CWS Market Review – December 8, 2017

“People calculate too much and think too little.” – Charlie Munger

Before I get to today’s newsletter, I wanted to let you know that I’ll be announcing the 2018 Buy List in the December 22nd newsletter. That’s in two weeks.

The new Buy List will have 25 stocks. I’ll be adding five new stocks and deleting five old ones. We like to keep our turnover low. The new list won’t take effect until the start of trading in the new year. I like to let investors know what the changes are a few days before they go into effect. I’m very excited for our new Buy List (our 13th!).

Now let’s turn to this week’s newsletter. On Thursday, the S&P 500 finally halted its four-day losing streak. The damage was very minor, and the major indexes are still very close to all-time highs. I have to say that the recent market environment has been nearly picture-perfect; interest rates and inflation are low, corporate profits are growing and consumer confidence is soaring. The S&P 500 has traded above its 200-DMA continuously for 18 months. I’ll warn you—this won’t last!

Lately, some big-name tech stocks have been getting knocked about. At the same time, Wall Street has been favoring cyclical stocks. The Dow Transports, for example, recently broke 10,000 for the first time ever. This could be the start of a major rotation. I’ll tell you what it all means.

We also have a big Fed meeting coming our way next week. Expect another rate hike. I think it’s a mistake, but alas, they didn’t ask me. Later on, I have some Buy List updates for you. Stryker, one of our stalwarts, just raised its dividend as it has every year since 1993. But first, let’s see what this rotation is all about.

Wall Street Turns from Tech to Cyclicals

While the stock market has remained strong, quietly there’s been a changing of the guard. Recently, big tech stocks have been lagging the market. Bear in mind what a good year it’s been for them. The tech sector has made up nearly half the S&P 500’s gains this year. If you lump Amazon in with the techs, then it’s more than half.

Tech first started to lag the market last Tuesday, November 28. It then got much worse for tech on Wednesday, November 29. After that, tech stocks appeared to stabilize, but they lagged again this past Monday. On our Buy List, Microsoft (MSFT) has been a victim of this shift. We can’t say yet if the trend is over.

Overall, the impact hasn’t been earth-shaking, but it’s interesting because it’s been so new. For so long, large-cap tech was such an easy trade. (There was a brief hiccup in June, but that didn’t last long.)

Here’s what’s important: The flip side of lagging tech is a buoyant environment for cyclical stocks. By Cyclicals, I mean stocks whose businesses are heavily tied to the economic cycle. You may own a wonderfully-run homebuilder or chemical maker, but their prospects are always at the mercy of where we are in the cycle. Investors need to understand that.

We can see a good example of this by looking at the Consumer Discretionaries ETF (XLY). This sector was a giant winner at the start of this bull market. Their outperformance lasted for years, but starting about two years ago, the Consumer Discretionaries started to lag. Not badly, but they did fall behind. Lately, however, they’ve been rock stars.

Similarly, the Dow Transports (^DJT) have been popping. This is an old-time index of 20 stocks involved in the business of moving people and things about. For the first time ever, the Transports broke 10,000. I wonder how many investors are aware that CSX Corporation (CSX), a boring old railroad, is up 56% this year. That’s more than all the FAANG stocks.

If we drill down a little, one of the best-performing sectors of the Cyclicals has been the homebuilders. NVR (NVR), for example, is a $3,400 stock that’s more than doubled this year. After a long brutal stretch, things are finally looking up for the housing market. Home prices are rising at their fastest pace in three years. Last week, we learned that new-home sales jumped to a 10-year high. It’s all about the cycle.

We’re also seeing new-found strength in financial stocks. On our Buy List, you can see that in stocks like AFLAC (AFL) and Signature Bank (SBNY). The theme seems to be stocks that do the financing, and stuff that’s bought via financing.

What Does This Rotation Mean for Us?

What does this shift to Cyclicals mean? I suspect that this is the market’s confirmation of some recent good news for the economy. As we’ve noted before, consumer confidence is at a 17-year high. Inflation is still low. Housing is coming back. GDP growth for Q2 and Q3 were pretty good, and it looks like Q4 may even top those two. Simply put, the economy is doing well, and the market’s rotation is reflecting that.

Another reflection of the improving economy is the flattening of the yield curve. The spread between the 2- and 10-year Treasury yields recently fell to just 57 basis points. That’s down from 130 basis points less than a year ago and 260 basis points four years ago.

The yield curve is going to get flatter soon. The Federal Reserve is getting together next week, and it seems certain that they’ll raise interest rates again. The central bank has said it sees three more rate hikes next year, plus another three in 2019. I think three hikes in 2018 has a good chance of happening, but I’m not so sure about 2019. At the upcoming Fed meeting, the Fed will update its projections. I won’t be surprised if they walk back their 2019 forecast.

The reason is the key part of the flattening yield curve—long-term rates aren’t moving that much. In fact, long-term yields are lower than where they were at the start of the year. Frankly, I’m not sure why that is.

Fortunately, we’re not economists and we don’t have to overly concern ourselves with why something is happening. As investors, it’s good enough to know that it’s happening. Shortly after the election, we saw a similar rotation away from tech and towards Cyclicals. However, that move was matched by a sharp drop-off in long-term bonds. We’re not seeing that this time.

This means that bonds are still pretty weak competition against stocks. While stock valuations are elevated (but not extreme), you can still find good deals. On our Buy List, there are several stocks poised to benefit from a continued rotation into Cyclicals. For example, I like Sherwin-Williams (SHW), the paint people. Also, Signature Bank (SBNY) continues to look good. Another Cyclical that looks good now is Wabtec (WAB). Now let’s look at a nice dividend boost from Stryker.

Buy List Updates

We got some good news this week from Stryker (SYK). The orthopedics company said it’s raising its quarterly dividend by 11%. The payout will rise from 42.5 to 47 cents per share.

With all those artificial hips and limbs, Baby Boomers are gradually turning bionic. This is great news for Stryker. The company has raised its dividend every year since 1993.

“Our financial strength is reflected in the 11% increase in our dividend for 2018 as we continue to execute on our capital-allocation strategy,” said Kevin A. Lobo, Chairman and Chief Executive Officer. “With strong organic sales growth and leveraged adjusted-earnings gains, we believe we are well positioned to continue to deliver dividend increases in line with our adjusted earnings growth.”

The new dividend will be payable on January 31 to shareholders of record on December 29. Based on Thursday’s closing price, SYK yields 1.24%.

Shares of Express Scripts (ESRX) have been acting much better recently. Since mid-October, the stock is up nearly 19%. The company is benefiting from an improved environment. Someone could make an offer for ESRX. Thanks to the CVS-and-Aetna deal, there’s a belief that Amazon may jump in, or possibly, Walgreens Boots Alliance. Bernstein recently upgraded the stock and raised its target price from $51 to $65 per share. It also said that Express could greatly benefit from tax reform.

Shares of Cinemark (CNK) got some welcome news this week. First, Cineworld said it’s buying Regal Entertainment for $3.6 billion. Whenever there’s one buyout in an industry, it usually bodes well for other companies. Perhaps someone will make an offer for CNK. The theater chain also announced it’s jumping into the subscription business.

For $8.99 per month, you’ll be able to see one film per month, plus get a 20% discount on concessions, and bring a friend along for $8.99 for a movie. I think this is a good idea. It’s probably not a game-changer, but it fights back against services like Movie Pass.

That’s all for now. The big news next week will be the Federal Reserve meeting. It will be a two-day meeting, on Tuesday and Wednesday. After the meeting, Janet Yellen will be holding a press conference. The Fed will also update its economic projections for the next few years. Then on Thursday, we’ll get the retail-sales report, and on Friday, the industrial-production report 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

Here’s an interview I did this past week on Bloomberg TV. I thought it went well.

Posted by on December 8th, 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.