CWS Market Review – May 16, 2014

“If you would know the value of money, go and try to borrow some.”
– Benjamin Franklin

On Monday, for the first time in history, the S&P 500 cracked 1,900. The Dow Jones Industrials also reached an all-time record high. But what’s surprising, and perhaps a little disconcerting, is that the bond market is rallying as well. In fact, the bond market has been doing even better than the stock market. On Thursday, the yield on the 10-year Treasury dipped below 2.5% to hit a six-month low (see the chart below).

These twin rallies seem to be the result of dueling hypotheses. If the stock market is rallying, that should mean that the economy is improving. At least, that’s the conventional wisdom. And when the bond market rallies, that’s often the omen of a recession. So what’s going on here?


In this week’s CWS Market Review, I’ll delve into the numbers and try to untangle the market’s bipolar disorder. I’ll also tell you what to do now to take advantage of this confusing market. We’ll also look at the latest from DirecTV. Up until now, there was a lot of chatter about a possible deal with AT&T. Now a deal is a very real possibility, and it may happen soon.

This week’s bad news was a sluggish outlook from Buy List member CA Technologies. I’ll have all the details in a bit. Plus, I’ll preview next week’s earnings reports from dividend champs Medtronic and Ross Stores. But first, let’s look at the market’s mixed message.

Why Stocks and Bonds Are Rallying Together

Wall Street seems terribly confused that stocks and bonds are rallying at the same time. For so long, we’ve assumed that they must always move in opposite directions. But that’s not necessarily the case.

While stocks and bonds have often been polar opposites, that usually reflects diverging opinions on the economy. Now, however, I think they’re both rallying, but for different reasons.

The stock market is easy. It’s up because investors see the economy doing well. Even though the GDP numbers for Q1 were pretty bad, a lot of the big banks on Wall Street think that growth for Q2 will come in over 3%. Maybe even higher.

The jobs market also continues to improve. There are still a lot of people out there looking for work, and the long-term unemployed figures are frustratingly high. But just this week, we learned that initial jobless claims dropped down to 297,000. That’s the lowest number in seven years. The jobs report for April was quite good. In 89 days (Feb/Mar/Apr), the U.S. economy created 713,000 new jobs.

Earnings aren’t bad either. For the first-quarter earnings season, 76% of the companies in the S&P 500 beat earnings expectations, while 53% beat sales expectations. What’s really telling for me is that cyclical stocks continue to do well. The Morgan Stanley Cyclical Index ($CYC) has outpaced the S&P 500 this year. The market’s recent pain has been centered on high-profile momentum stocks, but areas like Materials and Energy, the sectors most sensitive to the economy, have largely side-stepped the damage.

In any market, it’s interesting to see where the current “axis” is. By that I mean that to look at the stocks that are the best or worst performers each day. Sometimes the split is between growth and value, or risk and safety. Lately, the big split is between large-cap and small-cap. That’s most likely a reflection of the currency market. Larger firms to be more internationally focused while smaller firms are more domestically oriented.

This makes sense because outside of the U.S., the eurozone and Britain have been getting back on their feet. What’s interesting is that they’ve been helped by money running away from emerging markets. The euro recently hit a two-year high while the British pound touched a five-year high. Meanwhile, Janet Yellen and Fed have made it clear that interest rates need to stay low well after all the bond buying is done.

The bond market is also being helped by Uncle Sam’s improved finances. There’s still a lot of red ink, but not nearly as much as before. The Congressional Budget Office now sees this year’s budget deficit coming in at a “mere” $492 billion. As big as that sounds, it’s the smallest by far in recent years. The smaller the deficit, the less borrowing there is. This year’s deficit is projected to be 2.8% of GDP which would be the fifth-straight reduction. It would also be less than the average deficit of the last 40 years.

So these two rallies aren’t really a contradiction. Instead, the fight for capital has changed. Stock investors see an improved job market and more consumers. Bond investors see improved government finances and less borrowing. As long as short-term rates are low, the rational choice is to be invested in a diversified portfolio of high-quality stocks like our Buy List.

CA Technologies Is a Buy up to $32 per Share

On Thursday morning, CA Technologies ($CA) became our final Buy List stock to report earnings this season. For March, which ended their fiscal Q4, CA earned 61 cents per share. The good news is that this was three cents better than estimates. Their full-year forecast implied a range for Q4 of 57 to 64 cents per share.

The bad news is that for the coming fiscal year, ending next March, CA gave us a range of $2.45 to $2.52 per share. That was below the Street’s estimate of $2.54 per share. Traders didn’t like that news at all, and the shares tanked 3.4% on Thursday, to close at $29.05. Frankly, I find that reaction pretty puzzling. While the guidance is indeed lower than expectations, that should be seen within the context of CA’s beating expectations by a roughly similar amount. Perhaps some traders just wanted out.

Around here, we like to put our emotions aside and look at the numbers. Going by Thursday’s closing price, CA yields more than 3.4%, and the stock is going for about 12 times this year’s earnings. The company also said it’s going to buy back $1 billion worth of stock. CA isn’t a fast-growing company, but it has its strengths. I still like this stock, but I’m dropping our Buy Below down to $32 per share to reflect the recent selloff. Don’t let this guidance scare you. These quiet stocks have a way of pulling through.

AT&T Could Buy DirecTV within Two Weeks

Now let’s get to the fun stuff. In the last two issues of CWS Market Review, I’ve discussed the possibility of AT&T ($T) buying DirecTV ($DTV). There have been a lot of rumors about this, and the rumors gradually became whispers, and then the whispers became speculation. Now the speculation is officially news.

After the closing bell on Monday, the Wall Street Journal reported that a DTV/AT&T deal could come within two weeks. They’re talking about a price somewhere in the low- to mid-90s for DTV. The deal will probably be a mix of cash and stock.

I know this is exciting to see someone ready to buy out one of our stocks, but let me remind you that no deal has been made. Deals fall apart all the time. There are still financing and regulatory issues, plus the possibility of shareholder objections. I’m not saying any of these will happen, but I’m reminding you that problems can arise.

About the deal. All things being equal, companies would prefer to make acquisitions using their stock. It’s like having a currency you can print for free. Well, almost free. The issue with AT&T is that it pays a generous dividend (5% currently), so issuing more shares means sending out more dividend checks.

If a deal comes about, for track-record purposes, I’ll assume any cash from the deal will go directly into AT&T stock. That way, we’ll still have 20 stocks on our Buy List. AT&T will simply replace DirecTV. As always, I’ll provide complete details when and if this ever happens. Either way, DirecTV remains a very good buy up to $89 per share.

Expect a Small Earnings Beat from Medtronic

We have two Buy List stocks, Medtronic and Ross Stores, that are on the April, July, October, January reporting cycle. Both are due to report next week. Medtronic ($MDT) will report its fiscal fourth-quarter earnings on Tuesday morning, May 20. In February, they hit estimates on the nose. The medical-devices company also gave Q4 guidance of $1.11 to $1.13 per share. Wall Street has chosen the middle and expects $1.12 per share.

Interestingly, Bernstein thinks they’ll slightly beat expectations (but not on the top line). I think that’s probably right. They have a $70 price target. Medtronic has done well for us as it’s rallied in fits and starts over the last two years (see below). Last month, MDT finally surpassed its all-time intra-day high set more than 13 years ago.


I also expect that Medtronic will increase its dividend next month. That’s not much of a prediction on my part, since Medtronic has increased its dividend every year for the last 36 years. Medtronic is a good buy up to $65 per share.

Expect Strong Earnings from Ross Stores

Ross Stores ($ROST) continues to be one of my favorite retailers. They’re due to report earnings after the bell on Thursday, May 22.

At the start of last year’s holiday shopping season, Ross warned investors that business was coming in light. The stock got hit pretty hard, but when the results came in, it really wasn’t that bad. Wall Street had been expecting $1.09 per share. Ross said it would be between 97 cents and $1.01 per share. Ultimately, they made $1.02 per share. That’s really a microcosm of the last earnings season: companies warned that profits would be below expectations, then beat those lowered expectations.

Make no mistake, Ross is still doing quite well. For all of 2013, Ross earned $3.88 per share, which was a nice increase over the $3.53 from 2012. The fiscal year for 2012 was 53 weeks, which added 10 cents per share to that year’s earnings.

The best news was that Ross recently bumped up their dividend by 17.6%. The quarterly payout rose from 17 to 20 cents per share. That marked the 20th year in a row that Ross has increased its dividend. Not many retailers can say that.

For Q1, Ross sees earnings coming in between $1.11 and $1.15 per share. I think they have a very good shot of beating that. For all of 2014, Ross has a range of $4.05 to $4.21 per share. I think they can beat that as well, but it’s still early. The shares have been trending downward lately and are a very good buy here. Ross Stores remains a buy up to $76 per share.

I want to briefly comment on a few of our other Buy List stocks. McDonald’s ($MCD) has been doing very well lately. The burger giant recently hit a new all-time high. I noticed that UBS raised their price target on MCD from $107 to $120 per share. I’m raising our Buy Below on McDonald’s to $106 per share.

I want to reiterate what I said last week about Bed Bath & Beyond ($BBBY) being an outstanding buy. The home-furnishings store will report earnings again in another month, and I’m expecting good news. BBBY remains a very good buy below $66 per share.

While the rest of the market was getting hit hard on Thursday, shares of Oracle ($ORCL) rallied to a new 14-year high. This one took a while to pay off for us, but the shares are up more than 40% from last summer’s low. Once again, we see that being patient is a very good strategy. The only downside is, it takes time. Oracle is a solid buy up to $44 per share.

That’s all for now. There won’t be a newsletter next week. I’m going to get an early jump on the Memorial Day weekend. Don’t worry. I’ll cover our two Buy List earnings reports on the blog. Also, on Wednesday, the Fed will release the minutes from their last meeting. Expect traders to carefully scrutinize it for any clues about when interest rates will rise. I’ll be back in two weeks with more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by on May 16th, 2014 at 7:09 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.

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