CWS Market Review – September 7, 2012

The Great Summer Snoozefest came to an abrupt end on Thursday as the S&P 500 vaulted more than 2% to close at 1,432.12, which is its highest close since January 3, 2008. The Nasdaq Composite did even better; it hasn’t been this high since Bill Clinton was president.

Let me warn you, don’t get too comfy. Unfortunately, I think the easy money has already been made. In this week’s CWS Market Review, I’ll talk about the market’s newly found self-confidence. I also show you some of the best ways to position your portfolio over the next few weeks which I still think will be bumpier than most folks expect. But first, let’s look at what drove stocks to multi-year highs.

Super Mario Comes to the Rescue

Frankly, it’s about time the market broke out of its summer slumber. This was getting seriously dull. In the 21 trading sessions prior to Thursday, the S&P 500 had been locked in a tight trading range of less than 1.4%. It was like watching paint dry. Daily volatility was down more than 80% from last year.

The driver of Thursday’s rally was the news that the European Central Bank is going to crack open its piggy bank and start buying bonds in a massive way. I’ll skip the boring econo-babble and boil it down for you—the Europeans ain’t messing around anymore. The partial fixes that everyone’s been trying (and trying and trying) are now history.

Four weeks ago, I highlighted Mario Draghi’s statement that the ECB was “ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” As I explained, that was big. Central bankers simply aren’t in the habit of talking like that so we knew something big was up.

In plain English, the benefit of not being in a currency union is that you can print as much money as you want. Of course, if you go overboard, the market will start laughing at your money. History is full of these stories. But if you’re inside a currency union, then you can’t crank up the printing press—you’re trapped. To get more cash, the only thing you can do is borrow money. That’s what some eurozone countries were forced to do. The problem is that the bond market started to shut out Spanish and Italian debt.

When the yield on Spanish bonds hit 7%, the adults finally realized that this wasn’t going to work. You can’t expect someone to pay back money at 7% when their economy is going down the tubes. You’re just borrowing money to pay off your older debt. On Thursday, Mr. Draghi said he planned to buy an “unlimited” amount of bonds in order to push borrowing costs down. The Germans, as you might guess, weren’t pleased. Will it work? Honestly, I don’t know but Spanish bonds soared in response. The Spanish 10-year bond now yields 6.02%.

In my opinion, the key here is that the “unlimited” pledge finally breaks the trap of being in a currency union. This solution has the benefit of realizing what the problem has been all along. This really is a game-changer. In short, what Draghi wants to do is to take the huge risk premium of borrowing money off the table. The key part of this plan is that it doesn’t need to be perfect. It only needs to give countries like Italy and Spain a little more time to get back on their feet. The market clearly liked what it saw.

With Less Uncertainty, Our Buy List Soars

The fear of a meltdown in Europe had been hanging over the U.S. market for several months. What’s interesting is that the stock market has been cautiously rallying even though Wall Street’s earnings forecasts have been slowly coming down. Let me explain this apparent contradiction.

What’s happened is that valuations have increased, and that’s probably due to less uncertainty. There are few things Wall Street hates more than uncertainty. If the S&P 500 can earn $100 this year, which is quite reasonable, and we attach a P/E Ratio of 15 on to that (again, very reasonable), then today’s market valuation should hardly be surprising. Yet less than a year ago, the S&P 500 dipped below 1,100! Fear was in charge, and there wasn’t much we could do about it.

Thankfully, the mood has changed. The immediate benefit of the news out of Europe is that our financial stocks like JPMorgan Chase ($JPM) and AFLAC ($AFL) improved very nicely. Also, Nicholas Financial ($NICK) just topped $14 per share. Just three months ago, AFLAC was below $39 and on Thursday, it broke through $47. No matter how much AFLAC tells the market that it has cut its exposure to Europe, the stock market insists on treating the insurance company as if Europe is most of their business. That’s simply not the case. By the way, Barron’s recently made the case for AFLAC going to $60. I rate AFL a good buy anytime it’s below $50 per share.

I apologize if I take a moment to brag about the performance of our Buy List, but those of us who lived through the hurricane of this past May will understand. Good stocks were dropping simply on fear. I felt like I was doing more damage control than analysis.

For example, Bed Bath & Beyond ($BBBY) plunged from $74 to $58 on earnings that were disappointing but c’mon, they weren’t that bad. I told investors to relax and the shares are now back over $69. Look for a good earnings report later this month. BBBY is a good buy below $70.

Wright Express ($WXS) got hammered after its lower guidance a few weeks ago. The stock dropped from $64 to $60. Again, I told investors not to panic. Wright is now over $72 per share. The stock jumped 9.1% on Thursday after announcing its purchase of Fleet One. I’m raising my buy price on Wright from $65 to $75.

Last month, DirecTV ($DTV) missed earnings by four cents per share and stock dropped. Once again, I told investors to keep calm and once again, DTV just closed at a new 52-week high.

Fiserv ($FISV) also dropped after their earnings report even though the company raised the low-end of their full-year guidance. But traders got scared and sold. Now, just a few weeks later, the stock closed at a fresh 52-week high.

I often joke that our set-and-forget strategy for our Buy List is due to laziness. But honestly, passive investing is far superior to frequent trading. I almost feel sorry for day-traders who are gripped by every little price change. Our Buy List now has three stocks that are up more than 30% this year, plus another three that are up more than 20%. The lesson is that good stocks will come through; it just takes time.

Some Buy-List Bargains

I want investors to prepare themselves for a rough period over the next few weeks. There are still some trouble spots like the election, earnings guidance, a weak jobs market and an unsure consumer. Also, Europe isn’t out of the woods just yet.

Some stocks on the Buy List that look particularly attractive include Ford ($F) which is getting very close to $10. I also like Johnson & Johnson ($JNJ) at this price. The shares currently yield 3.6%. Sysco ($SYY) also offers a generous yield of 3.5%. High-yield stocks are always good to have in your portfolio during tough markets.

That’s all for now. There’s another Fed meeting next week but I don’t expect much will happen. I may be wrong but the election is just too close to make any major policy decisions. 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 September 7th, 2012 at 6:38 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.