It was a great week.
The winter rally is well under way and we’re keeping up with it. This past week saw nearly all of our holdings perform well, chief among them 
which gained 5% and 7% respectively.
In addition, we picked up shares of at $25 on Wednesday. Coupled with our position in bought last week at $29, the new position gives us a solid footing in old tech to further boost returns as this rally continues. So far, we’re up 3% and 1%.
The October consumer inflation report included no big gains in the core component despite the surge in energy prices which helped to leave a 14-year high in September’s annual CPI growth. Actually, the tiny 0.2% core rise followed 6 months of smaller gains. While it’s true that annual core growth returned to 2.1% year-over-year, weaker growth over the last 6 months leaves a small 1.7% annualized rate over that period. It looks like the long steady rise in energy prices has not spilled over into other areas.
So, that’s good for the economy.
Also, fears that the hurricanes would crack the country have proved unfounded. Although GDP growth should slow to roughly 2% in the fourth quarter, that will be temporary. Growth should return to nearly 4% in the first quarter of 2006.
We’ve already seen in retail reports that consumer spending is fine. High heating bills this winter will crimp that a little, but gasoline prices at the pump are now below pre-Katrina levels and that will help to offset those heating bills.
The inflation scare related to Katrina has also receded. Not only have energy prices backed down, but inflation has shown no uptrend at all.
Too, it’s no small matter that earnings growth has been swell. Operating earnings for the S&P; 500 rose 13% for the third quarter, and a similar increase in the fourth quarter is probable.
As economic and inflation fears subside, investors will pay more attention to valuation and earnings growth. That will allow the traditional year-end animal spirits to run loose, and is why I expect the rally to continue through New Year’s.
Are there any other stimuli? You bet. Barron’s pointed out the $2 trillion cash hoard sitting in the coffers of U.S. corporations. Naturally, companies are expected to use that cash in ways that prove beneficial to investors, like boosting dividends and repurchasing stock. Just last week, announced a $25 billion share repurchase program and a 25% increase in its quarterly dividend.
In sum, the U.S. economy is looking fine.
Last week, said it will start selling Apple’s iPods. It already sells iPod accessories, but now the player itself will join the shelf. We also learned that T. Rowe Price has an 11% stake in the company. It never hurts to see other smart investors heavily into something you own. So far, we’re down 7.7% on the stock, but I’m confident that it will prove to be a long-term winner. If you haven’t bought yet, it’s not too late. You can get it for less than I paid.
I wrote to subscribers last week from Kyushu, the southernmost of Japan’s four main islands. I mentioned that I was further researching the recovering economy there and would get back to them on what I found.
On Tuesday, Nov. 8, the Japanese government said Japan’s index of leading economic indicators fell to 50 in September compared with 100 in August. A reading above 50, which looks at 12 economic indicators that predict future economic developments, signals growth over the coming six months. A level below 50 suggests contraction. Banking stocks fell, including our holding, , which shed 1.8%.
In Kyushu, however, I heard news of a restaurant chain growing faster than it has at any time in its history because of companies spending more to take employees out to eat. Further, the island is bustling with new construction, including a bullet train spur down to the far reaches of the island. Buildings are leased out. There are Starbucks shops every six minutes as you walk around downtown Kumamoto. In short, life looks pretty prosperous down there. The trip reinforced my view that Japan is on an upward trajectory.
Then this week after I returned to my office outside of Tokyo, more national news hit the papers. Bloomberg reported on Tuesday that Japan’s current account surplus widened in September as exports rose to a record high. The surplus rose 6.5% from September of last year. Exports climbed 8.9% from a year earlier. It looks like global economic growth is stoking demand for Japanese goods. Rising exports combined with climbing domestic spending and corporate investment will help the economy sustain this latest expansion.
Stefan Worrall, an economist at Credit Suisse First Boston in Tokyo, said, “As we approach 2006 we have domestic demand, which is strong and being built up by employment growth, and businesses becoming more confident, and at the same time you have external demand becoming quite strong.” Those are nice factors to have coming together.
So far, our investments in Japan are down 4% and up 14% respectively.
As usual, there are several stocks I’m watching, chief among them this week being a maker of tools to produce microchips. It would complement our old tech holdings and further prove how much I believe in the recovery of the chip sector.
On Wednesday the company forecast flat profits and slowing order growth for its current quarter, and its shares fell. The company also posted a quarterly profit that fell by nearly half, but beat expectations as renewed demand for the chips found in everything from computers to cars began to fuel a recovery from the industry’s latest downturn.
“Some investors are still concerned that this is a one or two quarter blip and then there will be a downturn,” said Suresh Balaraman, an analyst with ThinkEquity Partners.
The company’s chief executive brushed aside Balaraman’s concern. He pointed to strong demand for memory chips, such as those found in Apple’s iPod, as proof that this is not a temporary uptick.
Taiwanese contract chipmakers have started buying more equipment and there are signs of life in China, which bought about $1 billion from the company in 2004, but very little this year.
“We think that the fundamental factors will allow us to continue growth. I wouldn’t even start talking about a peak at this point,” the CEO told analysts on a conference call.
The company trades at a discount to its main rivals. It has a P/E ratio of 22.4 for the 2006 fiscal year, compared with 26.1 for Tokyo Electron, 23.1 for Lam Research, and 26.7 for KLA-Tencor.
We would be wise to look past short-term concerns and focus on strong prospects for next year. I’m eyeing $17 as a good place to get in but have not placed an order yet. I’ll let subscribers to The Kelly Letter know if and when I do.
Now’s a good time to subscribe, by the way. The rally’s just far enough along to be sure that the the falling is finished, but not so far along that there are no gains left. I’m offering the first month free and after that it’s just $4.95 a month, so give it a shot. Many of my subscribers say that The Kelly Letter is the cheapest top-flight investment letter they’ve found.
