CWS Market Review – March 23, 2012

The S&P 500 closed lower on Thursday for the third day in a row. Don’t be too worried about the recent downtrend. All told, it amounts to a loss of 1.2%. Before this, the market had rallied for eight of the previous nine sessions and for 44 of the last 64. That’s a remarkable run.

We need to remember that for the last six months, the stock market has treated us very well. From October 3rd to March 22nd, the S&P 500 climbed 26.7% which ain’t bad for half a year’s work. Actually, that’s a pretty good return for two years’ work.

In this week’s issue of CWS Market Review, I want to focus on the upcoming Q1 earnings season. I’m expecting another round of great earnings from our Buy LIst stocks. Speaking of which, Oracle ($ORCL) delivered very strong results this past week (except the stock fell). I’ll share my view on that in a bit, but I’ll give you a preview: I’m raising my buy price on Oracle. I’ll also focus on the earnings report for Bed Bath & Beyond ($BBBY) which is less than two weeks away.

China’s Economy Faces Growing Pains

So what’s the cause of our three-day slump? The answer is China. The big-wigs there are concerned that their economy is slowing down. Of course, any developed country in the world would love to be growing at half of China’s “slowing” rate.

China is a major player and we need to take notice. A few weeks ago, it was big news when the premier of China reduced the country’s GDP growth target from 8% to 7.5%. That was the first time in eight years that the Chinese cut their growth target. Ever since then, a slew of negative economic news has come out. So far, the Chinese Fed has cut reserve requirements twice, but it hasn’t yet touched interest rates. Today we learned that a manufacturing index compiled by HSBC dropped to 48.1 in March. That’s the fifth-straight monthly decline. Any reading below 50 means the economy is contracting.

There’s a lot to admire about China’s rapid growth, but there are some emerging problems as well. I’ll try to portray the situation as simply as possible. Let’s say you’re some big-shot Chicom apparatchik in Beijing and you have a choice to make. Would you rather have A) millions of unemployed 19-year-old men in your central cities, most of whom have immigrated from the sticks to find work, or B) OMG, I’ll do anything that’s not that first thing!

I’m guessing you chose B. Smart move.

Think about this number: An estimated 230 million people have moved from rural China to the cities for work. That’s like Tom Joad times 1,000. That’s why a huge portion of China’s economy depends on exports. The country has transformed itself into a gigantic export machine, and they’ll do anything to keep it going. Those export sectors tend to be heavy industry sectors. Here’s another scary fact: Over 70% of the water in China’s five major rivers is “unsuitable for human contact.” This is the water that countless millions of people, including children, use every day.

Keeping the exports flowing is going to be a problem if Europe’s economy is flat on its back. Until now, China has played the currency game and weakened the yuan to keep the exports going. The country has a staggering $3 trillion in currency reserves. But now that game’s not going to be so easy to play since the euro also needs to fall. China’s challenge is to work to balance its economy so it’s not so dependent on shipping things out of the country. I don’t know what the answer is, but it would be good for everyone if China found a way to boost its domestic consumption.

If China is slowing, that’s a big deal for us. Economic growth from the world’s largest country helped the U.S. economy recover from the Great Kablooey of four years ago. Personally, I think some bears on Wall Street have been eagerly jumping on the news from China as an excuse to exit their positions. That’s understandable since the folks waiting for stocks to plunge have gotten it wrong for so long. They’re ready to take anything they can get.

Oracle Beats the Street by Six Cents Per Share

The next event on the horizon will be the first-quarter earnings season. Until last earnings season, Corporate America had amassed a string of impressive quarterly earnings. This time, Wall Street has been paring back estimates for Q1, but the numbers will probably be pretty good.

Right now, analysts see earnings rising by 5.5% over last year’s first quarter. If Wall Street’s earnings forecast is right, the S&P 500 is closing in on $100 in trailing four-quarter earnings. We’ll probably hit that mark some time this summer. The S&P 500’s current sub-1,400 position means that stocks are reasonably valued. I’m also pleased to see more companies raising their dividends. In January and February, 100 stocks in the S&P 500 increased their dividend. That’s the most at this time of year in at least eight years.

Perhaps the best news this week was the solid earnings report from Oracle ($ORCL). After the market closed on Tuesday, Oracle reported fiscal third-quarter earnings of 62 cents per share. This was six cents more than Wall Street’s forecast. Oracle’s earnings were up 15% over a year ago. The revenue number was inline with estimates. Oracle continues to do well with its licensing revenues, and profit margins are strong. The weak link is still hardware, but Larry Ellison has said that that business will pick up later this year. We’ll see.

On the earnings call, Oracle said to expect Q4 earnings to range between 76 cents and 81 cents per share. That impressed me. The Wall Street consensus had been 76 cents per share. This means that Oracle should earn roughly $2.40 per share for this fiscal year which ends in May.

The odd part was the stock’s reaction. Early Wednesday, Oracle gapped up to $31.15 per share, but the rally didn’t last. By the end of the day, the stock finished below $30. Then on Thursday, the stock fell below $29. I’m not worried at all. Recall that Oracle’s stock dropped after the last earnings report only to rally even higher shortly afterward. That came after a weak report and this was a good one.

One thing I got wrong last week was my forecast for a higher dividend. I said to expect Oracle to raise its quarterly dividend by one penny per share. No such luck. Overall, I’m very pleased with Oracle’s performance. This was a very good report, and the guidance is especially encouraging. I’m raising my buy price on Oracle to $32 per share.

Look for Strong Earnings from Bed Bath & Beyond

Two months ago, I raised my buy price for Bed Bath & Beyond ($BBBY) from $60 to $66. Apparently, the stock was inspired because it just smashed $66 this week and closed at a new all-time high. This is a solid company and it’s been a huge winner for us. This week, I want to preview the upcoming earnings report which is due on April 4th.

This requires a little explanation. BBBY’s fiscal year ends at the end of February. Many retailers do this so they can they can include the entire holiday shopping season in one quarter. So the report coming in two weeks will be for the important Christmas quarter. Typically, the holiday quarter accounts for around 35% of BBBY’s annual profit. In other words, this is a biggie.

Three months ago, Bed Bath & Beyond told us to expect Q4 earnings to range between $1.28 and $1.33 per share. That’s a bold forecast and my numbers say it’s a few pennies on the low side. For the fiscal year, BBBY’s forecast translates to earnings of $3.86 to $3.92 per share. That’s an annualized growth rate of more than 25%.

Thanks to the recent rally, I’m afraid that Bed Bath & Beyond isn’t the screaming value that it used to be. That’s why I’m going to keep my buy price at $66 until I hear guidance for next quarter. This is a good stock, but don’t chase it. Wait for it to come to you.

I’m pleased to see that the recent trend of investors willing to take on more risk has continued. An important sign is that high-yield spreads are now at their lowest level in more than six months. Many of our financial stocks have rallied lately. Hudson City ($HCBK), for example, broke $7.60 per share this week. JPMorgan Chase ($JPM) got above $45 this week.

Our Buy List continues to do well. On Wednesday, Wright Express ($WXS) closed at an all-time high. The stock was helped by graduating to the S&P 400 Mid-Cap Index. I’ve also been very impressed by the surge in Fiserv ($FISV). I think it can break $70 per share very soon.

Before I close, I want to highlight some of our high-dividend stocks. Sysco ($SYY) yields 3.62%. Reynolds American ($RAI) has been flat this year but the stock yields 5.42%. That’s equivalent to more than 700 Dow points. Let’s not forget CA Technologies ($CA) which quintupled its dividend this year. The shares now yield 3.69%.

That’s all for now. Next week is the final week of Q1 and it will probably be a slow news week. I’ll be watching for the revision to Q4 GDP growth. 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 March 23rd, 2012 at 6:34 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.