- - Thursday, July 15, 2010

ANALYSIS/OPINION:

With little in the way of economic data for the first part of this past week, it comes as little surprise that corporate earnings took center stage. Upbeat earnings reports and upwardly revised expectations from Alcoa, CSX, Intel and others fueled a nice upward move early in the week, particularly for the technology heavy Nasdaq index. Outlooks from Alcoa and CSX suggested a better second half compared with what some on the Street had been expecting, but we need to decipher between what may be wishful thinking and what may actually happen.

To be fair, some sour notes tempered positive news early in the week. Missed expectations from Yum Brands as well as a cautious outlook from Marriott International support the notion that we are not out of the woods.

Unfortunately, it reminds me what I wrote about last week (“With doubts about the recovery, what to do?”) when I touched on reduced expectations for growth. Unfortunately, those sour notes grew as the week wore on.

Midweek, the Federal Reserve trimmed its 3.2 percent to 3.7 percent growth forecasts to 3 percent to 3.5 percent. While this is not a major revision, the vast majority of the change is in the second half of the year and as such reinforces the notion that the recovery will slow in the coming months.

After that revision, a flurry of economic data released Thursday again emphasized a slowing in economic activity in the past few months. Case in point, the Federal Reserve Bank of Philadelphia’s Business Outlook index declined from 21.4 in May to 8.0 in June and fell again to 5.1 in July. Also on Thursday, we received the latest reading on New York manufacturing activity, which is expanding in July but at a much slower pace than in June or May per data from the Federal Reserve Bank of New York’s Empire State Manufacturing Survey.

If we step back and take a wider view by mixing the economic data and the company commentaries from earlier in the week, it confirms, to me at least, that the recovery will be spotty and that we will continue to grapple with the fallout of the past several years of excess as we continue to adjust to the new normal. While it may be a somewhat simplistic way to view it, the right-sizing that needs to take place after years and years of debt-led growth will take more than a few short years.

What we need to do as investors and stewards of our own money is to continually identify and revisit investing opportunities for growth as well as those that may be more defensive in nature. In recent weeks, I touched on several areas that were more defensive, including select exchange-traded funds and companies whose goods and services are more inelastic in nature.

Rather than rehash defensive plays, lets turn our investing lens toward an area that continues to grow: Internet traffic.

Anecdotal evidence and simple survey point to more people spending more time on the Internet. Searching for jobs, restaurants where kids eat free, free events, weekend activities, watching videos or listening to music, catching up with via Facebook, or simply reading the new e-mail. All of these activities are spurring Internet traffic.

Cisco Systems recently released the results of its annual Cisco Visual Networking Index Forecast, this one for 2009 to 2014, which projects that global Internet traffic will increase more than fourfold by 2014. The forecast, which focuses on both consumers and businesses, offers projections based on Cisco’s analysis and modeling of traffic, usage and device data from independent analyst sources. The global online video community will include more than 1 billion users by the end of 2010. Video traffic continues to be the most significant growth factor and it is expected to be the dominant driver in Web traffic growth, accounting for more than 91 percent of global traffic in the next three years.

Consider how people are consuming media these days, particularly video. Whether it’s pay-per-view, video-on-demand, or streaming services from Hulu, Netflix, via Apples iTunes, Googles YouTube or its pending GoogleTV — consumers are shifting their viewing habits. Then consider all the short-form programming that can be found in blogs, or on other Web sites such as “Funny or Die” and, well, you get the idea. Call it place shifting (consuming what we what, where we want, when we want) or some other buzzword, but the simple fact is the Internet has allowed us to decouple viewing video programming.

This growth in traffic will spur demand for Internet infrastructure, be it backbone technology such as routers and switches or data centers and related services such as collocation, interconnection and managed information technology infrastructure services, or companies that offer services for accelerating and improving the delivery of content and applications over the Internet.

Among the number of players in the ecosystem, Cisco is one clear beneficiary. We can tackle others in future columns. In the meantime, one potential starting point would be to dissect the holdings of either Internet HOLDRS Trust or Internet Infrastructure HOLDRS and start your investor due diligence there.

Good luck and good hunting.

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