/2010 but positions may change at anytime thereafter.

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