CWS Market Review – January 6, 2017

“Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.” – Warren Buffett

The 2017 trading year is underway, and so far, it’s been a decent one for Wall Street. On Wednesday, the S&P 500 came within inches of setting an all-time closing high. Hopefully this will be a pleasant change from last year when Wall Street had one of its worst starts ever.

Earlier this week, the Federal Reserve released the minutes from its last policy meeting, the one at which it decided to raise interest rates. I still believe the Fed is getting way ahead of itself on the need for higher rates. I suspect that as the year goes on, the Fed will gradually pare back its rate-hike plans. I’ll have more on this in a bit.

With the start of the new year, we have Q4 earnings season coming, starting next week. This should be a good one for Wall Street. Apart from the reports themselves, I’ll also be curious to see what companies have to say about 2017. For the first time in a while, the Street appears optimistic. Later on, I’ll cover the recent earnings report from RPM International, one of this year’s new stocks. The earnings missed expectations, but I’m not worried about RPM. I’ll also have some updates on our other Buy List stocks. But first, let’s take a closer look at the economy.

Q4 Earnings Season Looks to Be a Good One

On Wednesday, the Federal Reserve released the minutes from last month’s FOMC meeting. These minutes got a lot of attention because this was the meeting in which the Fed decided to lift interest rates.

Interestingly, the minutes showed that the rate-hike decision wasn’t terribly controversial. Instead, the committee was concerned about the possibility of the economy surging ahead this year with the aid of fiscal stimulus.

When the Fed made the rate-hike decision last month, it also released its forecasts for the next few years. The members expect to hike interest rates three times this year, plus three times next year and three more in the year after that.

Not to put too fine a point on it, but that’s nuts. That’s just my opinion, of course. As always, I like to keep an open mind about these things. As I see it, maybe the Fed will hike one or two times this year. I just don’t see the pressure out there for tighter money.

We’ll learn more later today when the government releases the December jobs report. You’ve probably noticed that the monthly jobs reports have decreased in significance over the past several months. That’s because they’ve mostly confirmed that the trend of the last few years is still firmly in place.

The consensus on Wall Street is for an increase of 175,000 non-farm payrolls, and for the unemployment rate to tick up 0.1% to 4.7%. Both sound about right, but what’s become more important is the wage-growth numbers. These have become some encouraging signs of wage growth. Frankly, though, we need to see more. Higher wages mean higher sales for companies, and further down the road, that means higher prices for shoppers. We’re still quite a way away from that scenario.

Fourth-quarter earnings season is set to begin next week, and it should be a decent one for the overall market. For the third quarter, the S&P 500 finally snapped its seven-quarter streak of declining operating earnings. The index made $28.69 per share (that’s the index-adjusted number), which was a 13% increase over the year before.

For Q4, analysts currently expect operating earnings of $30.48, which would be a 30% increase over the year before. Of course, that big increase is due to a poor environment in late 2015. During most of 2016, analysts gradually hacked down their estimates for Q4. They started off 2016 very optimistically. One year ago, they were expecting Q4 op earnings of $33.35. That’s been cut back by 8.6%.

If analysts are right about Q4, and I suspect they’re very close, that would mean the S&P 500 earned $108.84 per share in 2016. Two years ago, Wall Street had been expecting over $135 per share for 2016. The analysts weren’t even close. Still, 2016’s total is a decent increase over the $100.45 from 2015, but it’s below 2014’s $133.01.

A lot of the earnings recession was due to the pain in the energy sector, and that caused a pullback in capital expenditures. After all, when oil’s crashing below $30, no one’s in a hurry to start new projects, and that has a ripple effect. Now that oil’s back above $53, people feel a little different.

Wall Street expects 2017 operating earnings of $130.92 per share. I expect that to come down some. Setting that aside, it means the S&P 500 is currently going for 17.3 times this year’s estimate. I just don’t see that as being a bubble.

One interesting aspect of the recent earnings recession is that it didn’t hit dividends terribly hard. That was probably a sign, and an accurate one, that the earnings drop would soon pass. Last quarter was the 27th quarter in a row of dividend growth for the S&P 500. For Q4, dividends rose by 5.95%. Interestingly, Q4 had the fastest growth rate of the year.

For all of 2016, dividends rose 5.53%. This was the seventh calendar year in a row of rising dividends. Over the last seven years, dividends have grown at an average rate of 10.72% per year. So if the last seven years have been a bubble for stocks, then they’ve been a bubble for dividends as well. However, that’s an odd definition of a bubble.

Investors sometimes overlook the importance of dividends. Consider these stats: From the market’s closing low on March 9, 2009 until Thursday’s close, the S&P 500 gained 232.03%. But the S&P 500 Total Return Index, which includes dividends, gained 292.19%. The lesson is that reinvesting your dividends is a powerful tool for long-term investors.

Should We Fear the Strong Dollar?

Since Election Day, the U.S. dollar has been on a tear. That really isn’t a surprise given that our Fed is raising rates while other countries are still struggling with rock-bottom ones.

Before the election, one U.S. dollar could fetch 18 to 19 Mexican pesos. Now it gets you 21.4. It got so bad that the Mexican Fed jumped in on Thursday to save the peso. The situation is similar in Europe. There’s a good chance that the dollar could soon reach parity versus the euro for the first time since 2002.

But the really interesting action is happening in China where the government lets the yuan float freely—kinda. It floats within very narrow bands. But outside of China, the two currencies trade freely. Here’s where it gets interesting, because the offshore yuan usually doesn’t stray too far from the official rate. Lately, it has.

Just as in Mexico, the Chinese central bank stepped in to shore up the yuan, which caused the currency to jump against the dollar. The WSJ reported that “the rate that banks charge each other in Hong Kong’s overnight lending market leapt from 17% to 38%.” It’s as if the PBOC kneecapped the shorts.

The official stats aren’t too reliable, but it appears that the Chinese economy is slowing down. Whether it will be an orderly slowdown or a train wreck is an open question. Coupled with this is that money is flowing out of China. The government is trying to halt outflows, but as governments tend to do, they’re trying to stop the effect and not address the cause.

The concern is that China will devalue the yuan. In August 2015, the government shocked the world when it devalued. Of course, President-elect Trump has been very vocal about our trade deals with China.

I want to be careful not to overstate the issues, but the strong dollar could become an issue for investors. A big change in forex markets acts almost like a magnet near a compass—it throws off all the readings. Also, a strong U.S. dollar pretty much affects everything everywhere. The rising greenback could sink emerging markets and punish domestic manufacturing. It could also shelve any plans by the Fed to keep raising rates. Several companies have also warned investors about the impact of a rising dollar. I don’t want to alarm you, but this issue isn’t over, and it could become a major theme in 2017.

RPM International Misses Earnings

After being on our Buy List for three days, RPM International (RPM) decided to give us a disappointing earnings report. Let me assure you that the news wasn’t that bad, nor was it wholly unexpected.

The reason I added RPM is optimism for this year. The just-released earnings report covers September, October and November, when the company was impacted by the lingering effects of the earnings slowdown.

For fiscal Q2, RPM lost 54 cents per share, but after adjusting for impairment costs, RPM made 52 cents per share. That was nine cents below Wall Street’s estimate of 61 cents per share.

For Q2, RPM’s net sales rose by 3.0%. It would have been 5.5%, but currency exchange pinged them a bit. Of that, organic sales would have been up by 3.8%, while acquisition growth would have added 1.7%.

Frank C. Sullivan, RPM’s head honcho, said, “Mid-year restructuring and expense-reduction activities and the benefit of first-half acquisitions, along with having addressed the capacity situation at our DAP subsidiary, will allow revenue growth to be better leveraged to our bottom line during the fiscal 2017 fourth quarter and beyond.”

Frankly, RPM’s business is a bit choppy right now, but that’s not why I added it this year. The company should benefit from a resurgent economy, especially in the industrial sector. The company expects to make $2.62 to $2.72 for the back half of their fiscal year. RPM has already made $1.35 per share in the front half.

Shares of RPM were taken down for a 4.1% loss on Thursday. I’m not at all concerned about the company’s prospects. RPM is a buy up to $58 per share.

Buy List Updates

There wasn’t a whole lot of news on the Buy List this week, but I wanted to pass along a few items.

CR Bard (BCR) was upgraded by Morgan Stanley. They now have a $260 price target for BCR, which is about a 13.4% run from here. I’m not a big fan of price targets, but Morgan said it’s based on 20 times their 2018 earnings estimate of $12.98 per share. Then on Thursday, CR Bard got another upgrade, this time from Raymond James.

On Tuesday, Alliance Data Systems (ADS) said its board has approved an additional $500 million to its share buyback program. The old program expired at the end of last year. I’m not a terribly big fan of share buybacks, but I do love free cash flow. ADS remains a solid company.

That’s all for now. The big jobs report comes out later today. Next week, we’ll get the consumer-credit report on Monday. Wholesale inventories is on Tuesday. Initial jobless claims are on Thursday. We nearly set another multi-decade low this week. Then on Friday is the retail-sales report. It will be interesting to see some hard data on how strong holiday shopping was. 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 January 6th, 2017 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.