CWS Market Review – June 5, 2020

“There is scarcely an instance of a man who has made a fortune by speculation and kept it.” – Andrew Carnegie

This was obviously a tense and distressing week for our country. As usual, I’ll eschew any political commentary, but I will note that despite the drama of recent events, this was a fairly placid week for the stock market—and for our Buy List. On Wednesday, the S&P 500 broke above 3,100 for the first time in three months.

The S&P 500 closed lower on Thursday, but before then, it had rallied for four days in a row, for seven times in eight sessions. The S&P 500 isn’t too far from an all-time high. In fact, the Nasdaq 100 Index already made a new high this week. (This is an indexed skewed toward large-cap tech companies.)

Here’s a look at the S&P 500 over the past few weeks:

Our Buy List is also doing well. Eleven of our 25 stocks are positive for the year. At this rate, there’s a good chance that the Buy List as a whole will be positive for the year very soon. On Thursday, Danaher and FactSet both reached new 52-week highs. RPM International got to a new high on Wednesday. Our Buy List is up over 40% from its low.

In this week’s CWS Market Review, I want to take a closer look at some of the recent economic news. (Warning: It ain’t pretty.) I also want to comment on an emerging trend that’s unfolding just beneath of the surface of the stock market. I’ll also have some updates on our Buy List stocks (Middleby!). But first, let’s look at some terrible, horrible, no good, very bad economic news.

The Worst Jobs Market in Decades

I’m sending this newsletter on Friday morning, a few hours ahead of the May jobs report. That means I don’t have the numbers just yet, but I expect they will be very unpleasant. The report for April indicated that 20.5 million Americans had lost their jobs. The unemployment rate jumped to 14.7%. That’s the highest since the great Depression. The report for May should be similarly poor.

Last week, I mentioned the downward revision to the Q1 GDP report. The day after the GDP report, we typically get the reports on personal income and spending. This time, they were very unusual reports. For April, personal income rose by 10.5% while personal spending decreased by 13.6%. The lockdown has screwed with even boring economic stats. The personal-savings rate soared to 33%. That’s not even close to a typical number for this data series.

This tells you just how unusual the current economic climate is. We’ve never been in a situation where the economy didn’t merely slow down, but froze in place.

On Monday, we got a look at the ISM Manufacturing report. This report usually comes out on the first business day of the month. I like this report because the lag time is fairly low, although we should be aware that the factory segment of the U.S. economy is no longer its driving force.

Monday’s report came in at 43.1. That’s actually not so terrible, though it’s not good. That’s up from 41.5 for April, which was an 11-year low. This almost certainly signals that a U.S. recession began in March or April. The National Bureau of Economic Research is the most respected “recession-dating” organization. NBER hasn’t yet made an official announcement on the timing of a recession, but I think they’ll say something before the end of this year.

By the way, you’ll often hear that a recession is defined as back-to-back quarters of negative economic growth. We’ll most certainly get that when the Q2 GDP number comes out in late July. However, that’s not the correct definition of a recession.

NBER calls a recession “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” The 2001 recession happened without back-to-back quarters of negative growth.

On Monday, we also learned that construction spending fell 2.9% in April. That’s also bad, but not as bad as it could have been. It’s the lowest number since October 2018.

On Wednesday, ADP released its report on private payrolls. It showed that the economy lost 2.76 million private-sector jobs last month. As bad as that is, it was much better than expectations.

This morning’s ADP payroll report showed that the U.S. economy shed 2.76 million jobs last month. As bad as that is, it’s much better than expectations. The ADP report doesn’t always align with the government’s numbers.

Then on Thursday, the jobless-claims report showed that 1.877 million Americans filed for first-time jobless claims. That marks the ninth decline in a row (meaning a decline in the increase in the number of folks out of work). Economists had been expecting 1.775 million new claims. This was the first time since March 14 that the number came in fewer than two million.

The economic stats will continue to be poor as long as the economy remains closed. Fortunately, states and localities are gradually reopening. This has to be done with safety as the foremost priority. Only when businesses get back to something resembling normal will we see the economic numbers improve. Hopefully, that will be evident before the end of the summer.

Has the Cycle Turned?

I like to keep an eye on how well cyclical stocks are doing. These are companies whose fortunes are closely tied to the economic cycle. Cyclicals tend to move in strong up-down waves, hence the name cyclicals.

There’s no official definition or even index (that I know of) for cyclicals. Personally, I think of them as the four key cyclical sectors: Financials, Energy, Materials and Industrials.

Energy and Materials are obvious candidates for this category. In fact, I wouldn’t mind seeing these two sectors merged into one. Call it something like Natural Resources. The Energy sector has fallen so much that I wonder why it’s still a stand-alone sector. These two sectors behave very similarly anyway.

Industrials are an interesting sector in that they have the strongest correlation to the overall market. In other words, they’re the most like everyone else. As a result, the relative strength of the industrials tends to fluctuate the least.

You may be surprised that I classify Financials as cyclicals. I think they are, but they’re not pure cyclicals like the others.

Here’s a look at the relative strength of the ETFs of the four sectors divided by the ETF of the S&P 500. This figure allows us to see how well the cyclicals are doing compared with the rest of the market.

Energy, the black line, is certainly an outlier. However, we can see that all four sectors have lagged the market for a few years. Notice also that they all had prominent bounces a few weeks ago.

Looking at the relative performance of cyclical stocks is important because it tells us what the market is thinking. Also, once a trend gets established, it can last for several years. It’s not that cyclical stocks are in any sense better than defensive stocks. It’s about where we are in the cycle.

Cyclical stocks also benefit from a double-whammy effect. This means that they tend to outperform the market when the market itself does well. Conversely, they lag the market when the market does poorly. That’s certainly been the case this year.

Could this be the start of a long trend? I can’t say just yet, but it wouldn’t surprise me. With cyclicals, the key is spotting when the cycle changes, and it’s been several years since cyclicals have led the charge.

How do you know if your stock is a cyclical? On our Buy List, it would include businesses like Silgan (SLGN), Danaher (DHR), RPM International (RPM), Stepan (SCL) and Eagle Bancorp (EGBN).

Wall Street has shifted its thinking toward a cyclical recovery. If that’s correct, then these stocks should continue to prosper. Now let me update you on some of our Buy List stocks.

Buy List Updates

Silgan Holdings (SLGN) said it completed the acquisition of the dispensing business of the Albéa Group. This business is a leading supplier of pumps and sprays for the beauty and personal care markets. Last year, the business generated sales of $395 million. Silgan is an 8.9% winner for us this year. SLGN remains a buy up to $36 per share.

Three weeks ago, I highlighted Middleby (MIDD) and said I liked it below $60 per share. Well, it’s certainly done well since then. On Thursday, MIDD closed near $81 per share. MIDD is close to doubling its low from late March. This week, I’m lifting our Buy Below on Middleby to $85 per share.

Moody’s (MCO) is another stock that’s been rallying very well for us. Shares of MOC are up close to 70% from its March low. The ratings agency had a blow-out earnings report for Q1. Moody’s earned $2.73 per share, which was 51 cents better than expectations. I’m raising our Buy Below on Moody’s to $290 per share.

That’s all for now. The Federal Reserve meets again next week, on Tuesday and Wednesday. I don’t expect much action from the Fed this time, but it will be interesting to hear what the central bank has to say. This will be one of the meetings where the Fed will update its economic projections. Jerome Powell will hold a post-meeting press conference. Also on Wednesday, the government will release the CPI report for May. The last report showed deflation. 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 June 5th, 2020 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.