CWS Market Review – November 4, 2011

Even though October was the eighth-best month for the S&P 500 of the last 70 years, the market has taken back some of those gains thanks to the recent political chaos in Greece. Here’s what happened: George Papandreou, the Greek Prime Minister, surprised everyone on Monday by putting the euro zone bailout plan up for a referendum. Simply put, that freaked out everyone—and I mean everyone.

For a few hours it looked like Greece was really honestly going to default. Monsieur Sarkozy said that the Greeks wouldn’t get a single cent in aid if they didn’t adhere to the original terms of the bailout. It got so bad that the European bailout fund had to cancel a bond offering. Yields on two-year notes in Greece jumped to 112%.

Yes, 112%.

The ECB, under its new head Mario Draghi, stepped in and cut rates by 0.25% which seemed to calm folks down. At least for a little while. Only after his party revolted against the idea did Papandreou decide to ditch the referendum. That’s what traders wanted to hear. On Thursday, the S&P 500 jumped 1.88%, and the index is now up barely for the year.

So we dodged a bullet for the time being, but we’re not yet out of the woods. I think it’s obvious that Greece will get the aid although the details are still unclear. My fear is that this latest cure only addresses the symptoms and not the underlying problem.

The issue isn’t that Greece mismanaged its finances (which it did) but rather that the euro zone as currently constructed is inherently unworkable. As it now stands, the countries on the periphery of Europe have to run massive trade deficits with the heart of Europe (Germany, mostly), and without the ability to downgrade their currencies, they’re forced to run large public-sector deficits.

The equation boils down to this: The euro zone needs fiscal union or the euro dies. Perhaps a smaller euro zone could make it. If the EU was just a trading club for the rich nations of Western Europe, fine—that might work. But what’s happening now, I fear, is just delaying a problem that can’t be avoided.

The problems in Europe are having an unusual side effect on the stock market here. What we’re seeing is an unusually high correlation among stocks. In other words, nearly every stock is moving in the same direction, whether it’s up or down. It’s important for investors to understand this. The last time correlation was this high was in October 1987 when the market crashed.

Bespoke Investment Group, one of my favorite sites, tracks what it calls “all or nothing days” which is when the advance/decline line for the S&P 500 exceeds plus or minus 400. Since the start of August, more than half of the trading days have been “all or nothing days” which is a rate far greater than seen in previous years. The current market divide has energy, industrial, material and most importantly, financial stocks, soaring on up days, while volatility, gold and bonds rally on down days. The market is behaving like a legislature that has only extremists and no moderates.

I don’t believe the high correlation portends any ugliness for the U.S. market. Instead, I think it reflects the dominance of geo-political events over the market. Though one important side effect is that when everyone moves the same way, it becomes much harder for hedge fund managers to stand out from the crowd. That’s why we’ve seen crazy action in stocks like ($AMZN) and Netflix ($NFLX).

As depressing as the news is from Europe, there’s been more cause for optimism here in the U.S. While the economy is far from strong, it appears that the threat of a Double Dip recession in the near-term has fizzled. Last week, we learned that the economy grew by 2.5% for the third quarter. Job growth, of course, has been distressingly poor.

I’m writing this early Friday morning ahead of the big jobs report. Economists expect that the jobless rate will remain unchanged at 9.1% and that 100,000 new jobs were created last month. Even if we hit that expectation, that’s still pretty poor.

The good news is that this has been a decent earnings season for the market and especially for our Buy List. The S&P 500 is on track to post record quarterly earnings. The latest numbers show that of the 415 S&P 500 stocks that have reported so far, 288 have beaten expectations, 89 have missed and 38 were in line with estimates. Outside the S&P 500, 64.5% of companies have beaten estimates and that’s better than the previous two quarters. Our Buy List has done even better. Of the 12 Buy List stocks that have reported so far, ten have beaten earnings estimates, one missed and one was inline.

On Tuesday, Fiserv ($FISV) reported third-quarter earnings of $1.16 per share which was two cents better than estimates. The company also raised its full-year guidance (man, I love typing those words) from $4.42 – $4.54 per share to $4.54 – $4.60 per share. Shortly before the earnings report, Fiserv’s stock gapped up to over $61 but then pulled back after the earnings report came out. Fiserv is a good buy up to $62 per share.

Our star for the week and perhaps for the entire earnings season was Wright Express ($WXS). The stock soared 12% on Wednesday after its blowout earnings report. The company, which helps firms track their expenses for their vehicle fleets, reported third-quarter earnings of 99 cents per share which was six cents better than Wall Street’s consensus. That’s a 38% jump over last year. The company also said that it expects between 88 cents and 94 cents per share for the fourth quarter (the Street was expecting 94 cents per share). I was happy to see Wright extend its gain on Thursday as well. I rate Wright Express a buy up to $53.

The big disappointment this week came from Becton, Dickinson ($BDX). For their fiscal fourth quarter, Becton reported earnings of $1.39 per share which was inline with Wall Street’s estimate. The problem was their guidance for the coming year. Becton said that they expect earnings to range between $5.75 and $5.85 per share. That’s far below Wall Street’s forecast of $6.19 per share. I’m disappointed by this news but Becton is still a solid company. Sometime later this month the company will likely raise its dividend for the 39th year in a row. Investors shouldn’t chase this one but if the shares pull back below $65, I think Becton will be a good buy.

I also need to explain what happened to Leucadia National ($LUK) this week. A ratings company downgraded Jefferies ($JEF) in the wake of the immolation of MF Global. Leucadia owns about one-quarter of Jefferies so that impacted their stock as well. However, it’s not clear that Jefferies’s health is anywhere as dire as MF Global’s. Actually, the facts indicate that it’s almost certainly not.

At one point on Thursday, shares of Jefferies were off by more than 20% but cooler heads prevailed and the stock finished the session down by just 2.1%. Leucadia took advantage of the panic and picked up one million shares of JEF. At the end of the day, Leucadia’s stock managed to close six cents higher. The stock remains an excellent buy. By the way, this a good lesson on why you should be careful with stop-losses. Panic can set in and bust you out of good trades.

That’s all for now. In addition to tomorrow’s big jobs report, Moog ($MOG-A) is due to report earnings. Then on Monday, Sysco ($SYY) is scheduled to report. 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 November 4th, 2011 at 6:23 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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