CWS Market Review – November 12, 2010

As I expected, this has been a fairly slow week for market news. We’re now wrapping up the third-quarter earnings season, and overall, earnings have been very good. Unfortunately, the media hasn’t talked about this much.

Normally, the average stock beats its earnings estimate by 3%. Analysts like to low-ball since missing by a penny too little looks much better than missing by a penny too much. This season, the median earnings beat was by close to 5%. More than three of out every four stocks in the S&P 500 have beaten expectations. This is excellent news, and it will hopefully put an end to all the nonsense we heard about a Double Dip over the summer.

According to the latest numbers, Q3 earnings for the S&P 500 are up 36.1% from one year ago. The current projection is that earnings will be up another 26.8% for Q4. The S&P 500 is on track to earn $83.51 for all of 2010. The current forecast is for $94.34 for next year. Going by Thursday’s close, that’s a forward P/E of just 12.86. In other words, stocks are still a good deal.

The difficulty will be earnings for next year. Expanding margins have been the main driver of earnings increases, but that’s going to be much harder to do next year.

I’m happy to say that 14 out of the 15 stocks on our Buy List that report on the March/June/September/December cycle beat expectations. Only Moog ($MOG-A) missed and that was by a penny per share. Some stocks, like Wright Express ($WXS) and Nicholas Financial ($NICK), had exceptionally strong reports.

Now we’re moving on to earnings reports from companies whose quarter ended in October. In fact, the market was rattled today by earnings news from Cisco ($CSCO) which has an October quarter.

Cisco’s stock is almost exactly where it was 12 years ago. Oddly, some of the problems that Cisco faces are cutbacks in government spending. Cisco is feeling the pinch not just because of Uncle Sam but also at the state level and internationally as well. The company gets about 22% of its business from the public sector.

The most fascinating news this week was in silver, which is often called the “poor man’s gold.” On Tuesday the CME announced that it was raising the margin requirement on silver which, led to some crazy trading.

The Silver ETF ($SLV) traded an astounding 145 million shares on Tuesday. To put that in context, over the summer SLV often traded around 5 million shares per day. Thanks to the margin news, silver’s explosive rally was halted in its tracks. On Tuesday, SLV dropped from a high of $28.72 to a close of $26.18. In late August, SLV was going for $18.

The margin change is eerily similar to when margin rules were changed in 1980 when the Hunt brothers tried—and nearly succeeded—to corner the world silver market. They borrowed huge amounts of money for their gambit.

At first, it was a brilliant move and the brothers made billions. This is back when being a billionaire was something special. But the bottom fell out of the market on “Silver Thursday,” March 27, 1980. The plunge in silver was much greater than the plunge in gold. So far, SLV has recovered from its mini-plunge, closing at $27.11 on Thursday.

I don’t recommend investing in gold or silver, but I won’t be surprised to see gold move higher from here. In fact, it could go a lot higher. I published my gold model (or really a model for a gold model) last month in which I indicated that the key is real interest rates. As long as the Fed keeps interest rates low, gold ought to do well. I have nothing against gold, but I feel the best way to invest is with strong stocks. They’re much more stable and less open to speculative frenzies (but not impervious to them either).

Speaking of strong stocks, I should remind you that Reynolds American ($RAI) will be splitting its shares 2-for-1 next week. Don’t be alarmed if you see that the stock is down by 50%. It’s not really so. If you own RAI, you’ll have twice as many shares. The split will be effective on Tuesday morning.

Reynolds American got dinged on Wednesday due to the news of the graphic packaging that’s been proposed for cigarette boxes. After October 22, 2012, all cigarettes sold in the U.S. must have labels with phrases like “smoking can kill you.” The graphics have to cover half of the front and back of cigarette boxes.

We have three stocks on the Buy List whose quarter ended in October: Medtronic ($MDT), Eaton Vance ($EV) and Jos. A Bank Clothiers ($JOSB). I don’t know the earnings dates yet, but Medtronic and Eaton Vance usually report around Thanksgiving. JOSB will probably follow in early December.

Medtronic is the one I’m most confused about so let me share my thoughts on that one. I was very disappointed by Medtronic’s last earnings report. They missed by a penny and they also lowered their full-year EPS range from $3.45 to $3.55 to a range of $3.40 to $3.48.

My concern is that even their lowered forecast assumes a strong second half of the fiscal year. They can certainly hit those numbers. We’re still early since the fiscal year ends in April, but I have to say that there’s a chance that Medtronic could lower their forecast again. I’ve noticed that the Street’s estimate is down to $3.41 which almost certainly means that they’re worried about additional lower guidance.

Still, at $35 per share, the stock is a good value. Wall Street’s estimate for the October quarter is 82 cents per share. If Medtronic beats that with no accompanying lower guidance, the stock could be off to the races. But for now, I can’t tell how it will turn out.

I should urge caution on Eaton Vance’s earnings because the company’s bottom line can be fairly erratic. They don’t play Wall Street’s earnings game (which is kind of ironic for a mutual fund company). For example, EV missed earnings by 11 cents in May and by four cents in August. The stock got punished but it’s hardly anything like what you saw from Cisco today.

The big news next week will be the inflation reports and the IPO for General Motors. The plan is for GM to sell 365 million shares somewhere between $26 and $29 per share. That works out to somewhere between $9.5 billion and $10.5 billion. GM will also offer about $3 billion in preferred stock that will become common stock. I wouldn’t go anywhere near this offering. If you’re a U.S. taxpayer you already own GM, and that’s too much already.

I’ll have more market analysis for you in the next issue of CWS Market Review!

Best – Eddy

Posted by on November 12th, 2010 at 7:53 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.