CWS Market Review – August 10, 2012

The world’s most-hated rally continues pace. On Thursday, the S&P 500 closed higher for the fifth day in a row. The index is now at its highest level since May 1st, and we’re a little over 1% away from taking out a four-year high.

Our Buy List is also doing quite well. Oracle ($ORCL), for example, got to its high for the year, and it’s close to breaking through $32 per share. DirecTV ($DTV) just hit a new 52-week high. Stocks like AFLAC ($AFL) and JPMorgan Chase ($JPM) have been quite strong recently, and Harris Corp. ($HRS) has rallied for seven days in a row. Also, Nicholas Financial ($NICK) gave us a big present this week by increasing its dividend by 20%.

In this week’s CWS Market Review, we’ll take a closer look at what could be the end of Wall Street’s huge defensive rotation. I’ll also look at why the economy might be stronger than most people believe. Plus, we’ll preview Sysco’s ($SYY) earnings report. SYY currently yields a hefty 3.76%, and I’m expecting them to increase their dividend for the 43rd year in a row. Not many stocks can say that. But first, let’s look at the new mood on Wall Street.

“Believe Me, It Will Be Enough”

On July 26th, ECB President Mario Draghi dropped a bomb on world markets when he said: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”

Heavens to Murgatroyd! Central bankers aren’t supposed to speak in such dramatic tones. I mean, that’s just not done. Of course, the worry is that if he thinks there’s a reason to say “believe me,” that must mean that there are plenty of folks who, in fact, don’t believe him.

But any reason for doubt shouldn’t rest solely with Mr. Draghi and his level of commitment. For one, Draghi seems to be blurring the lines between monetary policy and fiscal policy. Plus, we still have to contend with the familiar question: “Will the Europeans set aside their bickering and do what it takes to save the euro?” As always, the Europeans appear to be a quintessential “hot bed of cold feet.”

The Germans, for example, are very much opposed to more bond buying. If anything, their opposition seems to be growing. If a new bond buying program does start—and it most certainly will—it will only be for countries in the periphery and after a formal request.

But let’s turn back to Mr. Draghi’s remarks. I’ll give him credit for one thing—he shook up the markets. Long-term bonds in Italy and Spain have rallied, and stock markets there have come back to life. The day before Draghi spoke, the Spanish 10-year yield peaked at 7.751%. Recently, it’s been below 6.8%.

The effect isn’t just in Europe, but it’s being felt in the U.S. as well. Here’s what you need to understand: Investors are creeping away from their tightly-held defensive posture and they’re slowly taking on more risk. Just look at the U.S. bond market: The yield on the 10-year Treasury jumped from an all-time low of 1.39% on July 24th to 1.69% on Thursday. I thought it was interesting that the U.S. Treasury had a lousy auction this week for a fresh batch of 10-year bonds. The auction had the lowest big-to-cover ratio in three years. Perhaps investors have finally grown weary of ultra-low risk.

Before Draghi’s remark, investors were shunning risk at every chance. I mentioned in last week’s CWS Market Review how dramatic the defensive posture had become. Consider that from July 5th to August 1st, the Russell 2000, which is a gauge of small-cap stocks (think “higher risk”), dropped by 5.7% while the S&P 500 managed to make a small gain. No one wanted anything with a hint of risk. But since August 1st, the tables have turned. The Russell has gained 4.1% which is more than double the S&P 500.

The move toward offense can also be seen with the highest-yielder on our Buy List, Reynolds America (RAI). The stock soared to a new high but dropped 90 cents per share on Tuesday. That’s a very big drop for a stock like Reynolds. I think it has less to do with the company’s business outlook, which is fine, than with the fact that investors are searching for growth opportunities. We’ve also seen key defensive sectors like Healthcare ($XLV), Utilities ($XLU) and Consumer Staples ($XLP) trail the market in recent days.

It’s too early to say if this turn towards the offensive will last. For now, our strategy is to focus on high-quality stocks, especially ones that the market doesn’t get. Speaking of which, let me say a few words about DirecTV ($WXS) and Wright Express ($WXS) because these are perfect examples of why our strategy of concentrating on high-quality stocks works.

Last week, I highlighted the market’s bizarre reactions to the earnings reports from DirecTV and Wright Express. The earnings reports certainly weren’t outstanding, but the market initially treated both stocks as if they’re in serious trouble. That’s clearly not the case. Yet all we had to do was wait a few days as both stocks recovered. In the last six days, WXS gained 6.4% and DirecTV is on the cusp of making a new 52-week high. Wright Express is an excellent buy anytime the shares are below $65. I’m also raising my buy price on DirecTV to $53.

Some Modest Economic Bright Spots

We had some surprisingly good economic news this week. I’m not saying that the economy is doing well, but it may be the case that things aren’t as dire as they seem. The trade deficit report for June, for example, came in narrower than expected. The deficit for May was also revised favorably.

The trade suggests that the government’s initial estimate for Q2 GDP of 1.5% is too low and is perhaps closer to 2%. This is good news because it indicates that weakness in Europe and the strong dollar aren’t hurting us as much as was feared.

The other good news was that jobless claims fell by 6,000. This is a very volatile metric with a lot of noise, but the trend is still going in the right direction. What we’re seeing is that companies are working hard to become more efficient. On Wednesday, the productivity report showed that worker productivity rose by 1.6% in the second quarter after falling by 0.5% in the first quarter. The short-term downside of rising productivity is that it may lead firms to be cautious about expanding their payrolls.

I was also impressed to see that the median price for a new home in the second quarter was up 7.3% from the same period a year ago. That’s the strongest growth rate in six years. The housing news is especially promising because a pick-up in the housing sector has often been the catalyst for U.S. economic expansions. This time around, we had an enormous over-supply of homes so prices went nowhere. At last, we’ve finally worked off that inventory.

Nicholas Financial Gives Us a 20% Raise

Also in last week’s CWS Market Review, I discussed the possibility of Nicholas Financial (NICK) raising its dividend. Sure enough, that’s exactly what the company did this week. I would have preferred to see NICK go for a bolder increase, but the company gave us a 20% raise which ain’t too shabby. NICK now pays 12 cents per share per share or 48 cents for the entire year. Going by Thursday’s closing price, NICK yields 3.57%. That’s a good deal.

Sysco (SYY) is due to report earnings on Monday, August 13th. The food service company is usually one of the last companies on our Buy List to report earnings. The June quarter is the fourth quarter of their fiscal year so we’re going to get a look at their year-end results.

In May, Sysco reported earnings of 44 cents per share which was a penny more than Wall Street’s consensus. This time around, the Street expects 54 cents per share. I think that’s about right, although it will be interesting to see how much inflation and currency impacted their bottom line. What I like about Sysco is that its business tends to be very stable.

For the year, Sysco should earn about $1.93 per share, and Wall Street expects $2.00 per share for the current fiscal year. That means Sysco is going for less than 15 times earnings. Furthermore, Sysco pays out 27 cents per share in dividends. That makes the current yield 3.76%. Plus, the company will almost certainly raise its payout this fall for the 43rd year in a row. I’m raising my price on Sysco to $32 per share.

Before I go, a few of the bargains on our Buy List include Ford Motor ($F), Stryker ($SYK), Medtronic ($MDT) and JPMorgan Chase ($JPM).

That’s all for now. Stay tuned for Sysco’s earnings report on Monday. We’ll also get the key industrial production report on Wednesday. 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 August 10th, 2012 at 6:49 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.