CWS Market Review – March 4, 2016

“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

Over the last few months, there’s been a global rush to safety that’s dominated world markets. Stocks have dropped, bonds have risen and volatility has increased. But over the last three weeks, that trend has started to unwind, and that trend is increasing every day.

Now stocks are rallying while bonds are retreating, and for the first time this year, the Volatility Index closed below 17. Suddenly, risky assets are popular again. Since February 11, the S&P 500 has gained 9% and our Buy List is up 10.2%. Check out how the stock market has performed (black line) compared with the Long Bond ETF (gold line).

In this week’s CWS Market Review, I’ll tell you what it all means. Plus, I’ll talk about the strong earnings report from Ross Stores. They had a very good holiday quarter. The deep-discounter also gave us a nice 15% dividend increase. (I love dividend hikes!) I’ll also bring you up to speed on some of our other Buy List stocks. But first, let’s look at the market’s newly-found appetite for risk.

Investors Rediscover Risk

The year 2016 got off to a no-good, horrible, very bad start for investors. What happened is that we saw a global flight from any and every asset that smacked of risk. Investors left stocks, particularly risky sectors like High Beta, and sought safety in areas like treasury bonds and dividend stocks.

The dynamic was simple. The risker it was, the worse it did. The safer it was, the better it did. Junk bonds and emerging markets tanked, but gold, the safest investment of all, did the best. The yellow metal shone for the first time in several years.

This mini-panic was fueled by concerns of a slowdown in the U.S. economy. This was compounded by fears of a currency war in Asia and Europe. In China, the economy is weak (we have to guess since no one trusts the government’s numbers), and the authorities are trying to weaken the yuan. Except they don’t want anyone to notice. I’m not trying to sound facetious. I really don’t think the suits in the PBOC understand that their actions reverberate, very quickly, all around the world.

In Europe, Mario Draghi is trying his best to get the Eurozone back on its feet. But in the Old World, bond yields have plunged to absurd levels. In Germany, a two-year bond will fetch you -0.6%. That’s 145 basis points less than a two-year U.S. Treasury bond.

In the U.S., the Federal Reserve has said it expects the U.S. economy will improve, and it’s standing by, ready to raise interest rates. The only problem has been that the economy wasn’t cooperating. Futures traders didn’t buy the Fed’s interest rate plans at all. The market expected the Fed to largely stand apart for the next year, and possibly longer.

But since February 11, the whole game has changed. Stocks are popular and bonds are not. In particular, High-Beta stocks are doing well. Junk bonds and emerging markets are up. So many beaten-down names from last year are recovering the strongest. On our Buy List, stocks like Ford Motor (F) and Bed, Bath & Beyond (BBBY) are up more than 20% over the last few weeks.

More Encouraging News for the Economy

As I mentioned in last week’s issue, the economic data have improved. The economy still needs a lot of work, but the arrows are pointing in the right direction. Just this week, we learned that the ISM Manufacturing Index improved to 49.5. That’s not great, but it’s the best number since September. Jobless claims have now been under 300,000 for 52-straight weeks. We also got good reports on construction spending, and the car sales report was quite good. (I’ll have more on Ford Motor later on.)

I’m particularly pleased to see that inflation expectations have picked up a tad. I don’t want to see a lot of inflation, but it’s very important that we steer clear of deflation. I like to look at the difference between the five-year Treasury and the five-year inflation-protected Treasury. That tells us what the market is expecting for inflation over the next five years. Recently, it dipped below 1% for the first time since 2009. But now, it’s now ticked up to 1.34%. I want it to go higher.

Tied to that is that crude oil has rallied well since February 11. It’s still dancing step-for-step right along side the stock market. As technician Charlie Bilello points out, oil has traded below its 200-day moving average for 400 straight days. That’s by far the longest run on record. But it’s important to note that the increase in prices may not be felt across the board. For example, natural gas prices just hit a 17-year low.

You can be sure this news is getting attention at the Federal Reserve, which meets again on March 15-16. Don’t expect a rate increase. But the market thinks there’s roughly a 50-50 chance the Fed could hike rates again by its September meeting. Just a few weeks ago, that was seen as a distant possibility. The Fed will also update its projections for the coming year. I think we’ll see the central bankers reel back their aggressive plans for interest rates.

On Thursday, the S&P 500 rallied as high as 1,993.69. That’s the highest in two months. Here’s an interesting fact I learned from Ryan Detrick: Every up day since February has closed near the high. That tells me that the bulls have found some courage. Earlier I mentioned that the Volatility Index closed below 17 for the first time this year. On February 11, it peaked at over 30. Measuring over the past three weeks, this has been one of the steepest declines in expected volatility on record.

While the market’s behavior has been quite good since February 11, I’m still not convinced that we’re out of the woods. As always, we need to play it safe. Investors should continue to buy and hold quality names. As we’ve seen, you never know when the market will suddenly turn in your favor.

Right now on our Buy List, I particularly like Microsoft (MSFT). The last few earnings reports have been quite good. At its current price, MSFT yields 2.75%. I also like Wells Fargo (WFC). The stock hasn’t performed well this year, but Wells is a very well-run outfit. WFC is currently yielding just over 3%. That’s not bad. Now let’s look at the latest earnings report from Ross Stores.

Ross Stores Beats Earnings and Raises Dividend

On Tuesday, Ross Stores (ROST) reported fiscal Q4 earnings of 66 cents per share. Let’s take a step back and see this earnings report in context. In August, when Ross released its second-quarter report, they also gave us guidance for Q3 and Q4. I remembering thinking it was odd that they would give guidance for two quarters out. But more pressingly, I was struck by how pessimistic the guidance was.

Ross said they expected Q3 earnings to range between 48 and 50 cents per share, and for Q4, they expected 60 to 63 cents per share. That was well below what Wall Street (and I) had been expecting. Of course, we know that Ross has a habit of low-balling Wall Street, and then “surprising” us with better-than-expected results. It’s a game they know well.

At the time, CEO Barbara Rentler said, “While we hope to do better, we are maintaining a cautious outlook for the second half, when we face more challenging sales and earnings comparisons. In addition, the macro-economic and retail landscapes remain uncertain.” The next day, shares of Ross plunged nearly 10%.

As it turned out, Ross was indeed being cautious. Very cautious. For Q3, the company earned 53 cents per share, and on Tuesday, we learned that they made 66 cents per share for Q4. I was particularly impressed with the details in the Q4 report. Previously, Ross said they expected same-store sales to grow between 0% and 1%. Instead, it was 4%. Overall sales rose by 7.2%, which also beat expectations.

For the whole year, Ross earned $2.51 per share. Net sales rose 8%, and same-store sales rose 4%. But the best news is that Ross raised its quarterly dividend by 15% to 13.5 cents per share. The previous dividend was 11.75 cents per share (it had been 23.5 cents prior to the 2-for-1 stock split).

Once again, Ross is offering conservative guidance. For Q1, they see earnings ranging between 69 and 72 cents per share. Wall Street had been expecting 76 cents per share. For the current fiscal year, Ross sees earnings between $2.59 and $2.71 per share. That’s below Wall Street’s consensus of $2.75 per share. For the quarter and full year, Ross expects same-store sales growth of 1% to 2%. I think we can expect some upside “surprises” this year.

This week, I’m lifting my Buy Below price on Ross Stores to $60 per share.

Buy List Updates

In last week’s CWS Market Review, I told you about the strong earnings report from HEICO Corp. (HEI). The company earned 49 cents per share for fiscal Q4, which was a 20% increase over the year before. All around, it was a solid report. HEICO also raised its full-year guidance. This week, I’m lifting my Buy Below on HEICO to $61 per share. These quiet stocks are fun to watch.

With the strong retail results from Ross Stores, you may have also noticed the rebound in shares of Bed Bath & Beyond (BBBY). On Thursday, the home-furnishings store broke $50 per share for the first time this year. The stock is up over 22% from its February low. BBBY will report earnings again on April 6. Bed Bath remains a good buy up to $53 per share.

Investor’s Business Daily recently featured Fiserv (FISV): “If you’ve withdrawn money from an automated teller or transferred a balance from one account to another, there’s a good chance it went smoothly in part because of Fiserv.” This is been such a solid company for so long, it’s easy to forget how special they are. You can see the whole article here.

Shares of Ford Motor (F) got a big boost this week after the automaker reported very good sales for February. Sales rose 20% from a year ago. Wall Street had been expecting a 12.6% increase. SUV sales were particularly strong. The stock is up more than 21% in the last three weeks. For now, I’m going to hold off raising the Buy Below. Ford Motor remains a solid buy up to $13 per share.

That’s all for now. The February jobs report is due to come out later today. In my mind, what’s more important than the net number of jobs created is an increase in hourly average earnings. I hope this trend continues. Next week will be a fairly quiet week for economic news. Wholesale inventories are reported on Wednesday. The latest Treasury Budget report comes out on Thursday. 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 Eddy Elfenbein on March 4th, 2016 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.