CWS Market Review – March 20, 2015

“It is not the crook in modern business that we fear, but the honest
man who doesn’t know what he is doing.” – Owen D. Young

I’m out of the office, enjoying a quiet vacation far from the madding crowds of Wall Street, but I wanted to send you an abbreviated CWS Market Review this week. There were two big stories this week. At the macro level, the Federal Reserve’s latest policy statement dropped the word “patient” from descriptions of the Fed’s outlook for raising interest rates.

The bulls were glad to see the Fed’s forecast showing that unemployment can go lower before it stokes inflation. Janet Yellen fed the optimism when she said, “Just because we removed the word ‘patient’ from the statement doesn’t mean we’re going to be impatient.” Almost instantaneously, the stock market jumped about 1% Wednesday afternoon.


The big story for our Buy List was a 25% dividend increase from Oracle (ORCL). For their fiscal Q3, Oracle earned 68 cents per share, which matched expectations. The company is basically doing well, but it’s being impacted by—I hope you’re sitting down—the strong U.S. dollar! The dividend news was good to see, and their cloud business is strong. Shares of ORCL jumped nearly 3% on Wednesday. I’ll have more details in a bit.

The Fed Feeds the Bulls

Wall Street had been a bit nervous going into this week’s Federal Reserve meeting. The Volatility Index (VIX) got as high as 17 last week. There’s been a disconnect between what the Fed’s been saying and what the market thinks will happen. The Fed has repeatedly hinted that they’ll start raising interest rates by the middle of this year. Wall Street thinks it will happen later.

For their part, the Fed took an April rate hike off the table. But previously, they had said they plan to be patient in their move to a rate increase. They stopped doing it this time. In Wednesday’s policy statement, the Fed said that it will be appropriate to raise rates when the FOMC “has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range.”

In other words, watch the labor market and inflation. Since we haven’t had much inflation lately (deflation, actually), that still signals to us that they’re in no hurry to raise interest rates. The bond market sold off after the Fed meeting, but the 10-year yield is still below 2%. If anything, the Fed is coming around to the bond market’s view.


You may be curious why the Fed and its outlook for interest rates are so important to investors. The reason is that short-term rates serve as the basic competition for investors’ money. For a long time, I haven’t been concerned by the market’s periodic downturns. Since the bull market began six years ago, there have been 12 dips of 5% or more. Each one led to a new high. The reason for my optimism is that the low rates offered in fixed income are a poor substitute for high-quality stocks. Why would anyone want to get 0.26% from a one-year Treasury when they could get 2.7% in Wells Fargo (WFC) or 2.9% in Microsoft (MSFT)? Those are conservative stocks, and they’re yielding 10 times what you can get in fixed income.

I apologize, but I’m going to use a fancy economic term, and that’s NAIRU. That stands for the non-accelerating inflation rate of unemployment. (Now you can impress people at dinner parties.) Translated into English, NAIRU means the unemployment rate below which inflation starts to rise. The problem is that no one knows exactly where NAIRU is. It would make things easier if we did, and NAIRU probably moves around as well. The reason I mention this is that the Fed this week lowered its NAIRU estimate. In December, the Fed said stable prices would happen when unemployment gets between 5.2% and 5.5%. They just lowered that range to 5% to 5.2%. That’s good news, because it implies the Fed will need to do less tightening as the economy improves.

The Fed has been pretty clear that a rate increase will happen later this year; 15 of the 17 FOMC members currently believe so. If the Fed thinks NAIRU has fallen, they’re not going to be raising rates so quickly. The Fed’s latest projections show that they expect, on average, to have rates at 0.75% by the end of this year. Plus, the Fed thinks inflation will range between 1.7% and 1.9% next year. In other words, even after the rates increase, we’ll still have negative real rates. To boil down this week’s news to a simple statement, while the Fed dropped the word “patient,” they still plan to be generally quite patient. That’s what made the bulls so happy.

What’s complicated things is our old friend, the strong dollar. The U.S. economy is gaining steam, while Europe is still weak. This week, in fact, Sweden’s central bank cut interest rates to negative 0.25%. The Riksbank thought their previous rate of -0.1% was simply too high. Mario Draghi is still doing everything he can to weaken the euro. The strong dollar has effects very similar effects of the Fed’s tightening—without the Fed’s actually tightening. Fortunately, the U.S. isn’t as export-intensive as other countries, so a strong dollar doesn’t immediately translate into a recession. But it does hurt. In fact, let’s look at the latest earnings report from Oracle.

Oracle Raises Dividend by 25%

On Tuesday, Oracle (ORCL) reported fiscal Q3 earnings of 68 cents per share. That matched Wall Street’s consensus. The bad news is that quarterly revenue came in at $9.33 billion, which was below consensus of $9.47 billion. Oracle said that if you exclude the impact of the strong dollar, quarterly sales would have risen by 6%.

Larry Ellison said that before the end of this year, his company will be making more money off cloud than (CRM). For fiscal Q4, which ends in May, Oracle sees earnings ranging between 90 and 96 cents per share. Wall Street had been expecting 88 cents per share.

I wanted to highlight this part of Oracle’s earnings call. This is Safra Catz discussing Oracle’s cloud business, which is also known as platform-as-a-service or Paas:

Our customers are clearly embracing Oracle PaaS faster than we expected, which is actually great for us. Just to give you a little bit of insight on how we look at the business, for every $1 million of license we sell, we expect to collect another $1 million from support over five years, for a total of $2 million, while for every $1 million of PaaS we sell, we actually expect to collect $5 million over five years.

Think about that! The best news for investors is that Oracle raised its quarterly dividend by 25%. The payout will increase from 12 to 15 cents per share. Oracle isn’t a big dividend payer, but an increase is still nice to see. Shares of Oracle jumped 3% on Wednesday to touch a two-month high. I’m keeping my buy below on Oracle at $48 per share.

Before I go, I wanted to highlight a few other points. Fiserv (FISV) finally broke $80 per share on Thursday. What an amazing stock this has been. Cognizant Technology Solutions (CTSH) also broke out to a fresh 52-week high. The stock is up 50% from its October low. eBay (EBAY) has slumped recently. The online-auction house was downgraded by Piper Jaffray due to concerns that PayPal will soon face more competition. That’s certainly true, but I think a downgrade is very premature. eBay remains a solid buy. AFLAC (AFL) nearly hit $64 per share on Wednesday. It’s about time the duck stock got some love from the market.

That’s all for now. There are two important economic reports to watch for next week. On Tuesday, the government releases the CPI report for February. We know that deflation has been moderated, but not yet by how much. The Fed clearly thinks deflation will soon pass, and I suspect they’re right. Then on Friday, the government releases the final report on Q4 GDP. 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 March 20th, 2015 at 7:08 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.