Archive for May, 2014
CWS Market Review – May 30, 2014
Eddy Elfenbein, May 30th, 2014 at 7:14 am
“Just because you buy a stock and it goes up does not mean you are right. Just because you buy a stock and it goes down does not mean you are wrong.”
– Peter Lynch
We’re back! I’m pleased to report that the bull market keeps on charging. On Thursday, the S&P 500 closed at 1,920.03. That makes the 13th time this year the index has set an all-time record high. (Perhaps I should go on vacation more often.)
I’ve also been surprised by how tame this market has been. We haven’t had a 1% drop in seven weeks. The Volatility Index ($VIX) recently dropped to a nine-month low, and it’s close to hitting a seven-year low.
One of the concerns I have with this market is the narrowness of it. In plainer terms, fewer and fewer stocks are doing the heavy lifting. With each successive peak in the S&P 500 (the black line), the number of stocks hitting new highs decreases (the blue line). That’s not a good sign.
That’s not all. This week, the government reported that for the first time in three years, the economy got smaller. For Q1, real GDP fell by 1%. Fortunately, that’s almost certainly a temporary blip. I’ll have more details in a bit. I’ll also look at the recent deal between AT&T and DirecTV, and later on, I’ll highlight some recent Buy List earnings, looking at what stocks look especially good right now. But first, let’s take a closer look at this amazingly resilient bull market.
Bull Markets Get Sloppy as They Get Older
One of the basic facts about bull markets is that they get sloppy as they get older. It’s always been that way, and I suspect it always will be. Consider that since the end of 2011, stocks with the worst balance sheets on Wall Street have done the best. In fact, they’ve done nearly twice as well as the S&P 500.
With Janet and friends inside the Fed keeping interest rates on the floor, it’s not such a burden having lousy finances. Companies that have issued junk debt in the past year have seen their stocks rise by an average of 26%. That compares with 15% for the rest of the market. There’s such a strong demand for higher-yielding debt that investors are willing to gobble up anything.
We’re still early in this game, but this is the type of behavior that leads to trouble. Fortunately for us, our Buy List stocks are fundamentally strong. The downside is that in a market like this, they can sit outside the rally. As always, patience is our best friend.
But what’s been even more impressive than the stock market rally has been the relentless rally in Treasury bonds. Bond guru Jeffrey Gundlach was one of the few people who said that bonds would rally this year, and he was bang-on right. On Thursday, the 10-year Treasury yield got down to 2.4%. That’s the lowest yield in close to a year.
Sheesh…anyone else remember when the end of QE was supposed to lead to a rotation out of bonds? That hasn’t happened, and it doesn’t look to start anytime soon.
So what’s going on with the bond market? Some people think bonds are reacting to bad economic numbers. That’s possible, but I’m a doubter. It’s true that Thursday’s GDP report was ugly. The Commerce Department said that for the first time in three years, the U.S. economy actually contracted. Real GDP fell at a 1% annualized rate during the first three months of this year.
Unpleasant, I know, but let’s remember that Q1 started five months ago and ended two months ago. In fact, it looks like the numbers for Q2 and Q3 will be pretty good. We’re also seeing a lot of strength in economically sensitive areas like transportation stocks. So the bond market has everyone perplexed.
Bill Dudley, the top dog at the New York Fed, gave an interesting speech last week which may explain what’s going on. The crucial point of Dudley’s speech came when he said he doesn’t expect real short-term interest rates to return to their historical level.
Let me explain. Here’s a very, very, very oversimplified explanation of what the Fed does. When the economy’s humming along, the Fed keeps real interest rates pinned at 2.5%. Anything above that is too tight. But when the economy’s in the dumps, the Fed lowers real rates to 0%. So the Fed’s job is to oscillate between 0% and 2.5%.
Please understand, this is a big generalization, but it works well for our purposes. Now Mr. Dudley said he thinks the 2.5% level no longer works. In fact, he expects real rates to stay “well below” that for a long time.
Dudley cites three reasons. First, he says, “economic headwinds seem likely to persist for several more years.” He may be right on that. Second, he notes the slowing growth of the labor force. Well, that’s certainly been the case. Third, he mentions changes in bank regulation and higher capital requirements.
Add these up, and we’re living in a low-rate world. If Dudley is right, and I’m not convinced he is, then it’s a major deal. It’s almost as if football suddenly changed from using 10 yards for a first down to only using seven, but no one told the players.
I can’t picture all the ramifications, but for certain, it’s a major change to the cost of capital. I would think lower “equilibrium” rates would depress dividend-payout ratios, since stocks wouldn’t have very strong competition from the short end of the bond market. It would also justify lower long-term rates, which is exactly what we’ve been seeing, so I’m not ready to dismiss Dudley just yet.
The AT&T Deal for DirecTV
In the last CWS Market Review I sent you, I said a deal between DirecTV ($DTV) and AT&T ($T) could come within two weeks. Well…my time horizon was way too long! The deal came a few hours later. It’s now official: AT&T and DirecTV are getting hitched. Here’s the Flash Alert I sent out on Sunday, May 18:
The merger deal calls for AT&T to buy DirecTV for $95 per share. The deal is a mix of cash and stock. The cash portion is $28.50 per share, and the stock portion is $66.50 worth of AT&T. They added a “collar” to the deal so no one is overly punished by a big swing in AT&T’s share price.
Here’s how it works: DTV shareholders will get 1.905 shares of AT&T if it’s below $34.90 when the deal closes. If AT&T is above $38.58 at closing, then they’ll get 1.724 shares of AT&T. If it’s between those two, they’ll get whatever ratio works out to $66.50 per share.
I expected shares of DTV to bounce up on the news, but it hasn’t happened. I think Wall Street suspects there are still some big obstacles to overcome. For one, there are regulatory concerns. AT&T will probably ditch some of their holdings to appease the government. That’s to be expected. They’ll need to convince the Federales that this is in the best interest of consumers.
There’s also the Sunday Ticket, which is DTV’s very lucrative deal with the NFL. In fact, AT&T is allowed to back out if DTV can’t extend their relationship with the NFL. For their part, AT&T said they expect an agreement to be reached, and I think they’re right about that.
I raised my buy below price on DTV to $95 per share. I expect this deal to close, but it will most likely take several months, perhaps more than one year. There’s no need for anyone to sell DTV, but your up side, at this point, is rather limited.
Medtronic Is a Buy up to $65 per Share
Now let’s look at two Buy List earnings reports we had last week. Last Tuesday, Medtronic ($MDT) reported Q4 earnings of $1.12 per share. That matched expectations, although I expected a little more.
“In our fourth quarter, our overall organization once again delivered balanced growth, with strong performances in some areas more than offsetting challenges in other parts of our business,” said Omar Ishrak, Medtronic’s chairman and chief executive officer. “We remain focused on delivering consistent and dependable growth across all of our businesses through our three growth vectors: new therapies, emerging markets, and independent services and solutions.”
Some good news is that the company finally settled its dispute with Edwards Lifesciences ($EW) over their CoreValve heart valve. Medtronic has agreed to pay EW $750 million plus royalty payments over the next eight years. As part of the settlement, both companies have agreed to stop suing the pants off each other. It’s time to move on.
Now for guidance. For this fiscal year, Medtronic sees earnings ranging between $4 and $4.10 per share. The Street had been expecting $4.09 per share. They expect revenue growth of 3% to 5% on a constant-currency basis.
The shares initially reacted poorly to the earnings news. But within a few days, the stock made back everything it had lost. It’s amazing what waiting a few days can do. Next month, I expect another dividend increase. I think Medtronic will raise their quarterly dividend from 28 cents to about 30 cents per share. Medtronic continues to be a very good buy up to $65 per share.
Ross Stores Reports Inline, Raises Guidance
A week ago Thursday, Ross Stores ($ROST) reported Q1 earnings of $1.15 per share, which matched the Street’s estimates. These are decent results, and they could have been a lot worse. Many other retailers put up some bad numbers. Frankly, I had been expecting more, but I hold Ross to a high standard. For Ross, revenue was up 5.6% last quarter to $2.68 billion, which was just shy of consensus. Comparable-store sales, which is the key metric for retailers, were up 1% for the quarter.
For Q2, Ross sees earnings of $1.05 to $1.09 per share and comparable-store sales growth of 1% to 2%. The Street had been expecting $1.08 per share. Bear in mind that Ross had a range of $1.11 to $1.15 per share for Q1, so they tended to be modest with their expectations.
For the entire year, Ross projects earnings of $4.09 to $4.21 per share. That’s an increase of four cents per share to the low end. The consensus on the Street is for $4.21 per share.
CEO Michael Balmuth said, “First-quarter earnings per share performed at the high end of our guidance as strict inventory and expense controls offset the impact from unfavorable weather and a more challenging retail environment. Sales trends improved in April, with more seasonal spring weather that coincided with the later Easter shopping period. Operating margin for the quarter was better than forecasted, declining 25 basis points to 14.6%. A 35 basis-point increase in cost of goods sold was partially offset by a 10 basis-point improvement in selling, general and administrative costs.”
I’m keeping our Buy Below at $76 per share, which is fairly wide, but I think Ross is underpriced here. Ross Stores remains a solid buy.
Buy List Updates
I wanted to add a few comments about some of our other Buy List stocks. Shares of Stryker ($SYK) got a nice lift this week after the company said it won’t be bidding for Smith & Nephew. That’s a smart move. I’m raising our Buy Below to $87 per share. I like Stryker a lot.
If you’re looking to start new positions, two of the best bargains on our Buy List are Bed, Bath & Beyond ($BBBY) and AFLAC ($AFL). My only caution is that it may take a while for the value to appear. AFLAC now yields 2.4%, and I expect to see a dividend increase later this year. BBBY is a buy up to $66 per share, and AFL is a buy up to $68 per share.
Express Scripts ($ESRX) got clobbered after its last earnings report. But as we often see with our Buy List, high-quality stocks prove to be sturdy. Shares of ESRX have rallied ever since. This week, I’m raising our Buy Below on Express Scripts to $74 per share.
CR Bard ($BCR) is another stock that’s been looking strong lately. The last earnings report was decent, in my view, even though it had a delayed reaction on Wall Street. Look for another dividend increase soon. CR Bard has raised their dividend every year since 1972. I’m raising our Buy Below to $151 per share.
Moog ($MOG-A) continues its surprising rally. The stock is up close to 20% in the last seven weeks. I don’t think a lot of folks saw that coming. I’m raising my Buy Below on Moog to $76 per share.
That’s all for now. Next week is a big week for economic reports. On Monday, the May ISM report comes out. Then on Tuesday, we’ll get a look at factory orders. On Wednesday, the Fed releases its Beige Book report. We’ll also see the latest reports on productivity, plus ADP releases its jobs report. Then on Friday comes the big May jobs report from the government. The last payroll report was a shocker (+288,000). It’s also very likely that the economy will finally surpass the payroll employment peak from 2008. 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!
Morning News: May 30, 2014
Eddy Elfenbein, May 30th, 2014 at 6:44 am
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Q1 GDP Falls 1%
Eddy Elfenbein, May 29th, 2014 at 10:10 am
The government reported that for the first time in three years, the economy contracted. Real GDP dropped by 1% for the first quarter of this year.
Remember that the first quarter began five months ago and ended two months ago. Wall Street currently expects good numbers for Q2 and for the rest of this year.
Morning News: May 29, 2014
Eddy Elfenbein, May 29th, 2014 at 6:40 am
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May 1970 – the Month the 1960s Boom Finally Ended
Eddy Elfenbein, May 28th, 2014 at 2:36 pm
From Gary Alexander at Navellier MarketMail:
On April 30, 1970, President Nixon came on national television to explain why he was expanding the Vietnam War into Cambodia. That set off a firestorm of protest, including the closure or partial shutdown of classes in over 450 college campuses, climaxed by the death of four students at Kent State on May 4.
The Dow collapsed on the Kent State killings – the greatest one-day drop in seven years, falling 2.6% to 714. In addition, May 4, 1970 was the day on which regular trading hours resumed on NYSE after a two-year experiment with shorter hours. From June to December 1968, the market closed each Wednesday. Then the market had limited hours (closing at 2:00 pm) in the first half of 1969 – all as part of an attempt to keep up with the huge volume of backroom work during the peak Go-Go years of the late 1960s.
The next day, Tuesday, May 5, Arthur Burns’ Federal Reserve leaped into the breach by reducing credit requirements on stock purchases from 80% down to 65%, even while some of the most glamorous stocks were collapsing. (On Friday, May 8 in Geneva, Bernie Cornfeld was forced out of Investors Overseas Service (IOS), which fell to a penny a share by 1972. On May 17 in Dallas, James Ling quietly resigned as CEO of trendy conglomerate Ling-Temco-Vought, whose stock price had fallen from $170 to $16.)
On Friday, May 22, a day on which the Dow hit a seven-year low, New York Stock Exchange President Bernard (“Bunny”) Lasker asked for and got an immediate audience with President Nixon, telling the President that the country was “five minutes till midnight of another 1929.” With no Memorial Day to stop the bleeding, the Dow dropped 20.81 points on Monday, May 25, the biggest one-day drop since the Kennedy assassination in 1963. With the Dow at 640, the reigning Dr. Doom, Elliot “Calamity” Janeway began talking about a Dow at 500 while John Kenneth Galbraith compared the current “insanity” to 1929.
The next day, May 26, the Dow hit its absolute bottom of the bear market at 631, and President Nixon called a meeting of 60 or more leading financial and business leaders to the White House on May 27.
That Wednesday meeting was “a cocktail hour of staggering economic importance,” according to John Brooks, since their appearance of action fueled a rally of historical proportions, a +5% 32-point Dow rally on May 27. For the three DAYS ending May 29, 1970, the Dow rose by an astounding 11%, even though the previous week, ending May 22, marked the fourth largest post-war weekly Dow drop to that date.
The bear market was over – 1929 was avoided – but there was a massive amount of cleaning up to do in the second half of 1970. Ross Perot was called in to save F.I. du Pont & Co, the nation’s third-largest brokerage firm (behind Merrill Lynch and Bache). By December 1, 1970, according to John Brooks:
“Wall Street hung by its fingertips. Roughly one hundred Stock Exchange firms had vanished over the past two years through merger or liquidation. Forty thousand customer accounts were involved in the 13 cases of liquidation, and most of them were still tied up, the customers, unable to get their cash or securities.”
—The Go-Go Years, by John Brooks, page 342
Morning News: May 28, 2014
Eddy Elfenbein, May 28th, 2014 at 6:43 am
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The VIX Plunges and the S&P 500 Hits New High
Eddy Elfenbein, May 27th, 2014 at 9:51 am
We’re back! I hope everyone had a nice weekend. On Friday, the S&P 500 closed at an all-time high. We’re up again today into another all-time intra-day high. The S&P 500 is currently at 1,908. Once again, the small-caps are doing the best.
The most surprising action is in volatility. On Friday, the VIX ($VIX) closed at 11.36, and we’re not far from making a seven-year low. On our Buy List, Moog ($MOG-A) is up to $73 per share, which is a new 52-week high. Oracle ($ORCL) is also in new high territory.
This morning’s durable goods report showed an increase of 0.8% in April. Economists were expecting a decline of 0.7%. The figure for March was revised to +3.6%.
Morning News: May 27, 2014
Eddy Elfenbein, May 27th, 2014 at 7:10 am
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Morning News: May 26, 2014
Eddy Elfenbein, May 26th, 2014 at 6:44 am
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No Newsletter Today
Eddy Elfenbein, May 23rd, 2014 at 7:48 am
Just a reminder that there’s no CWS Market Review today. We’ll be back next week with another exciting episode. Enjoy the long weekend!
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