CWS Market Review – August 26, 2011

“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” – Warren Buffett

Very true, Warren. Very true. Quietly, this past week has been a turning point for the stock market. The “Fear Trade” that gripped Wall Street this summer is slowly beginning to unravel. Specifically, the Fear Trade consisted of investors dumping cyclicals especially and crowding into gold and Treasury bonds. Starting on July 22nd, the Wall Street bears had been in complete command. Every rally was yet another opportunity to short. That is, until this week. After a staggering $2 trillion was shed by the S&P 500, the Fear Trade has finally gotten some (minor) pushback.

I’ll give you an example of what I mean: The S&P 500 made very similar closing lows on August 8th (1,119.46) and August 10th (1,120.76) and then again on August 19th (1,123.53) and August 22nd (1,123.82). Notice how close together those lows are. Yet the bears weren’t able to bring us any lower. That’s a telling sign.

It’s still too early to say if this is the beginning of a major leg up, but it probably signals that the worse of the Fear Trade is past us. On closer inspection, much of the negative news was vastly overhyped (I’m looking at you, S&P downgrade). We had some promising rallies on Tuesday and Wednesday, and Thursday looked to be a good day until the German market tanked. Still, I like the trend that I’m seeing.

The pushback isn’t just happening in the stock market; let’s look at what’s happening in Bondistan. Last Thursday, the yield on the ten-year Treasury dropped below 2% and the five-year plunged to an absurd 0.79%. The three-month LIBOR rate is actually less than the two-year Treasury yield. Dear Lord, I don’t know what to say about prices like that except that it shows us how much fear there was in the market. The short-term Treasuries even pulled a Blutarsky. In the CWS Market Review from three weeks ago, I wrote “All across the board, investors are dumping risk and hoarding security. Fear is giving greed a major beat-down.”

Well, greed is getting back on its feet. The five-year T-note recently broke above 1%. Of course, that’s far from normal, but the key is that people aren’t suddenly dumping bonds and hoarding stocks. Instead, they’re walking back from some of the fear that took hold of the markets this summer.

With the Fear Trade, the riskier an asset was (or was perceived to be), the worse it did. Junk bonds, for example, have been getting beaten like a rented step-mule. The Wall Street Journal recently wrote: “The spread on the Barclays Capital High Yield Index over Treasurys widened to 7.66 percentage points this week—the highest since November 2009—from 5.87 percentage points at the end of July.”

The clearest area where the Fear Trade is coming unglued is in the gold pits. On Wednesday, gold dropped $104 per ounce which is one of its biggest plunges ever. Earlier this week, gold peaked at $1,917 per ounce and it closed the day on Thursday at $1,775.20. As long as real rates are low, gold will do well; but the metal has gotten ahead of itself. Once the Fear Trade got going, investors headed into the only areas that were working. Soon that turned into a flood and everything else got left behind (AFLAC at $35?). I remember when the Nasdaq peaked 11 years ago and there were healthy REITs that were paying 12% dividend yields. Only in retrospect do we see how insane that was.

I’m writing this early Friday morning and the big news due later today is the Ben Bernanke speech at the Fed’s annual shindig in Jackson Hole, Wyoming. I don’t expect any news, but too many people who ought to know better think the Fed will announce another round of Quantitative Easing. That simply isn’t going to happen. As a result, many traders expect Wall Street to be disappointed if QE3 doesn’t come our way. Call me a doubter, but that may have weighed on the stock market on Thursday. If anything, some of the recent data takes pressure off of Bernanke and the Fed.

The other important item on Friday will be the first revision to second-quarter GDP growth. The initial report said that the economy grew by 1.3% during the second three months of the year. Wall Street expects that to be revised slightly and they’re probably right. Still, the second quarter is now well within our rear-view mirror. I’m more concerned with the rest of Q3 and Q4.

Now let’s look at what’s happening with our Buy List. We only had one earnings report this past week which was from Medtronic ($MDT). The company reported fiscal Q1 earnings of 79 cents per share which matched Wall Street’s estimate. I wasn’t expecting much of an earnings surprise or shortfall. Honestly, this company has some problems, but ultimately, I think they’re manageable. I’d really like to see Medtronic become a leaner and meaner outfit and I think the new CEO agrees.

The best news is that they reiterated their full-year guidance of $3.43 to $3.50 per share. As I’ve said before, never dismiss these “reiterations.” Hearing that things are still “on track” is news. If you recall, MDT slashed their full-year guidance several times last year.

Let’s run through some numbers here: Shares of MDT dropped from over $43 in May to nearly $30 this month. The shares rallied on the earnings report not because the news was good but probably because there wasn’t any bad news. You often see that in value investing when investors get so disgusted by a stock that they expect to be disappointed. As odd as it may sound, that’s often a good buying opportunity.

Even the low end of Medtronic’s range tells us that the stock is going for less than 10 times this year’s earnings estimate. That’s a good value. The stock currently yields 2.86% and the dividend has been raised for the last 34 years in a row. Medtronic is a good buy below $35 per share.

We only have one earnings report due next week and that’s from Jos. A. Bank Clothiers ($JOSB) on Monday. If you recall, JOSB got smacked hard in June when the company’s fiscal Q1 earnings came in two cents below consensus. That two-penny miss caused the stock to plunge more than 13% in one day.

For Monday, the Street expects earnings of 68 cents per share. Sales should rise about 11% to $210 million. I should warn you that since JOSB doesn’t provide guidance, the earnings can vary widely from consensus. Sixty-eight cents sounds slightly low but I’m afraid traders are very strongly biased to be disappointed by whatever JOSB says. My advice is to not be surprised by a pullback. If you don’t already own JOSB, hold on. If you don’t own it, don’t chase it. If JOSB’s earnings come in at 70 cents or more and the stock pulls back below, it will be a very good buying opportunity. I’ll have more on the earnings report on the blog.

I also want to highlight Oracle ($ORCL) which looks very good at this level. In seven weeks, the shares have dropped from $34 to $26 yet their business outlook remains unchanged. The next earnings report should be out in mid-September. Oracle is an excellent buy below $25.

That’s all for now. There’s some talk going around that the NYSE might be closed due to Hurricane Irene. I’ll let you know as soon as I do. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by on August 26th, 2011 at 6:48 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.

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