CWS Market Review – December 2, 2011

If you were expecting a calm, reasoned financial market going into the holidays, I’m afraid you may be disappointed. On Wednesday, the Dow soared 490 points for its single-best day in nearly three years. This came after the stock market suffered its worst Thanksgiving week since 1932.

Usually, when the market does as well as it did on Wednesday, it’s following a big down day. But Wednesday’s move came after a slight rally on Tuesday. The S&P 500 gained 4.33% on Wednesday which was its eighth-best gain following an up day in the last 70 years.

I was pleased to see that stocks only finished modestly lower on Thursday. The S&P 500 is now back above its 50-day moving average and it’s only a small push from breaking above its 200-day moving average.

In this issue of CWS Market Review, I want to delve into some of the reasons for the market’s abrupt about-face. I’ll also tell you how to position your portfolios for the last few weeks of 2011. Remember that historically, the best time of year for stocks is a 17-day run from December 22nd to January 7th. More than 40% of the Dow’s historical gain has come during this period which is less than 5% of the calendar year.

The catalyst for Wednesday’s rally was—we’re told—the news that the Fed teamed up with other central banks to provide more liquidity for the global financial system. Allow me to explain; it’s all very simple. The Federal Reserve and other central banks agreed to lower the pricing on the existing temporary U.S. dollar liquidity swap arrangements from OIS +100 basis points to…ugh…getting sleepy…can’t…stay…awake…zzzzzzzz.

Look, forget all the mumbo-jumbo. The stock market did not see one of its best rallies in decades because some bureaucrats put out a press release. Thankfully, they’re not that important. Instead, the market rallied because the market’s cheap. It’s that simple. The problem is that no one wanted to be first in the pool. I don’t blame them. Playing the bear had been the winning trade for three-straight weeks. Screaming you’re scared from the rooftops is the only trade that’s made anyone any money. Plus, our friends across the pond have been doing their best to show that they’re as clueless on how to run their economies as we are in running ours.

To borrow from Comrade Trotsky, you may not be interested in the European financial crisis but the European financial crisis is interested in you. The news from Europe has been the main driver of the U.S. market for the last several weeks. But as I mentioned in the CWS Market Review from two weeks ago, our markets are slowly disentangling themselves from the mess in Europe.

Just look at the decent economic news we’ve had recently. Please note that I’m not saying “good news,” just that there’s zero evidence of an imminent Double Dip. The fact that we can say that in December would have surprised a lot of folks this summer. For example, this past earnings season was pretty good. Thursday’s ISM report was decent. The Chicago PMI just hit a seven-month high. I’m writing this in the wee hours of Friday morning so I don’t know what the jobs report will say (check the blog for updates), but this week’s ADP report was very encouraging.

Next Friday will be the big EU summit. This is it—Zero Hour. The Germans want more fiscal integration, and I think they’ll get it (of some sort). The Germans finally got religion once one of their bond auctions fizzled. When the country that’s supposed to bail everyone else out can’t get a loan, well…then it’s time to worry.

But now the Germans have stopped dragging their heels. Anyone with a sense of history will have to appreciate the recent quote from Radek Sikorski: “I will probably be the first Polish foreign minister in history to say so, but here it is: I fear German power less than I am beginning to fear German inactivity.” Strange days, no?

For Europe, this is beginning to feel like the fall of 2008. France’s AAA credit rating is on life support. Despite the bond auction disaster, the German one-year note recently went negative meaning that investors would prefer to take a loss just so they can be a creditor to Germany. This is exactly the kind of hysteria that’s been rattling our markets since August. It’s a mystical aura of fear, and that’s masking a truly inexpensive American market (Ford’s at 5.6 times 2012 earnings!)

Now that everyone’s been suitably freaked out, they can finally do something. In fact, we’re starting to get an idea of what the game plan will look like. The basics are that Germany wants the ECB on a tight leash while it wants to set hard rules for how budgeting is done in the Euro zone. No surprises there. I suspect the Germans may give up their opposition to joint euro-bonds if the member states agree to some sort of debt-reduction fund. I’m not sure of the details, but something the market likes will come out of the summit. That’s not a guess. There’s no other alternative.

But this crazy correlation we’ve had to Europe makes no sense. Here in the U.S., investors are quietly warming up to risk. We’ve already seen high-yield spreads in the U.S. begin to narrow as Treasury yields have climbed. Since December 23rd, the yield on the 30-year Treasury has risen by 30 basis points to 3.12%. The 10-year yield is up to 2.11% which is its highest yield in more than one month. As recently as July 25th, the 30-year was at 4.31%.

Now let’s turn to some recent news from our Buy List. On Tuesday, Jos. A. Bank Clothiers ($JOSB) reported very good earnings for its fiscal third quarter. The company earned 54 cents per share for the three months ending on October 29th, which was three cents better than Wall Street’s estimate.

JOSB’s business continues to hum along: earnings grew by 19% last quarter and revenues rose by more than 20%. The company has now reported higher earnings in 40 of its last 41 quarters including the last 22 in a row. However, there was one hitch. In the earnings report, JOSB warned that the fourth quarter “has started out more slowly than we had planned.”

The market didn’t like that at all and chopped 3.7% off the stock on Wednesday in the face of a big rally plus another 2.4% on Thursday. Until we hear more, I’m inclined to side with Joey Banks. This is a very solid company. Some of you may recall six months ago when the market slammed JOSB for a 13% one-day loss after it missed earnings by—are you ready?—one penny per share. JOSB is a very good buy below $54 per share.

In the CWS Market Review from October 14th, I said that I expected Becton, Dickinson ($BDX) to soon raise its dividend for the 39th year in a row. Sure enough, Becton came through and announced a 9.8% increase dividend increase on November 22nd. The new quarterly dividend is 45 cents per share and based on Thursday’s market close, BDX now yields 2.43%. There aren’t many stocks that can boast a dividend streak like Becton’s. Honestly, the stock is a bit pricey here in the low $70s. My advice is: don’t chase it. Instead, wait for a pullback below $65 before buying BDX.

Last week, Medtronic ($MDT) reported fiscal Q2 earnings of 84 cents per share which was two cents better than estimates. This is pretty much what I expected. Two weeks ago I wrote that “they can beat by a penny or two.” I have to explain that the market has dismally low expectations for Medtronic even though the company is still doing well with pacemakers and insulin pumps. The trouble spot is Infuse, its bone growth product used in spinal fusions. Sales for Infuse dropped by 16% last quarter.

The key for us is that Medtronic also reiterated its full-year EPS forecast of $3.43 to $3.50 per share. This means the stock is going for just over 10 times earnings. I’m raising my buy price for Medtronic to $40 per share.

On November 22nd, Gilead Sciences ($GILD) stunned Wall Street when it announced that it’s buying Pharmasset ($VRUS) for $11 billion. That’s an insanely rich price for a company that doesn’t have any products on the market yet. (I had to reread that sentence just now after typing it. Yep, it’s still nuts.)

So what does Pharmasset have? The company is pretty far along in developing oral drugs for hepatitis C. That could be a very lucrative market. Still, I think this was a terrible move on Gilead’s part. This is a business deal made out of fear rather than trying to spot an opportunity. Gilead was simply nervous that someone else would snatch up Pharmasset. I very much doubt that Gilead will be on our Buy List next year.

You may have noticed that Nicholas Financial ($NICK) has been especially volatile of late. Why? I have no idea. There’s been no news. I suspect that it’s pure market jitters. Of course, it’s the market’s irrationality that helps us find bargains, so that means we have to deal with bad volatility as well. Over the last two weeks, little NICK has gone from $11.75 per share down to $10.01 and then back up to as much as $11.56 yesterday. I don’t have any more to say than “ride out the storm.” NICK is an excellent stock.

Some other stocks on our Buy List that look attractive include Oracle ($ORCL), Moog ($MOG-A) and Ford ($F). Oracle should be coming out with its fiscal Q2 earnings in two weeks. Ford just reported a 13% sales increase for November. Also, Reynolds American ($RAI) has recently broken out to a new 52-week high. The stock is currently our top-performing stock for the year (+28%). The shares currently yield 5.37% which is equivalent to 645 Dow points.

That’s all for now. Today is the big jobs 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

P.S. I’m going to unveil the 2012 Buy List on Thursday, December 15th. As usual, I’m only adding and deleting five stocks from the current list. (Low turnover is my BFF.) I won’t start tracking the new Buy List until the start of the year. I like to make the names known publicly beforehand so no one can claim I’m front-running the market somehow.

Posted by on December 2nd, 2011 at 8:04 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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