CWS Market Review – March 8, 2013

“The meek shall inherit the earth, but not its mineral rights.” – J. Paul Getty

Shortly after the opening bell on Tuesday, the Dow finally broke through to a new all-time high. The previous high had been reached on October 9th, 2007, nearly five-and-a-half years before, or 1,974 days to be exact. Let me add that there are certainly a lot of valid criticisms of the Dow. It’s price-weighted and contains only 30 stocks, but make no mistake—the fact that the oldest and best-known index of U.S. stocks just reached an all-time high is a big deal. In less than four years, the Dow has added an astounding 7,780 points.

Since the mega-low reached four years ago tomorrow, the S&P 500 Total Return Index has gained more than 148%. Let’s take a step back and consider some important facts: This is one of the greatest bull market rallies in history, and our Buy List, I’m happy to report, has done much better. For being dead, discredited and worthless, buy-and-hold has had a rather successful four years. The U.S. equity market has added nearly $10 trillion, and as well as the market has done, valuations are still below their peak. Did anyone see this coming four years ago?

Remember how scary things were back then. In 2008, the Dow had its worst year in 77 years. Actually, the market’s rally has been even more impressive when we consider the massive losses centered on some infamous financial stocks. AIG is still trading but it’s 97% below where it was in October 2007.

To show you how much things have changed, in this week’s CWS Market Review, I’ll make the case that right now is the golden age for investing in financial stocks. I’ll also discuss a few upcoming Buy List earnings reports. Several of our Buy List stocks such as Fiserv ($FISV), JPMorgan Chase ($JPM), Oracle ($ORCL), Wells Fargo ($WFC) and Stryker ($SYK) have recently broken out to fresh 52-week highs. (I just raised my Buy Below on Stryker last week, and the stock jumped even higher! SYK is our first 20% winner in the year.) Heck, even WEX Inc. ($WXS) has made back much of what it lost. But first, in response to many questions from readers, I wanted to give you my thoughts on Apple ($AAPL).

Apple Is a Strong Buy Up to $435 per Share

An interesting aspect of this recent market rally is that Wall Street’s super-star stock, Apple ($AAPL), has been left in the dust. Since peaking at $705 in September, shares of the iPod/Pad/Phone maker have fallen as low as $419. That’s a staggering loss of nearly $270 billion in market value.

Many of you have asked me my opinion on Apple so I’ll cover it now and say that the shares are a very good buy (note that AAPL is not on our 2013 Buy List). Let me explain what’s been happening. In the world of investing, money managers are under a great deal of pressure to seek out “non-correlated assets.” In simpler terms, when everybody else zigs, they want stocks that zag.

If the stock market rises, say, 3% in a given month, then we have a pretty good idea of where stocks like DuPont ($DD) or Procter & Gamble ($PG) or Merck ($MRK) will be. But a money manager can’t rely on doing what every else does. If they’re charging top-dollar fees, they need to zero in on the assets that are, in essence, doing their own thing. For a long time, Apple was certainly doing its own thing and doing it very well. Apple wasn’t only weakly correlated with the rest of the market, but there was hardly a major stock out there that behaved like Apple. The closest I could find was Qualcomm ($QCOM) and even that correlation was pretty weak.

At the risk of metaphorical excess, Apple became the golden goose. Money managers just gobbled up shares of AAPL and watched the profits roll in. In Fortune this week, Philip Elmer-DeWitt wrote about the harrowing tale of Andy Zaky who bankrupted a hedge fund and paid newsletter service solely dedicated to investing in Apple. Things were getting crazy, but now we’re seeing the flip side of non-correlation: A rising tide can send a non-correlated boat right to the bottom.

At Business Insider, Joe Weisenthal and Matthew Boesler pointed out that Apple’s recent collapse has been mirrored by the fall in gold miners. This makes sense because all those non-correlated sectors that provided so many good times last year are being abandoned all at once.

I had considered adding Apple to this year’s Buy List but I didn’t think the selling was over just yet. Now, however, the shares are quite inexpensive and most of the momentum guys have been cleared out. The numbers at Apple are simply phenomenal. Apple is sitting on $137 billion in cash, or $145 per share. Going by Thursday’s closing price, Apple is trading for less than 10 times this fiscal year’s earnings, and the dividend yields 2.5%. I’m still not adding Apple to our Buy List (I can’t make any changes until the end of the year), but I rate AAPL a very good buy if you can get it below $435 per share.

The Golden Age of Investing in Financial Stocks

Despite the massive flameout in many financial stocks, the current environment is ideal for investing in financial firms. Eighteen months ago, I said that the Financial Sector ETF ($XLF) was “a speculative buy if it drops below $12 per share.” It did, and today the XLF is over $18. As well as it’s done, the fundamentals of the financials are still remarkably strong.

This is excellent news for stocks on our Buy List like JPMorgan Chase ($JPM), Wells Fargo ($WFC) and Nicholas Financial ($NICK). Let’s run down some of the reasons why the financial sector is so appealing. The biggest is that the Federal Reserve is keeping short-term interest rates near 0% and has promised to keep them there for some time. The Fed’s position clears up a lot of uncertainty, and Wall Street likes it that way. Another big reason in favor of financials is that the economy is slowly improving. At a firm like Nicholas Financial, the overall quality of their loan portfolio has improved dramatically.

We also have to look at the mortgage market. For obvious reasons, many financial stocks are closely tied to the mortgage market, and the U.S. housing sector continues to improve. Thanks to Bernanke and his friends at the Fed, the bond-buying policy has pushed down mortgage rates and they’ll probably stay low. This time, the improvement in the housing market is far sounder and more sustainable than it was last decade. Let’s not forget that lending standards have thankfully improved.

Another key point is that valuations for many financial stocks are still quite modest. JPM just broke though $50 per share and it’s going for less than nine times Wall Street’s estimate for next year’s earnings. Based on Thursday’s close, JPM yields 2.4% and I’m expecting the bank to raise its dividend soon. I think the current 25-cent quarterly dividend will go up to 30 cents per share. That would still be less than 22% of their full-year earnings.

Given the current environment, I doubt many investors will be able to beat XLF this year or do it with less volatility. We’re going to look back at this era as a great time to buy financial stocks.

Three Upcoming Buy List Earnings Reports

Three of our Buy List stocks are due to report earnings later this month. Ross Stores ($ROST) already told us they had strong sales for their fiscal fourth quarter (ending in January). The discount retailer raised its Q4 guidance to a range of $1.05 to $1.06 per share; then a few weeks later Ross raised guidance again, this time to $1.06 to $1.07 per share. Since that’s a pretty tight range, I’m going to go out on a limb and say that’s probably very accurate. Ross Stores also sweetened its dividend by 21%. I love it when good companies raise their dividends.

I’ll be curious to see what kind of guidance Ross offers for Q1. The economic reports suggest that consumers haven’t slowed down at all, although Ross had a tepid sales report for February, and the stock dropped more than 7% on Thursday. For Q1, I’m expecting a range somewhere between $1.00 and $1.10 per share. Don’t let the recent downdraft rattle you: This company has been making all the right moves. Ross Stores is an excellent buy up to $62 per share.

Oracle ($ORCL) is also due to report earnings soon. I don’t know the exact date just yet, but it will probably be sometime in the week after next. I’m looking forward to a good report from Oracle. In December, Larry Ellison’s software empire told us to expect earnings (their fiscal third) to range between 64 and 68 cents per share. I’ve run the numbers, and I think that’s too low. My numbers say that Oracle should be able to deliver 70 cents per share.

I’ll give you a very brief idea of how to think about Oracle. The company is doing very well except for one major weak spot which is hardware. Some of this is due to Oracle’s previous acquisitions. The company has assured us that hardware is about to turn a corner. We haven’t seen this just yet, but it’s been promised. Well, now I want to see some hard evidence.

I also want to see what Oracle has to offer as far as guidance for Q4 (ending in June). The Street currently expects 88 cents per share, but I think the company may offer a conservative estimate. Unlike other companies in the U.S., Oracle has been doing fairly well in Europe. Oracle remains a very good buy up to $37.

Late last year, shares of FactSet Research Systems ($FDS) got dinged when the company gave weaker-than-expected guidance for their second quarter (ending February). The issue isn’t so much problems within FactSet; rather it’s that many banks have been working to cut costs. In fact, we recently saw that as JPMorgan said that it’s looking to cut up to 17,000 jobs by the end of next year (another reason why financials are so strong).

For Q2, FDS said revenues rose to $212 – $215 million, and EPS climbed to $1.11 – $1.13 per share. The Street had been expecting revenue of $216.3 and EPS of $1.13. So this wasn’t exactly a big “miss” but the stock dropped 4.4% which was one of the reasons why I added FDS to this year’s Buy List. FactSet is a very solid company. I’m raising the Buy Below on FDS to $100 per share.

Updated Buy Below Prices

Before I go, I want to say that Harris Corp. ($HRS) is an exceptionally good buy right now up to $53. The stock was punished this week when it was downgraded by Oppenheimer. You can take advantage of their ball call. In addition to FactSet Research, I also want to raise the Buy Below price on Stryker ($SYK) to $66. I’m lifting JPMorgan Chase ($JPM) by two dollars to $52 per share. I’m also going to raise Cognizant Technology Solutions ($CTSH) by one dollar to $82 per share, and WEX Inc. ($WXS) by three dollars to $75 per share.

That’s all for now. Next week, we’ll get important reports on retails sales, industrial production and consumer inflation. 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 Eddy Elfenbein on March 8th, 2013 at 7:06 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.