CWS Market Review – August 17, 2012

“The race is not always to the swift, nor the battle to the strong, but that’s how the smart money bets.” – Damon Runyon


Oh dear Lord, this is the most boring market possible. August 2012 has turned into the Great Summer Snoozefest. The VIX recently dipped below 14. Trading volume is at the lowest point since 2007. Just look at the S&P 500’s daily performance from August 8th to August 15th: +0.06%, +0.04%, +0.22%, -0.13%, -0.01% and +0.11%. Wake me when it’s over.

The good news is that our Buy List has been doing quite well lately. On Monday, a good earnings report prompted Sysco ($SYY) to leap 4.5%, and the stock has continued to rally. Harris Corp. ($HRS) just made another 52-week high; it’s now up 27.64% for us on the year. DirecTV ($DTV) is up nearly 20% in two months. Since August 2nd, our Buy List is up 5.37% compared with 3.70% for the S&P 500.

In this week’s CWS Market Review, we’ll look at some facts hiding just below the surface of this somnolent market. I’ll also highlight the good earnings out of Sysco, and we’ll discuss the upcoming earnings report from Medtronic ($MDT). But first, let’s look at what’s driving this low—very, very low—volume rally.

The Quiet Rotation from Bonds to Stocks

On Thursday, the S&P 500 closed at 1,415.51. The index is just 0.25% away from cracking its 51-month high. The rally is even more impressive when you consider the amount of dividends that have been paid out. Fact: More companies in the S&P 500 are now paying dividends than at any time since 1999. Adjusted for dividends, the S&P 500 now stands at an all-time high. You wouldn’t know that from watching the financial media.

It’s amazing to contrast the low volatility we’re seeing this August with the dramatic action we saw one year ago. The raucous debt-ceiling debate mercifully came to an end on August 2, 2011, but the market’s fireworks were just starting. The Dow dropped 512 points on August 4th and another 644 points on August 8th. Gary Alexander notes that the Dow moved at least 423 points on four straight days from August 8th to August 11th. Gary writes, “From August 2 to September 9, 2011, the Dow went up or down over 250 points on 12 of 28 trading days.” In the last five months of 2011, the S&P 500 had daily swings of 2.5% or more 22 times. But that hasn’t happened once this year.

Looking back on it, the panic of last summer was a great buying opportunity for patient investors like us. Those who kept cool while everyone else was freaking out did very well. Remember some of these prices from last August—Reynolds American ($RAI) below $32 per share, or Fiserv ($FISV) below $51? Thank you, panicked investors!

What’s catching my attention about this rally is the quiet move away from Treasuries. The yield on the 10-year Treasury is now up to 1.83%. That’s a 45-basis-point jump in three weeks. Of course, that was off the lowest yield ever for the 10-year in the history of the Republic so it’s kind of odd to say that yields have “shot up all the way to 1.83%.” That’s still very, very low.

But the move is significant, and it’s been matched by other bonds at the long end of the yield curve, particularly beyond five years out. Typically, a sell-off in long-term bonds would be matched with a rotation towards cyclicals. And as I described last week, that’s what we’ve seen (Harris and Ford, for example). But really, the rotation hasn’t been as large as I would have expected.

What’s going on here? Frankly, I can’t be certain. My suspicion is that the market is slowly beginning to realize that the economy is better than most people believe. This week’s report on industrial production was another piece of evidence supporting this thesis. In the CWS Market Review from two weeks ago, I included a chart showing the performance of stocks and long-term bonds since March. My point was to show how much better bonds had performed than stocks, reflecting the market’s strong defensive posture. My timing was impeccable because the relationship has completely reversed itself since then. Here’s an updated version:

If the economy is indeed stronger than is commonly believed, what can we expect as investors? For one, we can shelve all the silly babble about QE3. As far as stocks are concerned, we can expect to see a slow, steady melt-up in equity prices. Don’t expect to see any sudden vaults of 3%, 4% or more. We’ll also see the market focus on domestic industries, small-caps (due to their size, smaller companies often have less international exposure) and cyclicals. I doubt higher-yielding stocks and defensive plays in general will get burned. But then again, they won’t see the lion’s share of the gains.

Some of the stocks on our Buy List that are poised to thrive, assuming the stronger-economy thesis is correct, include Ford ($F), JPMorgan Chase ($JPM), Moog ($MOG-A), Nicholas Financial ($NICK), Wright Express ($WXS), Fiserv ($FISV) and Bed Bath & Beyond ($BBBY).

By the way, have you noticed how much BBBY has recovered from its so-called “poor” guidance? The stock plunged 17% in one day after the company said this quarter’s results would be 5% to 10% below the Street’s consensus. I thought the reaction was crazy, and I said so. BBBY is an excellent buy any time you see it below $70 per share.

Sysco Rallies on Strong Earnings

On Monday, Sysco ($SYY) reported earnings of 55 cents per share for the fourth quarter of their fiscal year. That’s basically what I had been expecting. Wall Street’s consensus was for 54 cents per share. For the entire fiscal year, Sysco made $1.93 per share. That’s a good result, and investors should be pleased.

Let’s look at some of the numbers: Quarterly sales came in at $11 billion, which is a 5.9% increase over last year’s Q4. What Sysco calls “adjusted operating income” increased by 2.2% to $608 million. The company faces rising food costs, but I’m impressed by how well they’re managing the issue. The Street expects earnings for the current fiscal year of $1.98 per share. That means the stock is going for about 15 times earnings.

Shares of Sysco gapped up 4.5% on Monday, and the shares advanced on Tuesday and Wednesday as well. But the best thing about investing in Sysco is the dividend. Sysco has increased its payout every year for the last 42 years. There aren’t many companies that can claim a record like that. This November, I expect them to do it again. The stock currently yields 3.7%. Sysco is a solid buy for income-oriented investors up to $32 per share.

Medtronic Is a Buy up to $44 Per Share

On Tuesday, August 21st, Medtronic ($MDT) is due to report earnings for the first quarter of their fiscal year. The stock has been gaining ground recently, and it just poked its head above $40 per share. In May, Medtronic told us to expect revenues to rise between 2% and 4% for this year. They see full-year earnings-per-share ranging between $3.62 and $3.70. That’s decent growth in this environment. Last year, Medtronic made $3.46 per share. The stock is close to breaking its high from six months ago.

I like Medtronic a lot and frankly, the company often doesn’t get the credit it deserves. I’ve been impressed that demand has returned for their pacemakers and defibrillators. My rough numbers say that Medtronic earned 87 cents per share for Q1 (give or take), while the Street expects 85 cents per share. Honestly, I’m not too worried about a minor earnings miss or beat this early in the fiscal year. Instead, what I want to see is if the company is executing well, and I have little doubt that they are. In June, Medtronic raised its dividend for the 35th year in a row. Thanks to the recent rally. I’m bumping up my buy price on Medtronic to $44 per share.

Before I go, several readers have written in, thanking me for my avoid-at-all-costs recommendation on Facebook ($FB). Folks want to know if I like it at this heavily reduced price. The short answer is no. The longer answer is nooooooo.

That’s all for now. Outside of Medtronic’s earnings report on Tuesday, next week should be another sleepy week on Wall Street. I doubt we’ll see much action until after Labor Day. But I’ll be here. 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 17th, 2012 at 8:02 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.