CWS Market Review – September 11, 2015

“Preventing liquidation of an unbalanced market will leave you in tears.”
– Ben Bernanke

Next week is the big FOMC meeting, and there’s a chance that the Federal Reserve will raise interest rates for the first time in nine years.

Wall Street is completely obsessed with this issue. Frankly, I’m conflicted on even discussing it with you. Whatever the Fed does next week is truly not very important to us as investors. Yet I feel the need to at least touch on the subject since it’s dominating the news on Wall Street. Plus, as the decision day gets closer, we still don’t know exactly what the Fed will do.

In this week’s CWS Market Review, I’ll take a closer look at the issues confronting the Federal Reserve. For now, Wall Street seems to doubt that a rate hike is coming, but not by much. The more important issue is that the bond market is still calm, and the broader economy is improving. Later on, I’ll preview one of our Buy List earnings reports coming next week. Our Buy List has outpaced the market in five of the last six days. I’ll also update you on some of our other Buy List stocks. But first, let’s see what’s in store for the Fed as they get together next week in Washington.

The Fed Will Probably Do Nothing Next Week

We have a slight clue as to what the Federal Reserve will do from keeping an eye on the futures pits. Traders there buy and sell contracts on just about everything, and that includes the Fed funds rate. By looking at the prices on those futures, we can make out what the market thinks the Federal Reserve will do. (You can see for yourself at this page run by the CME.)

One month ago, China shocked the financial world by devaluing its yuan. That was their biggest deval in two decades. It’s not exactly a secret that the PRC keeps its currency artificially low in order to make its exports cheaper on the world market. Naturally, the Communists love money just like everybody else. It’s not that your currency needs to be cheap; it’s that it needs to be cheaper than everybody else’s. So the fear was that this devaluation could set off a deval frenzy as other countries raced to the bottom.

Scary, but not likely. Still, that devaluation was the first domino to fall. Soon, the mighty Kazakh tenge plunged by 22%. Other currencies followed. Then Asian equity markets buckled, and soon enough, our markets dropped as well.

Are those fears overblown? Sure. As big as China is, all the revenues from that country account for a rounding error for the S&P 500. In fact, the figure is probably less than the 2% number you often hear once you exclude semiconductors and other tech products which are sent to China to be re-exported elsewhere. China, I’m afraid to say, just isn’t that important to us yet.

Before China’s surprise devaluation, futures traders thought there was a 60% chance the Fed would start raising rates at its meeting scheduled for September 16-17. Since then, that figure has dropped to about 26%.

Jon Hilsenrath, the WSJ reporter who’s often considered to be the Fed’s major media conduit, recently said that the central bank is not in agreement on what to do. I would think that the Fed would want to show a unified front, considering it’s the first rate increase since 2006. When Hilsenrath writes “senior Fed officials” in one of his stories, you can be sure they’re very senior Fed officials. It’s his story from Wednesday that has me thinking the Fed will hold off on any rate increase.

The monetary doves, those who are against raising rates, say that inflation is nowhere to be seen. Commodity prices are down. This Labor Day weekend, a gallon of gas was 99 cents lower than it was last year. While the jobs numbers are good, workers haven’t seen much in the way of higher wages. It’s hard to make an argument that the economy is overheating. If I were on the Fed (and I have not been asked, at least not yet), I would vote against raising interest rates. I’m not ardent in this belief. It just seems too early.

The hawks, those who want higher rates, have points to make as well. The jobs situation has improved dramatically from a few years ago. The last jobs report has the unemployment rate at 5.1%. That’s the lowest in more than seven years. The unemployment rate is lower now than it was at any time from May 1974 to March 1997, except for one month in 1989. The initial jobless claims report has been below 300,000 for 27 weeks in a row.

The hawks also say that you can’t wait for inflation to show up before you raise rates—you need to strike before inflation appears. So far this year, core inflation, which excludes food and energy, is running at 2.2%. Next week, we’ll get the CPI report for August. The headline inflation, which includes everything, hasn’t hit the Fed’s target of 2% in more than three years.

The other problem for the Fed is that the world is heading in one direction (lower rates, more stimulus) while the Fed is paring back. In Europe, Mario Draghi is trying to run Ben Bernanke’s playbook. So far, it’s been a flop. In China, the government is going out of its way to prop up its delicately-managed financial markets. The mismatch between the U.S. and the rest of the world is part of the reason for the recent turbulence.

The good news is that the stock market has started to relax a bit. Still, I’ve said I won’t give the “all clear” sign until the VIX closes below 20. On Thursday, the VIX closed at 24.37 which is a three-week low.

Remember how calm things were? Less than two months ago, the WSJ said, “It’s Official: This Is the Most Boring Stock Market in Decades.” Or as I wrote so eloquently in June, “This market’s just dull, dull, dull.” Through this past Tuesday, the S&P 500 had seven 2% moves in just 13 days. In the 167 days prior to that, we only had one 2% move.

Looking past the September meeting, futures traders think there’s a 60% chance of a rate hike in December. In fact, that may be the compromise reached at next week’s meeting. Here’s the point I think many investors are missing: interest rates will still be low after a Fed hike. In fact, real short-term rates will most likely be negative for another 18 months, and probably longer.

There’s no guarantee, but low real rates has been one of the backdrops for bull markets. One rate hike is not a killer for stocks or the economy. The problem comes when rates get too high. Until that happens, the broad outlook for stocks is quite good.

Oracle’s Fiscal Q1 Earnings Preview

Next week, Oracle (ORCL) is due to report fiscal Q1 earnings on Wednesday, September 18, after the closing bell. This is one of our two Buy List stocks with August-ending quarters. The other is Bed, Bath & Beyond (BBBY), which isn’t scheduled to report until September 24.

Three months ago, Oracle had a lousy earnings report. The company was clearly a victim of the strong dollar. Oracle’s quarterly revenues fell by 5%, but they said that if it hadn’t been for the strong dollar, quarterly revenues would have risen by 3%. The company told us to expect Q4 earnings to range between 90 and 96 cents per share. As it turned out, Oracle wasn’t even close—they earned just 78 cents per share. While the strong dollar caused a lot of damage, that wasn’t all. Oracle’s software sales fell 6%. The company loves to tell us how well its cloud business is doing but that’s not very big.

For Q1, Oracle said it expects earnings between 56 and 59 cents per share. That’s pretty weak, and Wall Street expects even worse. The current consensus is at 52 cents per share. It’s interesting that the Street is going below the company’s public guidance. That’s not a sign of faith.

Since the last earnings report, the stock has been a disaster. Shares of Oracle nearly broke below $35 a few weeks ago. Oracle is now going for 13.6 times last fiscal year’s earnings. By most conventional metrics, Oracle is a good bargain, but there needs to be some good news to get investors excited again. I’m also curious how long Oracle will continue with two CEOs. With a lower share price, the company may want to prove that it’s moving forward with greater direction. I’m still a fan of Oracle, and I’m sure the dollar headwinds are tough, but I want to see better numbers here soon. This week, I’m lowering my Buy Below on Oracle to $40 per share.

Buy List Updates

Since the stock market broke down in August, I’ve been hesitant to lower our Buy Below prices. The market is still in flux, and I don’t want investors to be swung back and forth. As always, our strategy is to be patient and wait for bargains.

This week, I want to lower the Buy Belows for eBay (EBAY) and PayPal (PYPL). I gave both somewhat elevated Buy Below prices because I knew there would be heavy demand going into the spinoff. Unfortunately, both stocks have been punished recently. Just this week, eBay was downgraded by Cantor Fitzgerald from buy to hold. I’m going to lower the Buy Below by $2 per share for both stocks. eBay is now a buy up to $28 per share, and PayPal is a buy up to $38 per share.

Express Scripts (ESRX) announced this week that its CEO, George Paz, will be retiring in May. He’s been a great leader for the company and I’m sad to see him go. ESRX’s current president, Tim Wentworth, will succeed Paz as CEO. Wentworth came on board three years ago when ESRX bought Medco Health Solutions. I expect another good earnings report next month. Express Scripts is a buy up to $92 per share.

That’s all for now. The big news next week will be the FOMC meeting. The Fed will meet on Wednesday and Thursday, September 16-17. The meeting will be accompanied by an update on the Fed’s economic projections. I should warn you that the Fed has a pretty bad track record at this. The meeting will be followed by a press conference from Fed Chairwoman Janet Yellen. The rate decision should come at 2 p.m. on Thursday. On Tuesday, we’ll get reports on retail sales and industrial products. Then on Wednesday, the CPI report for August comes out. 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 September 11th, 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.