CWS Market Review – November 6, 2015

“If the incoming information supports that expectation, then…December would be a live possibility.”

So said Fed Chairwoman Janet Yellen on Wednesday. Central bankers are trained to speak in convoluted econo-babble, so that’s as strong a signal as you’re going to get. But make no mistake, it’s a big deal. This means the Fed is serious about raising interest rates next month.

What’s more important than what an economist says is what the bond market says, and the bond yields have snapped into action. Just this week, the six-month Treasury came within inches of cracking 0.3%. True, that ain’t much of a yield, but it’s the highest we’ve seen in six years. To put that in perspective, one month ago, the six-month was yielding just 0.06%.


But there’s a key difference in the Fed’s outlook this time. Wall Street is starting to realize that the Fed will probably do a one-and-done. In other words, the Fed may raise rates once shortly and then leave rates alone for several months. That’s a strategy the Fed hasn’t done in many years. I’ll break down what it means for investors.

We had two Buy List earnings reports this week. The good news is that both beat expectations. The bad news is that both got punished by the market. Fortunately, the damage at Cognizant Technology Solutions (CTSH) wasn’t too bad, but we can’t say the same for poor Qualcomm (QCOM). The shares got hammered on Thursday for a loss of more than 15%. To quote Charlie Brown, “Ugh!” My apologies to those who suffered from the loss. I’m very disappointed in this stock, and I’ll give you a complete summary below.

But first, let’s look at the latest goings-on for the economy and what a “one-and-done” strategy means for us.

The Fed May Raise Rates Once and Pause

On Wednesday, Janet Yellen testified before Congress about the state of the economy and about when would be an appropriate time to lift interest rates off the barroom floor, where they’ve been since 2008.

She said that the Fed’s December 15-16 meeting is a “live possibility,” but was quick to temper that with the usual caveat that the Fed will monitor incoming data. Bill Dudley, the top dog at the New York Fed, agreed with Yellen: “It is a live possibility, but let’s see what the data show.”

This outlook comports with the Fed’s most recent policy statement. As I discussed last week, the key factor for a December rate hike will be the labor market. While it’s true that unemployment has fallen, the number of people in the jobs market is frustratingly low, and wage gains have been modest.

The market is starting to adjust. According to futures prices, Wall Street now thinks there’s a 58% chance that rates will rise next month. But what’s interesting is that the traders think rates won’t go up again until next June, and even there, the odds are only 50-50.

When Alan Greenspan raised interest rates in 2004 thru 2006, he did so 17 times over 17 consecutive meetings, each time by 0.25%. This experience has led investors to believe that once a rate hike cycle has begun, it will stay that way; but that’s not the case.

So the Fed may be setting itself up for a one-and-wait more than a one-and-done. The fact is that the jobs market and inflation aren’t quite strong enough to generate a round of rate hikes, but I doubt a single increase would do much harm. On Wednesday, Yellen said that the economy is “pretty strong and growing at a solid pace.”

With somewhat higher rates and an improved economy, this ought to boost the overall stock market. The earnings outlook is expected to improve this quarter, and we should see steady profit growth into 2016. We’re obviously a long way from interest rates posing a threat to equity yields. In particular, the new climate will favor consumer spending and finance. This means companies like Ford Motor (F) and Ross Stores (ROST). By the way, Ford reported another good month for sales. Last month was their best October in 11 years.

The resurging economy will also help many industrial stocks, particularly some bargain names. On our Buy List, that means names like Wabtec (WAB), which has been weak lately. I also like Snap-on (SNA) here, but be careful not to chase it above my $169 Buy Below price.

Another big change for investors is that the U.S. dollar has leveled off after its big run-up. That means we won’t see the big dent that currency translation did to some of our earnings reports like AFLAC (AFL) or Oracle (ORCL). The overall outlook for stocks is still positive, but investors should play it safe. Focus on dividends and stocks with strong balance sheets. As always, check out the names on our Buy List. Now let’s look at this week’s earnings reports.

Cognizant Unexpectedly Meets Expectations

On Wednesday, before the opening bell, Cognizant Technology Solutions (CTSH) reported Q3 earnings of 76 cents per share and revenue of $3.19 billion. If you recall, the IT outsourcer had forecast earnings of “at least” 75 cents per share on revenue of “at least” $3.14 billion. Last week, one keen market observer wrote, “Guess what? They’ll beat both numbers.” Indeed, that guy was correct.

The hitch is that CTSH has a nice track record of creaming Wall Street’s (and their own) expectations. Bear in mind that on Planet Wall Street, you’re expected to beat expectations. If you only meet expectations, well…that’s not expected. But don’t be fooled: Cognizant had a solid quarter. Quarterly revenues rose 23.5%.

“Our balance sheet remains very healthy. Cognizant recorded another quarter of strong cash generation, resulting in an increase of almost $500 million in cash and short-term investments,” said Karen McLoughlin, Chief Financial Officer. “Additionally, during the quarter, we repaid the $100 million balance of our revolving credit facility and repurchased over $156 million of shares under our existing stock-repurchase program. Year-to-date, we have repurchased 5.3 million shares for $334 million, reflecting the confidence in our business, commitment to drive shareholder value and ability to generate strong cash flows.

I like their business strategy. After Obamacare passed, Cognizant made a shrewd move into Healthcare, and that’s paid off for them. Last year, they bought TriZetto for $2.7 billion. Last quarter, Healthcare revenue was up nearly 30%.

Now let’s look at guidance. For Q4, Cognizant sees earnings of at least 77 cents per share. Wall Street had been expecting 77 cents per share. Cognizant also expects full-year earnings of at least $3.03 per share. That’s an increase from the previous guidance of at least $3 per share.

They also raised their revenue guidance to at least $12.41 billion. That would be a 21% increase over last year. Not too shabby. This is the third time this year CTSH has raised its revenue guidance.

The shares pulled back about 2% on Wednesday, but I’m not at all bothered. Cognizant is an excellent stock, and it’s our third-best performer on the year with a YTD gain of 27.6%. I rate Cognizant Technology Solutions a buy any time you see it below $70 per share.

Qualcomm Plunges 15% on Weak Outlook

On Thursday, Qualcomm (QCOM) was the single worst-performing stock in the S&P 500. The shares plunged more than $9 to close at $51.07. At one point, stock dipped below $50. The day’s loss came to 15.25%. Ouch.

This has been a terrible stock for us this year. I don’t hide from my mistakes. Instead, I face them and absorb the lesson. Long-time readers know that I’ve been down on the stock for some time. In fact, in last week’s earnings preview, I wrote “Frankly, I’m not expecting much.” Yep, that’s what we got.

Now let’s look at the ugly details.

Qualcomm reported fiscal-Q4 earnings of 91 cents per share. That actually beat Wall Street’s estimates by five cents per share. The company had said to expect earnings between 75 and 95 cents per share. Quarterly revenue fell 18.5% to $5.46 billion.

For the entire fiscal year, Qualcomm made $4.66 per share. That’s a hefty drop from last year’s total of $5.27 per share. The company seems to have already written off 2015.

“Our fiscal-fourth-quarter revenues and EPS were at the high end of our expectations, with stronger-than-expected MSM chipset shipments offsetting slower-than-expected progress concluding new license agreements in China. We executed a major increase in our capital-return program in fiscal 2015, returning a record $14 billion of capital to stockholders,” said Steve Mollenkopf, CEO of Qualcomm Incorporated. “We are encouraged by customer reaction to our flagship Snapdragon 820, are on track to deliver on our fiscal 2016 cost-reduction targets and expect to exit fiscal 2016 on an improving financial trajectory.”

For Q1, Qualcomm sees earnings of 80 to 90 cents per share on revenue of $5.2 billion to $6.0 billion. That’s way below expectations. The Street had been expecting Q1 earnings of $1.08 per share on revenue of $5.74 billion. For last year’s Q1, Qualcomm earned $1.34 per share and had revenue of $7.1 billion. That gives you an idea of how poor the outlook for them is.


I feel bad for Qualcomm. In the last year, the company has been attacked from all sides—it’s been a perfect storm of bad news. Qualcomm has faced anti-trust battles. They had to write a big check to the Chinese government to make one headache go away. Some of their key customers have started making their own chips. On top of that, an activist shareholder is demanding that the company be broken up.

I had mistakenly believed that Qualcomm’s downside was somewhat limited. After all, in March the company bumped up its dividend by 14% and announced a $15 billion buyback. The market didn’t care. With the lower share price, QCOM now yields close to 3.8%. This week, I’m dropping my Buy Below on Qualcomm to $50 per share.

You may be wondering if a case like Qualcomm would ever cause me to abandon the rules of the Buy List and ditch a stock before the end of the year. It’s certainly tempting, but the answer is no.

For one thing, it’s very difficult to predict what the market will do in the short term. Lots of good stocks suffer painful downturns only to rebound later on. I can’t predict those moves and I don’t pretend that I can.

Last year, Cognizant was in a sour mood. The stock dropped 12.6% in one day and I had people asking me if it was time to dump it. I said I was still a fan, and I’m glad we held on. Since then, CTSH is up more than 50% for us. Just a few weeks ago, eBay dropped sharply, but in the last 11 days, the shares are up 21%. As the great Jesse Livermore said, “It was never my thinking that made the big money for me; it always was sitting.”

The rules of the Buy List are there to show investors that you don’t need to be glued to your portfolio 24 hours a day. Over-trading is the curse of the investor class. Sure, you’ll get a dud every so often, but a diversified portfolio of high-quality stocks will serve you well.

I have to make a correction. In last week’s newsletter, I said that Moog (MOG-A) was due to report earnings last Friday. That was an estimate based on their previous earnings reports. It turns out I was off by one week. The company has since issued a press release saying it will report on Friday, November 6, which is later today. (Dear Moog people, if you’re reading this, please let us know a little earlier!) The report hasn’t come out yet, but you can check the blog for the latest.

Before I go, I want to raise my Buy Below prices on two of our Buy List stocks. I’m bumping eBay’s (EBAY) Buy Below up to $32 per share. I’m also raising Microsoft’s (MSFT) to $56 per share. Both companies had good earnings reports recently, and both have gapped higher for us.

That’s all for now. Not only is Moog’s earnings report due later today, but so is the big October jobs report. It may already be out by the time you’re reading this. If the numbers are good, the odds of a December rate hike will rise. There’s nothing big in the way of econ reports next week, but earnings season is winding down. Soon we’ll get our October-cycle earnings reports (Ross Stores and Hormel Foods). 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 November 6th, 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.