CWS Market Review – December 23, 2011

Merry Christmas!

Santa Claus made an early arrival this year as the S&P 500 rallied for the last three days in a row, and we’re one good push from hitting our highest close in six weeks. The stock market will be closed on Monday so there are only five trading days left in 2011. As of now, our Buy List holds a slight lead over the S&P 500. As I’ve mentioned before, this could be our fifth-straight year of beating the market but it looks like it will come down to the wire.

Unfortunately, our Buy List wasn’t helped this week by our two stocks that reported earnings. First, Oracle ($ORCL) got body-slammed for an 11.7% loss on Wednesday after the company reported earnings three cents short of expectations. This is especially embarrassing for me because I told you Oracle would beat expectations by at least three cents per share. Ugh! I’ll have more on Oracle in a bit but I’ll tell you now that I still like the stock and that it is a member of the 2012 Buy List.

The other bad apple was Bed Bath & Beyond ($BBBY) which got a 6.3% haircut on Thursday. However, this story is very different from Oracle’s because I was very impressed with BBBY’s earnings report. They beat their forecast and raised full-year guidance for the third time this year. I’ll go into BBBY’s outlook in more detail in just a bit.

While I’m keeping BBBY on next year’s Buy List, if you’re thinking of starting a new position here, I’d caution you that the stock is on the expensive side. The Street’s estimates for next year’s earnings strike me as overly-optimistic. Still, BBBY is an outstanding company.

Remember that the 2012 Buy List will go into effect on Tuesday, January 3rd (the market will be closed on January 2nd). To reiterate, the new buys are CA Technologies ($CA), Hudson City Bancorp ($HCBK), CR Bard ($BCR), Harris ($HRS) and DirecTV ($DTV). The deletions are Abbott Labs ($ABT), Becton, Dickinson ($BDX), Deluxe ($DLX), Gilead Sciences ($GILD) and Leucadia National ($LUK).

I like to pre-announce the new Buy List so that no one can claim I use any tricks in getting a head start. This is actually hurting me this year. Since I announced the new picks, Harris is up by 7% and Hudson City is up 9%. While these gains don’t count for my 2012 track record, there’s nothing stopping you from getting in on the action.

Now let’s take a closer look at why stocks have been in a better mood lately. The reason is rather simple: the economic news continues to look promising. To be sure, we’re a long way from robust economic health, but things are looking better nearly every week. More importantly, the market is slowly realizing that we can prosper even as our friends across the pond are, shall we say…having difficulties.

Last week, I highlighted the very good jobless claims report. It was even better this week. There were 364,000 claims for initial unemployment insurance which is the lowest number since April 2008. This probably means that about 200,000 net new jobs are being created each month. Goldman Sachs estimates that any jobless claims figure reading below 435,000 indicates that the economy is creating more jobs.

The brighter economic news is having an important effect on consumers. This is crucial because consumer spending makes up 70% of the economy. So much of this is a game of psychology. People spend more when they feel more optimistic, and rising spending leads to greater optimism. (The Q3 GDP report was tepid, but remember that Q3 ended three months ago and that it started six months ago.)

The latest report on consumer confidence showed a big uptick in November, and it’s now at a six-month high. One important reason for greater confidence is probably due to lower gas prices. As difficult as this may be to believe, prices at the pump have been heading lower. According to numbers from, the average price for regular gas is down to $3.20 per gallon from close to $4 last spring. Lower gas prices have a big impact on the economy. They act almost like an immediate across-the-board raise for millions of consumers.

More good news may come out shortly. I’m writing this early on Friday and the durable goods and personal spending reports are due out later this morning. There’s even talk that Q4 GDP growth could top 4%. That would get 2012 off to a very nice start. I also noticed that the Volatility Index ($VIX), often called the Fear Index, dropped to 21.16 on Thursday which is its lowest close since July 26th. This is less than half of what it was during some of the hairy periods this fall. How quickly sentiment can change.

Gold, which is probably the ultimate fear trade, has melted down over the past few weeks. The metal recently dipped below its 200-day moving average. This is another signal that investors are growing less fearful. Plus, this may be early speculation that interest rates could go up sooner than expected. If that happens, I would expect to see a major rush out of gold.

Lots of people have foolishly called for a top in the bond market. They’ve all been wrong. So what did I do? Two weeks ago, I finally joined in. I think we’re going to see bond yields gradually move higher and this will be in tandem with renewed economic confidence. The yield on the ten-year bond has already dipped up by 15 basis points since Tuesday. This is a good omen because it will shake loose some of the scared money currently parked in Treasuries.

Take a look at Johnson & Johnson ($JNJ) which currently yields 3.5%. Actually, it really yields even more than that. In April, I expect JNJ to announce its 50th consecutive annual dividend increase. Let’s say JNJ raises their quarterly dividend from 57 cents per share to 59 cents per share. That would give the stock a yield of 3.62% which is roughly four times what a five-year Treasury note gets you. Not to mention that JNJ is rated AAA which Uncle Sam is not. The important takeaway for investors is to understand that the bond versus stock equation clearly favors stocks right now.

Now let’s return to Oracle ($ORCL). First, I must apologize for my awful prediction. Three months ago, Oracle said it expected to earn between 56 and 58 cents per share for their fiscal second quarter. Instead, they earned 54 cents per share. Sales came in at $8.81 billion which was well below the $9.23 billion expected by Wall Street. The plunge on Wednesday was Oracle’s biggest drop since 2002.

What went wrong? Part of this was due to foreign exchange which the company can’t do much about. Part was also due to the weak economy which may have already passed, especially in tech. Part of this was surely due to poor execution on Oracle’s part.

The company’s hardware business isn’t very strong at all. However, Larry Ellison said that hardware could start growing as early as next quarter. In recent years, Oracle has relied heavily on acquisitions. The problem now is that the company has been hurt as the approval process has been taking longer. That sounds like a lame excuse, but that’s what they said.

I’m still an Oracle fan. The company is very profitable. Gross margins increased last quarter and they generated $2.3 billion in cash flow. Historically, Oracle has bounced back strongly whenever it’s had disappointing results. On the conference call, Oracle said that sales will grow between 1% and 5% this quarter which was below analysts’ estimates of 7.4%. The company also said it expects to earn between 55 and 58 cents per share. Wall Street was at 59 cents. Those really aren’t awful numbers. Right now, the Street is angry at Oracle because they missed their own numbers. I’m not pleased either, but I see the larger picture. I’m lowering my buy price on Oracle to $30 per share. This is a very good stock.

The drop in Bed, Bath & Beyond’s ($BBBY) stock is a little harder to understand. The company had an outstanding quarter. For the three months ending in November, BBBY earned 95 cents per share which was six cents more than analysts expected. In September, the company told us to expect EPS between 82 and 87 cents per share.

The only possible weak spot was that sales grew by 6.8% which was below Wall Street’s estimate. The important metric is comparable store sales and that was up by 4.1% which is a drop-off from previous quarters.

I’ve been very impressed by the way BBBY has expanded its profit margins. The company has increased its year-over-year net margins for the last 11 quarters in a row. For the trailing four quarters, net margins are roughly at 10% and I doubt that can go much higher. In other words, the easy gains in pricing have already been made. That’s going to be a lot tougher from now on.

The best news was that BBBY raised its full-year forecast for the third time this year. The company now sees fiscal 2012 earnings-per-share coming in between $3.86 and $3.92. Wall Street currently thinks the company will earn $4.39 for fiscal 2013. I’m not so convinced. I suspect it will be closer to $4.25 but I realize I’m being conservative.

The current quarter is the biggie for BBBY. On their earnings call, the company said they expect to earn $1.26 to $1.32 per share. That’s up from $1.12 per share a year ago. I’m keeping my buy price on Bed Bath & Beyond at $60 per share. I still like this company a lot but I want to hear what kind of outlook they have for next year before I feel that this is one of our most compelling buys. I should add that oftentimes our top-performing stocks in a given year are ones I thought were slightly overpriced. That’s precisely why we have a broadly diversified Buy List.

I’m pleased to see that Nicholas Financial ($NICK) has started to perk up lately. The stock got as high as $12.90 on Tuesday. Expect another strong earnings report in another month. Abbott Labs ($ABT) also broke out to a new 52-week high on Thursday. Although ABT won’t be sticking around the Buy List next year, it’s handed us a nice 16.2% gain for this year (or 20.5% when we include the dividend).

For an improving economy, I expect to see healthy gains from Buy List stocks like Ford ($F) and Moog ($MOG-A). Also, don’t overlook some of the high-yielding stocks on the Buy List like Reynolds American ($RAI) or Sysco ($SYY). Reynolds is our top-performing stock this year.

That’s all for now. The stock market will be closed on Monday. 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 December 23rd, 2011 at 7:16 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.