CWS Market Review – August 12, 2016

“Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.” – Will Rogers

If I were to ask someone who only paid attention to major news headlines and gave zero attention to the stock market where they thought the market currently is, they’d probably think we’re in pretty rough shape. I doubt they’d say were in an all-time record high with low volatility.

But that’s the truth. In fact, on Thursday, all three major indexes closed at all-time highs. The last time that happened was on December 31, 1999. The stock market has shaken off nearly every reason to go down (Brexit, China, Zika, terrorism, politics). It’s almost as though the worse the news is, the better the stocks do.

Fortunately, we got some good news last week, with a strong jobs report. There’s also—finally—some decent news on wages. I’ll have more details for you in a bit. We also had a nice earnings beat from Cognizant Technology Solutions, although the outlook was on the cautious side.

Later on, I’ll preview two Buy List earnings reports for next week, Ross Stores and Hormel Foods. My numbers say Ross Stores should beat expectations. But first, let’s take a closer look at this boring, dull, lethargic stock market. Which, by the way, is at an all-time high.

The Current Market Is Boring, and That’s a Good Thing

I think I’m running out of stats to explain how drowsy this market is. Let me try a couple on you: In the last 27 days, the second-worst day for the S&P 500 was a loss of 0.36%. Oh the humanity! Every day but one has been better than that.

The daily range of the S&P 500, meaning the distance between the high and the low, has been less than 0.65% 19 times in the last 22 days. To put that in perspective, that didn’t happen once during the first 45 trading days of this year. Notice how much smaller the daily “candlesticks” have become in the chart above. The beginning of this year was like a different world.

Remember how poorly the market started out this year? It was one of the worst starts to a year in history. By February 11, the S&P 500 was down more than 10% for the year. But the funny thing is, this rally is still hated. The sentiment indicator from the American Association of Individual Investors shows that the number of bulls came in below average for a record 40th week in a row.

I’ll consolidate a great deal of market wisdom by telling you that the stock market likes to move at two speeds—fast/down and slow/up. Inexperienced investors are obsessed with the first speed. We pay attention to the second.

Interestingly, we had a good example of the fast/down speed after Brexit, but what inexperienced investors never seem to grasp is that by the time it’s clear what’s happening, it’s over. Consider that the S&P 500 is up nearly 10% from its post-Brexit low. Peter Lynch once said, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” That’s very true. Volatility will come back. Sometime. But don’t bother trying to predict when.

The U.S. Economy Created 255,000 Jobs Last Month

Last Friday, the government said that the U.S. economy created 255,000 net new jobs last month. That easily beat Wall Street’s forecast of 180,000. The numbers for May and June were revised higher as well.

When you smooth out all the bumps, we’ve been on a trend of creating about 220,000 to 230,000 jobs per month, and this report confirms that the trend is alive and well. That’s the red line in the chart below, with in the S&P 500 in blue. The unemployment rate stayed at 4.9%.

But what really caught my attention is that average hourly earnings rose by 0.3%. That’s not bad. This is a key number to watch, because the more folks make, the more they spend. Consumer spending is the main driver of the economy. We also want to pay attention to inflation. So far, inflation has been well contained, but that may be due to wage growth being sluggish.

For the first time in a while, I think the market is underestimating the odds of a Fed rate increase. This is a strange position for me to be in, since the markets and the Fed have consistently overestimated the timetable for rate hikes. If a robot endlessly said, “the rate-hike timetable will be pushed back,” it would look a lot more prescient than a lot of well-paid economists. Prices may start to creep higher, and that would get the Fed’s attention.

Right now, the futures market thinks there’s roughly a 50-50 chance of a rate hike coming at the Fed’s December meeting. Goldman Sachs recently said that the odds are 75%. I’m siding with Goldman on this. It’s not a lock-solid bet, but it is likely, especially if this jobs trend keeps up. If you recall, last December, the Fed raised rates for the first time in nearly a decade.

The final earnings numbers for Q2 are almost in. So far, 78% of companies in the S&P 500 have beaten their earnings expectations, while 56% have beaten on sales. Of our 16 Buy List stocks that have quarters ending in June, ten beat Wall Street’s estimate, three missed and another three matched estimates.

Cognizant Technology Solutions Is a Buy up to $63

Last Friday, Cognizant Technology Solutions (CTSH) became our final Buy List stock to report Q2 earnings. For the second three months of the year, the IT outsourcer earned 87 cents per share. That was five cents more than expectations. Quarterly revenue rose 9.2% to $3.37 billion, which matched consensus.

Overall, this was a good quarter for Cognizant. The company, however, was cautious about the rest of the year.

“Our second-quarter performance, as anticipated, represented broad-based revenue growth across service lines, geographies and industries, including healthcare and financial services,” said Francisco D’Souza, Chief Executive Officer. “While our revised guidance reflects the impact of near-term macroeconomic headwinds, our longer-term outlook and underlying business fundamentals remain strong. We continue to see an expanding market opportunity ahead and are well positioned to capitalize on the digital transformations taking place among enterprises around the world.”

“The shift to digital continues to intensify and accelerate,” said Gordon Coburn, President. “Our strong second-quarter revenue growth, adding incremental quarterly revenue of nearly $170 million, is the result of clients turning to Cognizant to help them define strategy and infuse new technologies to address key challenges and implement new business models. Our robust strategy and implementation capabilities have made us a key partner to clients as they fundamentally transform their businesses and navigate the shift to the digital economy.”

Gordon said that the pound’s fall post-Brexit knocked off about $40 million in revenue. He also noted that some major healthcare companies are holding back on spending, since they’re working through deals.

Cognizant sees Q3 coming in between 82 and 85 cents per share, whereas Wall Street had been expecting 86 cents per share. On the plus side, Cognizant reiterated their full-year guidance range of $3.32 to $3.44 per share.

On the revenue side, Cognizant sees Q3 ranging between $3.43 billion and $3.47 billion. Wall Street had been expecting $3.54 billion. The company also changed its full-year guidance range for revenue from $13.65 billion to $14.0 billion to $13.47 billion to $13.60 billion. Wall Street had been expecting $13.75 billion.

The stock had a frenetic day last Friday. Shortly after the open, CTSH dropped to a 3.2% loss for the day. Traders then did an about-face. By the afternoon, CTSH made up everything it had lost and peaked at a gain of 2.9%. Due to the conservative guidance, I’m going to lower our Buy Below on Cognizant to $63 per share. The company also added $1 billion to its stock-repurchase plan.

Earnings Preview for Ross Stores and Hormel Foods

Second-quarter earnings season is now over for our stocks on the March/June/September/December reporting cycle. However, we have three stocks that are one month off cycle; their quarters ended with July, and soon they’ll report earnings.

This Thursday, August 18, Ross Stores (ROST) will report its fiscal Q2 earnings after the market closes. When the last earnings report came out in May, the deep discounter said it expected Q2 earnings to range between 64 and 67 cents per share. Wall Street expects 67 cents per share. Ross also sees same-store sales rising by 1% to 2%. I think their guidance is quite conservative, and I expect to see an earnings beat.

I’ll be curious to see if Ross updates its full-year guidance, which is currently at $2.63 to $2.72 per share. I should add that Ross has been gobbling up tons of its own stocks. Ross pays a dividend, but it’s quite modest—just 13.5 cents per share, which works out to a yield of 0.87%.

Shares of ROST have rallied strongly over the last few weeks, and the stock hit another new all-time high on Thursday.

Hormel Foods (HRL) is also due to report its earnings on Thursday, August 18, but their report will come out before the opening bell. The Spam people said they expect full-year earnings between $1.56 and $1.60 per share. They’ve already made 83 cents per share for the first two quarters of the year.

One point of concern is Hormel’s shrinking margins. That caused the stock to get dinged hard earlier this year. Wall Street’s consensus for Hormel’s fiscal Q3 is for 35 cents per share, which is a 25% increase over last year.

HEICO (HEI), our quietest, smallest and best performer, is scheduled to report its fiscal Q3 earnings on Wednesday, August 24. I’ll have more details on HEI next week.

That’s all for now. There are a few key events to look out for next week. On Tuesday, the July CPI report comes out. Inflation has been rather subdued, but with some modest gains in wages, there soon could be a rise in consumer prices. I don’t think it’s likely, but we need to keep an eye the data. On Wednesday, the Fed will release the minutes from its last meeting. This is when the Fed said, “Near-term risks to the economic outlook have diminished.” I’ll be curious to hear more details. 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 August 12th, 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.