CWS Market Review – December 16, 2011

Before I get into today’s CWS Market Review, here’s my Buy List for 2012:

Bed Bath Beyond ($BBBY)
CR Bard ($BCR)
CA Technologies ($CA)
DirecTV ($DTV)
Fiserv ($FISV)
Ford ($F)
Harris ($HRS)
Hudson City Bancorp ($HCBK)
Johnson & Johnson ($JNJ)
Jos. A. Bank Clothiers ($JOSB)
JPMorgan Chase ($JPM)
Moog ($MOG-A)
Medtronic ($MDT)
Nicholas Financial ($NICK)
Oracle ($ORCL)
Reynolds American ($RAI)
Stryker ($SYK)
Sysco ($SYY)
Wright Express ($WXS)

Fifteen of the stocks from last year will stay on the list for next year. The five new stocks are CR Bard ($BCR), CA Technologies ($CA), DirecTV ($DTV), Harris ($HRS) and Hudson City Bancorp ($HCBK).

The five deletions are Abbott Labs ($ABT), Becton, Dickinson ($BDX), Deluxe ($DLX), Gilead Sciences ($GILD) and Leucadia National ($LUK).

The new Buy List goes into effect on January 2, 2012 which is the first day of trading of the new year. For tracking purposes, I assume the Buy List is a $1 million portfolio that’s equally weighted among 20 positions of $50,000 each based on the closing price of December 30, 2011. As usual, I can’t make any changes to the Buy List during the year.

Through Thursday’s close, our 2011 Buy List is down 1.63% for the year while the S&P 500 is down 3.33%. Including dividends, our Buy List is up 0.15% while the S&P 500 is down 1.36%. There are only ten trading days left this year, but it’s looking like we’re going to beat the market for the fifth year in a row. Once again, we’ve shown that discipline and patience can beat the market.

The problem for us right now is that market hasn’t been in a terribly good mood. After putting on a decent rally of close to 9% between November 25th and December 7th, the S&P 500 is limping into the end of the year. On Thursday, the index closed at 1215 which I like to call the Magna Carta line. If all goes well, we can be at back at the Black Death (1348-1350) in early in 2012.

There are some reasons for optimism. For one, the economic news continues to be…not awful, which is a pleasant change of pace. On Thursday, for example, we learned that the number of initial jobless claims fell to 366,000 which is the lowest number since May 2008. This stat tends to have a lot of noise so it’s best to see more confirmation of a positive trend, but the past few reports have been pretty good.

The Philly Fed report showed that manufacturing picked up there at the fastest pace in eight months. The report from the New York Fed also showed that the economy is better than expected. I noticed that FedEx ($FDX) posted good earnings recently. This is noteworthy because their business is often a good barometer for the overall economy.

A recent poll of economists showed that they expect the economy to grow by 2.9% in the fourth quarter. That’s a big increase from 2.3% in a similar poll conducted last month. While that’s hardly a great rate, it’s a nice improvement over what we’ve seen (not to mention that many gurus confidently predicted we’d been in a nasty Double Dip right now). Only 25% of economists currently believe the economy will hit a recession in the next 12 months. Interestingly, the Federal Reserve met this week and their statement revealed no changes to current policy.

Another good sign is that we’re seeing more strength in small-cap stocks. This sector got absolutely hammered during the late summer this year. Between July 13th and October 3rd, the Russell 2000 ($RUT), which is an index of small-cap stocks, dropped 27.2%. That’s 10% more than the loss suffered by the S&P 500. When people get scared they run towards safety. Or rather, what they think is safe. That means large-cap multinationals.

Only when investors are more confident are they willing to take on more risk. Since October 4th, the S&P 500 has put on 10.6% while the Russell 2000 has added 17.5%. That’s a good sign. I’m also pleased to see the unraveling of stocks with absurd valuations like Netflix ($NFLX) and ($AMZN). (And yes, Amazon still has a long way to fall.) I’ll also point out that trading volume has been suspiciously light recently. Perhaps traders are getting fed up with the constant price swings.

We’ve also seen a major breakdown in the price of gold. The Midas Metal fell below $1,570 per ounce this week. My guess is that this is related to the recent breakdown in the euro. As the euro loses ground to the dollar, the ECB will have more “permission” from the markets to lower interest rates. Remember that the price of gold is really a ratio—gold per dollar. In other words, movements in gold are often less about the metal and more about the currency.

Investors are finding a lot more interest at the longer end of the yield curve. The yield curve has narrowed over the past few days. Part of this is certainly due to efforts of the Federal Reserve’s QE program, but I suspect many investors are riding this wave. On Wednesday, an auction of 30-year T-bonds went off at the lowest yield ever. The bid-to-cover ratio, which measures investor interest in the auction, was the highest in eleven years. A recent auction of three-year notes had the highest bid-to-cover ratio ever recorded for that maturity.

I also want to touch on the financial sector. This part of the market has been a bust this year. Outside of a few positions like Nicholas Financial ($NICK) or JPMorgan ($JPM), our Buy List has been pretty light on financials. My feeling is that many financials were a value trap. This is when a stock or sector appears to be cheap based on traditional metrics but that’s only because the share prices correctly anticipated further declines in the fundamentals. I think that’s exactly what happened this year. Now, however, it’s becoming safer to move cautiously into financials. I think it’s very possible that the Financial Sector ETF ($XLF) can be at $16 this time next year.

The only earnings report next week for our Buy List will come on Tuesday when Oracle ($ORCL) reports its fiscal second-quarter results. The company has told us to expect EPS to range between 56 and 58 cents. Let me reiterate what I said last week. I think Oracle has a good shot of earning 60 cents per share. Their cash flow has been very strong. Their licensing business continues to do well, although I’m a little concerned about the hardware side of the business which is a bit shaky. Bear in mind that Oracle earned 51 cents per share in last year’s Q2 which was very strong. The shares have dropped down to $29 recently which is a very attractive price. Oracle is a buy up to $34 per share.

That’s all for now. Be sure to keep checking the blog for daily updates. Hopefully Europe will still exist next week. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by on December 16th, 2011 at 6:51 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.