CWS Market Review – February 20, 2015

“It was never my thinking that made the big money. It was always my sitting.”
– Jesse Livermore

Once again, the Federal Reserve has given a green light for investors. This week, we got the minutes from the Fed’s last meeting, and once again we have clear evidence that the Fed isn’t about to raise interest rates anytime soon. With interest rates dragging on the floor, stocks continue to be the best alternative; and high-quality stocks like those on our Buy List are doing especially well.

Historically, the stock market has done well during Christmas, but February is typically lackluster. This year has been just the opposite. January was poor, but February has been quite good. So far this month, the S&P 500 is up 5.14%, which puts it on pace for the best month since October 2011. I’m happy to say that our Buy List is doing even better. We’re up 8.51% this month, and we already have three stocks that are up more than 10% on the year, including Cognizant Technology Solutions ($CTSH) which is up 17.7%.


This has been a good earnings season for us, and this past week, we got good earnings reports from Hormel ($HRL) and Wabtec ($WAB). Both stocks broke out to new 52-week highs. I’ll have more on their earnings reports in a bit. I’ll also preview upcoming earnings reports from Express Scripts ($ESRX) and Ross Stores ($ROST). But first, let’s take a closer look at what’s on the Fed’s mind.

The Federal Reserve Is on the Side of Stocks

Actually, it’s a little more complicated, because it’s not solely about what’s on the Fed’s mind, but it’s also about what the market thinks is on the Fed’s mind. Furthermore, it’s what the Fed thinks the market thinks the Fed is thinking. We’re quickly entering an infinite regress of central bankers, which is a highly disquieting thought indeed.

I’ll try to bring some clarity. The Federal Reserve has gone to extreme lengths to help the economy get back on its feet. Only now are we starting to see real gains. In the last year, the economy added 3.2 million jobs. This led to a series of speculations that the Fed is about to pull back on what central bankers like to call “accommodation.”

The Fed successfully wrapped up its bond-buying program despite many predictions that they would keep it going. So far, the Fed has acted smoothly. But recently, the Fed has gotten ahead of the game on interest rates. I believe the Fed has led investors to believe rates are going up sooner than they really are. The Fed has strongly implied that rates will start rising around the middle of this year. Call me a doubter. For one, prices are falling. I don’t see how you can raise interest rates when you have actual deflation. This week’s PPI report showed that wholesale prices fell 0.8% in January. Also, the futures market has begun to doubt that a rate increase will come by mid-year.

The key factor to look at is real interest rates, meaning the interest rate adjusted for inflation. So even if rates are near 0%, deflation translates into higher real interest rates. That’s not what we need right now. Next week we’re going to get the CPI for January, and I expect to see more deflation at the consumer level.

But I don’t think the deflation will last. The early evidence shows that gasoline prices stopped falling a few weeks ago and have risen about 20 cents per gallon on average. Longer-term interest rates have climbed as well. The yield on the 10-year Treasury is back above 2.1%. That’s still low in an absolute sense, but it’s higher than where it was. Coupled with this increase in yields, the stock market has divided as well. Bloomberg recently noted that since February 6, stocks with the lowest yields have done the best, while those with higher yields have done the worst.

On Wednesday, the Federal Reserve released the minutes from their last meeting. I should explain that the Fed minutes are a study in indefinite pronouns (“many said this, some said that”). But the overall tone shows a central bank worried about the fragility of the recovery. The futures market currently implies a 20% chance that interest rates will rise by June. Before the Fed minutes came out, it was 25%. While the number of jobs has grown, workers haven’t seen much in the way of a pay increase. That’s certainly not putting any pressure on prices. Since the summer, inflation expectations have plunged.

The Fed has said they’ll be “patient” in their decision to raise rates. Now investors are debating how long the word “patient” will appear in Fed policy statements. At this rate, I don’t think the Fed will raise rates until 2016, or possibly late 2015. This newly found reticence has been good for stocks. Just look at a one-year Treasury, which currently yields 0.23%, compared with a blue-chip like Microsoft ($MSFT), which yields 2.85%.

The stock market has responded. The S&P 500 touched another new all-time high this week. The Nasdaq Composite has rallied seven days in a row and is finally within sight of its all-time high, which it reached 15 years ago. (If only the sock puppet were alive to see this day.) As Jesse Livermore said, it’s the sitting that made him money. That patience has paid off for us this month. Now let’s take a look at some of our recent Buy List earnings reports.

Wabtec Is a Buy up to $99 per Share

Two of our new Buy List stocks reported earnings this week. On Wednesday, Wabtec ($WAB) said they earned 95 cents per share for Q4. That’s a good number, and it was a penny per share above Wall Street’s consensus. If you’re not familiar with Wabtec, they make locomotives, brakes and other systems for the freight- and passenger-rail sectors. It’s one of those fairly dull industries that’s more profitable than you might think. That is, if you ever thought about it.

CEO Raymond T. Betler said: “We finished the year with a strong performance in the fourth quarter, and we are anticipating record results again in 2015. While we expect to face challenges this year, including global economic uncertainty and foreign currency-exchange headwinds, we will benefit from ongoing investment in freight-rail and passenger-transit projects around the world. Our long-term growth prospects remain solid, thanks to our diversified business model, balanced strategies and rigorous application of the Wabtec Performance System.”

That’s the theme of many of our companies—things are going well, but forex is a headwind. Wabtec earned $3.62 per share for all of 2014, which was a healthy increase over the $3.01 they earned in 2013. For 2015, Wabtec issued guidance of $4.05 per share. That was below Wall Street’s expectations. Going into the earnings report, the Street had been expecting earnings of $4.15 per share.

But it couldn’t have been much of a disappointment, as the shares rose 2.3% on Wednesday and another 2.4% on Thursday. The stock is up more than 10-fold in the last ten years. On Thursday, WAB closed above $95 for the first time ever. This week, I’m raising my Buy Below on Wabtec to $99 per share.

Hormel Foods Beats Earnings and Raises Guidance

On Thursday, Hormel Foods ($HRL) reported earnings for the first quarter of their fiscal year. Their fiscal year ends in October. For Q1, Hormel earned 69 cents per share. That was five cents better than expectations. Quarterly revenue rose 6.8% to $2.4 billion. That was a bit below consensus of $2.47 billion.

“We are off to an excellent start to our fiscal year, with double-digit earnings growth and record sales in the first quarter,” said Jeffrey M. Ettinger, chairman of the board, president and chief executive officer.

“Jennie-O Turkey Store increased operating profit by 56 percent, with strong value-added product-sales growth, robust turkey markets and favorable input costs,” remarked Ettinger. “Refrigerated Foods also turned in an excellent quarter by driving increased value-added sales, aided by the benefit of lower pork costs. Grocery Products was challenged by high input costs and soft sales on some brands, while International & Other delivered increases despite difficult export markets,” commented Ettinger. “Specialty Foods is focused on driving higher margins in the newly acquired CytoSport business, and going forward we believe the business is well positioned to deliver results in line with our expectations.”

Thanks to the strong Q1, Hormel raised its full-year guidance. They now see earnings ranging between $2.50 and $2.60 per share. That’s an increase of five cents at both ends, which matches the earnings beat. Wall Street had been expecting $2.54 per share. Shares rallied nearly 3% on Thursday. I’m lifting my Buy Below on Hormel Foods to $61 per share.

Ball Corp. Buys Rexam

In the CWS Market Review from two weeks ago, I told you that Ball Corp. ($BLL) was in talks to buy Rexam, a British aluminum-can maker. After a long courtship, Ball finally made an honest woman out of Rexam. On Thursday, they announced a $6.8 billion merger agreement. The combined entity will be the largest maker of food and beverage cans in the world.

Ball estimates cost savings of $300 million by 2018. I’m always skeptical of these cost-savings estimates, but clearly there will be some. The combined company will have 22,500 employees and $15 billion in sales.


Shares of Ball rallied strongly on anticipation of the deal and fell 4% after the deal was announced. The specifics of the deal are a bit complicated, but I’ll give you the simple version. Ball is paying a 17% premium for Rexam. The deal will be financed with $2.2 billion in new equity, a $3 billion revolving-credit facility and a 3.3 billion-pound bridge loan. (Pounds are, apparently, what British people use for money.)

There are still regulatory hurdles in Europe and the United States, plus shareholders have to approve the agreement as well. As part of the deal, Ball agrees to pay a “break fee” of 302 million pounds if the merger falls though due to regulatory reasons. The companies say they expect the deal will ultimately be completed sometime during the first half of 2016. This is a bold move on Ball’s part. Ball Corp remains a solid buy up to $75 per share.

Two Buy List Earnings Reports Next Week

We have two more earnings reports next week. Express Scripts ($ESRX), the pharmacy-benefits manger, is due to report Q4 earnings on Monday, February 23. Express Scripts was one of our stronger performers late last year. The company has hit expectations on the nose for the last two quarters.

In October, ESRX narrowed their 2014 estimates to $4.86 — $4.90 per share. That implies Q4 earnings of $1.36 to $1.40 per share. Wall Street’s consensus is for $1.38 per share, which sounds right to me. I’ll be curious to hear what guidance they have for 2015. I’m expecting around $5.35 per share, give or take. ESRX is a buy up to $87 per share.

Ross Stores ($ROST) is due to report their fiscal Q4 earnings on Thursday, February 26. The stock has done an amazing turnaround over the past seven months. At one point, shares of Ross dropped below $62 last July. This week, it cracked $97.

The deep discounter said that earnings for Q3 would range between 83 and 89 cents per share. I thought that was obviously too low and said so. I was right—Ross earned 93 cents for Q3. For Q4, Ross said that earnings should range between $1.05 and $1.09 per share. That’s more realistic. The Street, however, thinks Ross is still playing games. The current consensus is for $1.11 per share. Given that the Street expects an earnings beat, the short-term risk is to the downside. That’s just a warning that Ross may slide next week. Don’t be alarmed. Ross is a very good stock. I’m keeping my Buy Below at $96.

That’s all for now. Next week is the final trading week of February. We’ll also get some of the important end-of-the-month economic reports. On Thursday, the government releases the CPI report for January. Spoiler Alert: I think we’ll see another big drop in consumer prices, but deflation may soon peter out. Then on Friday, the government will revise its estimates for Q4 GDP. The initial report said the economy grew by 2.6% in real terms for the final three months of 2014. I think that might be bumped up a little. 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 February 20th, 2015 at 7:14 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.