CWS Market Review – July 13, 2012

The second-quarter earnings season is about to enter full bloom. We only have a few reports in so far, but the early numbers indicate this is going to be a lousy season. Bespoke Investment Group found that only one of the 16 companies that have reported has beaten expectations.

This is especially disappointing because Wall Street has been slashing its earnings forecasts for the last several weeks. In other words, we’re having trouble meeting reduced expectations. On top of that, many companies have offered lower guidance for the rest of the year. On Thursday, the S&P 500 closed lower for the sixth day in a row.

So who’s to blame for the poor earnings? We can point to the usual suspects like tight margins and weak growth in Europe. But we also need to pin some blame on a new suspect: the strong U.S. dollar. Thanks to the euro’s tanking, the dollar has rallied to a two-year high and this has made many U.S.-based companies less competitive in foreign markets. Unfortunately, this will put the squeeze on stocks like Ford ($F).

In this issue of CWS Market Review, we’ll take a closer look at some of the upcoming reports for our Buy List stocks. I’ll also highlight which stocks look especially good right now. There are lots of good bargains out there. (Anyone notice the nice rally in Johnson & Johnson ($JNJ) in the past month?). I’ll also look at the prospects for the U.S. economy. Other regions around the world are clearly slowing down. Will the U.S. follow?

It’s Time for JPM to Face Wall Street

I’m writing this letter very early on Friday morning and some time later today, JPMorgan Chase ($JPM) will be our first Buy List stock to report earnings. This report will obviously be of great interest to Wall Street not only due to JPM’s huge influence on the Street but also because we’ll get to see the first details of how serious the trading losses were in their London office. Officially, CEO Jamie Dimon has said that the trading loss was $2 billion and that it might grow to $3 billion, but New York Times said that it might be as high as $9 billion. Unfortunately, there’s been far more speculation than news.

Before the losses were reported, Wall Street had been expecting JPM to earn $1.24 per share for Q2. The consensus is now down to 76 cents per share. Since the bank has 3.81 billion shares outstanding, a $2 billion loss works out to 52.5 cents per share. So the decrease in guidance closely matches the expected trading loss.

Here’s my take: The trading loss is simply inexcusable and I’d like to see Mr. Dimon leave the CEO’s suite. The share price has suffered from what we euphemistically call “headline risk.” But JPM is still a very profitable outfit. If earnings, excluding the big loss, are still strong, which I expect will be the case, JPM is an outstanding buy. The key for us is to see how strong the fundamentals of the bank are. After a brief recovery during June, the stock has drifted lower again recently. I still rate JPMorgan a strong buy anytime the stock is below $38 per share. The problem for us is that even if the bank’s earnings are good, it may take some time before investors are willing to go back into the stock. This is an investment for the long haul.

Stryker and Johnson & Johnson Will Report Next Week

Stryker ($SYK), the medical equipment firm, is due to report earnings on Tuesday. Three months ago, the company reported earnings of 99 cents per share which matched estimates. Revenues were above expectations and gross margins improved. For Q2, Wall Street is again expecting earnings of 99 cents per share. I’ve run the numbers and that sounds about right.

In April, I was pleased to see Stryker reiterate its forecast of “double digit” earnings growth for this year. I think there’s a good chance that this forecast is too low, but I wouldn’t expect any increase in guidance until later in the year. Double-digit earnings growth translates to earnings of at least $4.09 per share. That means the stock is going for less than 13 times earnings. That’s a good deal for a high-quality stock like Stryker. I also think we’ll see another generous dividend increase later this year.

Over the past few months, shares of Stryker have closely followed the S&P 500 (see the chart below). Stryker is a much better bargain than the overall market so I expect to see some outperformance soon. I rate Stryker a very good buy up to $60 per share.

Johnson & Johnson ($JNJ) hasn’t officially said when it will report earnings, but I’m assuming it will be sometime next week. JNJ is oddly in a position somewhat similar to JPM in that their seemingly endless recalls soured many investors on the stock. The good news is that the company has a new CEO, and it appears that JNJ has put these issues behind them. After doing not much of anything for several months, the stock suddenly perked up last month. From June 12th to July 3rd, Johnson & Johnson gained nearly 10%. On Thursday, the shares got very close to a new 52-week high.

JNJ’s stock got knocked around earlier this year when the guidance they gave for 2012 ($5.05 to $5.15 per share) was below Wall Street’s consensus of $5.21. Yet as things now stand, I think JNJ has a decent shot of getting to $5.21. The Q1 earnings report was pretty good. Wall Street’s consensus for Q2 is $1.29 per share. That’s very doable. JNJ currently yields 3.6% which is more than twice a 10-year Treasury. I rate Johnson & Johnson a strong buy up to $70 per share.

Some Buy List Bargains

Like the rest of the market, our Buy List has gotten tossed around for the past few days, but several stocks look especially good right now. Fiserv ($FISV), for example, has performed exceptionally well. The stock got to a 52-week high last week. I’m looking forward to another good report soon.

CR Bard ($BCR) is one of our quiet stocks, but it’s continued to thrive in this market. The stock broke above $108 recently and it’s now our #2 best performer this year with a gain of 23.52%. CA Technologies ($CA) is in first place with a gain of 26.11%.

I was rooting for Oracle ($ORCL) to finally break $30 per share. The stock came within two cents on July 3rd, but it couldn’t do it. I still like Oracle a lot. The last earnings report gave me a lot of confidence in ORCL. The stock is a great buy below $30.

Don’t Believe the Recession Talk—For Now

There’s a growing chorus of folks who are convinced that the U.S. economy is either in a recession right now or about to go into one. I want to choose my words carefully here. While there’s plenty of evidence that economic growth is very sluggish, there’s zero clear-cut evidence that the economy is currently in a recession. That may soon change, but until then, I don’t see an imminent recession nor do I see the Federal Reserve launching another round of quantitative easing.

The stock market is still trying to recover from the lousy jobs report from last Friday. The jobs market, however, may have turned a corner. On Thursday, we got the best jobless claims report in more than four years. Some folks are dismissing the report as an anomaly due to the July 4th holiday. We’ll need more data to say for sure, but this could indicate some strength in employment. Even the dismal gain of 80,000 jobs in June is still a gain. During the depths of the recession we saw massive jobs losses each month.

Ben Bernanke and his buddies at the Fed seem to prefer a wait-and-see approach. On Wednesday, the Fed released the minutes from its June 19-20 meeting. This gave us some hints as to what the Fed is thinking. The central bankers agreed that unemployment will be a problem for another five to six years, but they don’t believe that’s serious enough to provide for more stimulus.

The minutes indicate that members of the Fed have been disappointed by economic growth being slower than expected (I share that view), and they’re concerned that inflation is trending below its 2% target. Apparently, there’s opposition to further stimulus, but we don’t know how broad that opposition is.

As market watchers, we’ve already seen economically cyclical stocks lag the market. This was a tipoff that the economy wasn’t as rosy as many people expected. This week, several Wall Street firms got the hint and slashed their forecasts for Q2 GDP growth. They estimate growth coming in between 1% and 1.5% which is very weak, but it’s still not receding.

The weaker growth has caused the bond market to continue its rally. This week, the U.S. Treasury sold 30-year bonds at a record low yield of 2.58%, and 10-year bonds at a record low of 1.46%. While the economy is in a rough patch right now, the evidence still does not point to a recession. In fact, many market watchers now anticipate economic growth (and profit growth) to accelerate into 2014.

That’s all for now. Next week will be a big week for earnings. We’ll also get key reports on industrial production and retail sales. This will tell us more about how the economy is behaving. 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. Here are some more videos (here, here, here, here and here) of the interview I did with Brian Richards of The Motley Fool.

Posted by on July 13th, 2012 at 6:17 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.