Tuesday, February 9, 2010

Americas Equity Morning 02.09.10

Companies Featured -AYE.N, BSX.N, CAT.N, CBB.N, CMG.N, CVS.N, INTU.O, IR.N, LNC.N,

Business Services: Tax Prep Channel Checks Suggest Challenging Season Vikram.Malhotra

After speaking with multiple franchisees of both H&R Block and Jackson Hewitt, we believe the 2010 tax season will prove challenging in terms of both volumes and pricing. We reiterate our UW rating on HRB ($20.96), and are Not-Rated on JTX ($2.26), given the uncertainty regarding its banking relationships. While the IRS has yet to release interim tax season data, our channel checks suggest up to a 5% decline in industry-wide tax filings this year, somewhat worse than the IRS’s forecast heading into the season. HRB franchisees suggest that corporate initiatives to improve retention are having only limited impact, and that picking up share from JTX is a short-term strategy at best.

Strategy/Economics/Portfolio Changes

Global Equity Strategy/Buy Industrials:

Earnings Expectations Too Cautious We are upgrading Industrials to overweight. Both macro (stage of the cycle, slope of the yield curve, improving capex drivers) and micro factors (pricing, costs, margins, inventory and order books) support a more positive view. Scott Davis & Team have also upgraded their US Industry view to Attractive from In-Line. We think Industrial earnings expectations are too low – particularly in the US. The potential for upgrades – when earnings momentum is slowing for other cyclicals – should be a strong support for relative performance as momentum behind leading economic indicators begins to fade and the threat of policy tightening and/or higher long rates limits multiple expansion for equities in general and cyclicals in particular.

China Economics: Upgrade 2010 Forecasts on Improved External Outlook

We have raised our forecasts for China’s GDP growth and inflation in 2010 to 11% (from 10%) and 3.2% (from 2.5%), as the external outlook appears stronger than we previously envisaged. The strong export growth in December 2009 to some extent reflected the low base effect, but it is consistent with the OECD leading indicator as well as robust demand from emerging markets. The growth rate of exports to AxJ, Latam and Africa – which account for nearly 50% of China’s total exports – was 20-30% YoY in December 2009.We have revised our forecast for export growth in 2010 to 15% from 9%. The stronger exports will contribute to economic growth mainly through their positive impact on private investment in manufacturing, such that the contribution of net exports to growth remains zero.
Strategy/Europe Economics: Ripples at the Periphery, Setbacks for the Core

Europe appears set to disappoint in terms of growth, trailing behind the US and emerging markets. Last week we saw disappointing data out of Germany, and this week the region’s 4Q GDP reports could confirm that a slowdown is already underway. Our favorite proprietary models tracking the euro area business cycle show clear signs of deceleration in manufacturing and overall GDP growth. A plunge in December industrial production creates a very weak entry point into 2010, suggesting that our below-consensus forecast of 1.2% for the year may need to come down. The ongoing recovery thus remains very much “triple-B” (bumpy, below-par, and brittle).

Currency Strategy: Punish the Printers — Reversal Faster than Expected

Our global currency outlook for 2010 had one major idea: a reversal in the “punish the printer” theme. Our thesis for currencies in 2010 was that the huge excess liquidity conditions that prevailed in 2009 and drove many currencies into misalignment would reverse in 2010 as central banks withdraw liquidity and the US economy outperforms. We expected exchange rates to move back towards fair value.So far this scenario has occurred even quicker than we imagined.The biggest surprise has been the early withdrawal of liquidity by China through an increase to its reserve requirement ratio. Also, our China team has raisedforecasts for Chinese GDP growth and inflation in 2010, as Qing Wang notes in this bulletin. This, combined with uncertainties surrounding potential regulations on the ability of banks to take proprietary risk, might have important implications for liquidity and the level of volatility in asset markets.


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