CWS Market Review – November 25, 2012

“If it’s stupid but it works, it isn’t stupid.” – Anonymous

I hope everyone had a nice Thanksgiving. Due to the holiday, trading on Wall Street was shortened last week. The exchanges were closed on Thursday, and trading ended early on Friday. The good news is that despite the limited hours, traders were in a buoyant mood. The S&P 500 jumped over its 200-day moving average on Monday, and on Friday, it once again cleared 1,400.

Breaking the 200-DMA is a crucial milestone for us. I’m happy to say that for the first time in several weeks, I’m very bullish on the stock market. In the past several issues of CWS Market Review, I’ve warned investors to expect a rough market and adopt a more conservative posture. But with the election behind us, the clouds have cleared, and I see a strong year-end rally ahead of us. In fact, I think the S&P 500 can break 1,500 by the early part of 2013.

In this week’s CWS Market Review, I’ll discuss my outlook for the stock market. I’ll also highlight the strong earnings report we got from Medtronic ($MDT). The shares are back over $43. I’ll also take a look at the upcoming earnings from Jos. A Bank Clothiers ($JOSB). But first, let’s look at the market’s new sunny disposition.

Expect a Strong Year-End Rally

Since mid-September, the stock market has been variously concerned with the election, the impending fiscal cliff, renewed violence in the Middle East and still more economic dysfunction from Europe. The market’s default response is to worry excessively about worst-case scenarios. Then, when the impending concern finally arrives, we see that it wasn’t so bad after all. That’s been the script for the last two months.

I noted that this recent selloff was a bit different from typical selloffs in that economically cyclical sectors had been holding up well. That told me that this was more of a nervous reaction rather than a precursor to a prolonged downturn. The problem is that once the market’s mood gets going, it’s hard to shut it off. That’s why I think the breaking of the 200-day moving average last week was so important. Bespoke Investment Group noted that all ten sector groups within the S&P 500 remain below their 50-day moving averages.

When we look at the numbers, the math is still clearly in favor of stocks. While the third-quarter earnings season was hardly a blockbuster, the outlook remains decent. Profits were down 3.6% from a year ago, but earnings did beat expectations. Analysts have gradually pared back estimates for Q4, but that’s largely ended. The consensus on Wall Street now expects earnings for the S&P 500 of $25.77, which would be an increase of 8.6% over last year’s Q4. That’s not bad. It may come down to the wire, but the S&P 500 is currently on track to earn almost exactly $100 for all of 2012. With the S&P 500 now over 1,400, we’re hardly overpriced.

But what about next year? While earnings estimates for 2013 had been dropping, they’ve recently stabilized. Wall Street currently expects earnings of $113.45 for 2013. That means the S&P 500 is going for less than 12.5 times next year’s earnings. I’ve also been impressed by the earnings guidance we’ve seen for next year (Medtronic is a very good example of that).

Now compare a stock market at 12.5 times earnings with the 10-year Treasury bond currently yielding 1.69%. Even if stocks don’t advance at all next year, the dividend yield will easily top the 10-year T-bond. While the Treasury purports to offer safety, I think the true risk now is being out of the stock market. Interestingly, the S&P 500 closed the day on Friday almost exactly 4% below its highest close since 2007.

When we open the hood on the recent sell-off, I’m immediately struck by how resilient high-quality stocks like AFLAC ($AFL) have been. Since the market peaked on September 14th, AFL has gained 4.5%. The stock finished the day on Friday about 1% from a fresh 52-week high. This tells us that investors aren’t scared. They’re just being more selective. This is also why I’m so optimistic that our Buy List will beat the market for the sixth year in a row.

Medtronic Is a Solid Buy but Don’t Chase It

Last Tuesday, Medtronic reported earnings of 88 cents per share, which matched Wall Street’s consensus. As I indicated in last week’s CWS Market Review, Medtronic usually comes very close to the consensus, which is one of the reasons why I like the stock.

The good news for Medtronic is that their two largest business segments, heart rhythm management and spinal products, appear to be stabilizing. The bad news is that Medtronic, like so many other companies, is feeling the squeeze of weak growth from Europe and Asia. For the quarter, total revenue grew by 2% to $4.095 billion.

I’m still satisfied that Medtronic is executing well. The most important news in this earnings report is that Medtronic reiterated its full-year earnings forecast of $3.62 to $3.70 per share. Note that this is for the fiscal year that ends next May.

In the last issue of CWS Market Review, I lowered my Buy Below on Medtronic to $44 per share. I’m going to keep it there. Even though Medtronic has recovered nicely since the earnings report, investors shouldn’t chase it. Always be patient, and wait for good stocks to come to you. We’re in this game for the long haul. Medtronic remains a very solid buy any time you see it below $44 per share.

Jos. A Bank Clothiers Is a Good Buy up to $48

The next Buy List stock to report on will be Jos. A Bank Clothiers ($JOSB). While the company hasn’t confirmed the earnings date yet, it will probably be around next Wednesday. Frankly, JOSB has been a disappointment this year. We always want to be candid about our investing mistakes. The company had a terrible earnings report in May, and the stock got slammed. Investors then overreacted and expected even more dire news from Joey Banks. When the last earnings report turned out to be not nearly as bad as expected, the shares surged. Short sellers had ganged up on JOSB, so they were hit hard by the rally. In fact, it was a classic short-covering rally as the stock was propelled higher by short sellers covering their bets.

My advice is to remain cautious of JOSB. For the time being, I’m keeping my Buy Below price at $48 per share. JOSB is a good stock, but it’s another stock not worth chasing. Before I’m willing to raise my Buy Below, I want more proof that the company has worked out its short-term problems. To be fair, the company told us in advance that fiscal Q1 has started poorly. Let’s see what the company has to say this time.

Before I go, I want to highlight some exceptionally good values on our Buy List. Moog ($MOG-A), for example, looks especially cheap right now. Also, CA Technologies ($CA) currently yields 4.5%. That’s a very good deal. I also really like Oracle ($ORCL) below $35 per share. The company will report its fiscal Q2 earnings in about three weeks. Look for another earnings beat.

That’s all for now. This Thursday, the government will release its revised estimate for third-quarter GDP growth. The initial report was for 2%. Economists expect the revision to be 2.8%. 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 November 25th, 2012 at 8:41 pm

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.