CWS Market Review – March 29, 2019

“The conventional view serves to protect us from the painful job of thinking.”
– John Kenneth Galbraith

After ten years, the yield curve has finally gone flat. Ironically, this was caused by good economic news. A flat curve is a natural response to a growing economy, but the flat curve has some important implications for the economy, the stock market and our portfolios.

In this week’s CWS Market Review, we’ll take a deep dive into all things yield curve. I’ll also discuss the good earnings report from FactSet. The stock gapped up to a new 52-week high. I’ll also preview next week’s earnings report from RPM International, and I have a bunch of new Buy Below prices. But first, let’s look at what the yield curve has to say.

What Does the Flat Yield Curve Mean?

Wall Street has been in a tizzy over the yield curve. As we know, Wall Street loves to stress about something. Or anything. Wall Street’s favorite mode is being “concerned.” If need be, this can be upgraded to “distressed.” Most of the time, I tell you that this week’s “concern of the year” is over-rated and not to worry about it.

This is different. An inverted yield curve truly is a big deal. The hitch is that it’s not immediate. Let me take a step back. By yield curve, I mean the difference between short-term and long-term interest rates. Normally, the yield curve is upward sloping, meaning you get paid more the longer you lend your money. That makes sense, but every so often, the yield curve goes flat, or even gets inverted. That’s when short-term rates rise above long-term rates.

An inverted yield curve is one of the few good predictors of a bad economy. For a field with lots of stats, we still have little idea of how well the economy is doing at the moment. Economists have a terrible track record of predicting recessions, but the yield curve could have won a few Nobel Prizes based on its track record. The spread between the 2- and 10-year Treasuries has been an omen of bad times consistently for the last 35 years.

Check out this tidbit from MarketWatch:

Researchers at the San Francisco Fed say the 3-month/10-year curve is the most reliable indicator, while Cleveland Fed researchers note that inversions of that measure have preceded the past seven recessions with only two false positives — an inversion in late 1966 and a very flat curve in late 1998.

That’s way better than most economists.

To show you how much things have changed, in 2011, the 2/10 Spread reached 291 basis points. It’s now down to 16. The spread between the 10-year and three-month yield is currently negative by four basis points.

While the yield curve is important, I’ll caution you that it’s not an instant tripwire. Let’s look at some recent history. The 2/10 Spread inverted in May 1998. It then went back before becoming very inverted in 2000, but the recession didn’t officially begin until 2001. Even in the last recession, the 2/10 Spread inverted in late 2005. The recession didn’t start for two more years.

It’s a mistake to dismiss the yield curve as a technical indicator like the 200-day moving average. The yield curve has real world ramifications. A few years ago, I ran the numbers and found that the stock market does much better when the spread between the 90-day and 10-year Treasury yield is 121 basis points or more. If you’re a bank, an inverted curve means it’s not profitable to borrow short and lend long. (And yet, starting a bank in 2010 was probably one of the most profitable things you could do.)

In the 12 months following a negative 2/10 Spread, the economy has been in recession about 50% of the time. There is, however, the chance that the yield curve may have lost its predictive powers with the advent of the Fed’s new policies. These things can change. When we had a gold standard, inverted curves were the norm.

I don’t have any plans to alter our investing strategy. Our stocks are stronger than what a yield curve can do. With a flat curve, I would expect to see better valuations among defensive stocks. As I’ll explain later, stocks like Hershey (HSY) and Church & Dwight (CHD) have recently hit new highs. Think of it this way: an inverted yield curve is like rougher seas. If your ship is sturdy, then it doesn’t matter.

FactSet Is a Buy up to $258 per Share

On Tuesday, FactSet (FDS) reported earnings for its fiscal second quarter and the results were pretty good. This is for the quarter that covered December, January and February.

For Q2, FactSet earned $2.42 per share compared with $2.12 per share last year. Wall Street had been expecting $2.33 per share. Quarterly revenue rose 5.9% to $354.9 million, and organic revenue rose 5.7%. Annual Subscription Value, or ASV, rose to $1.44 billion. I was pleased to see that FactSet increased its adjusted operating margin to 33.2% from 31.4% a year ago.

“As we close the first half of the year, we are pleased to have built upon our long track record of continuous and steady growth. Our team capitalized on growing demand for our core solutions with focused execution as we continued to serve as a trusted partner to our clients,” said Phil Snow, FactSet CEO. “Looking ahead to the second half of the year, we will continue to execute against our proven strategy of providing smarter, connected data and technology solutions that make for an open and flexible user experience.”

As of the end of the quarter, FactSet has a client count of 5,405. That’s an increase of 108. The user count increased by 6,854 to 122,063. Annual client retention was greater than 95% of ASV.

FactSet also updated its financial guidance. The company expects revenue to range between $1.41 billion and $1.45 billion. They see adjusted operating margin between 31.5% and 33.5%. Lastly, they see full-year earnings between $9.50 and $9.65 per share. That’s an increase of five cents to the low end. This was a solid report for FDS.

After the report, shares of FDS opened higher, then lost it all, then rallied back very impressively. This week, FDS hit a new 52-week high. I’m lifting my Buy Below on FactSet to $258 per share.

Preview of RPM International’s Earnings

We have one earnings report next week. RPM International (RPM) is due to report its fiscal Q3 earnings on Thursday morning, April 4. This will be our final off-cycle report until Q1 earnings season begins in mid-April.

I’ll be honest – RPM has been a disappointment this year. The last earnings report was pretty ugly. For its fiscal Q2, RPM reported earnings of 52 cents per share. Sales rose 3.6% to $1.36 billion. Wall Street had been expecting 68 cents per share.

The CEO had some excuses: “Like many manufacturers, our bottom line was impacted by a continued rise in costs for raw materials, freight, labor and energy, as well as adverse foreign-exchange translation.” We already knew the company was facing these issues, but I didn’t realize the problem was so acute. For Q3, RPM expects earnings between 10 and 12 cents per share.

I’m not done yet with RPM. There’s still a lot of time to turn things around, but I want to see some evidence soon. All companies hit rough patches, but not all manage through them the same.

Buy List Updates

Continental Building Products (CBPX) rallied after its last earnings report. Since then, it’s given back the entire gain, and then some. I still like Continental and this is a good price. This week, I’m dropping my Buy Below down to $26 per share.

Eagle Bancorp (EGBN) is another good stock that’s been weak lately. In five trading days, EGBN fell 13%. I’m not worried about Eagle. The stock is going for about ten times this year’s earnings. I’m lowering my Buy Below to $55 per share.

Remember when Church & Dwight (CHD) fell sharply after missing earnings by one penny? The stock lost more than 7% in one day. As it turns out, a stock that’s raised its dividend for 23 years in a row is worth sticking with. Since then, CHD made back everything it lost and just hit a 52-week high on Thursday. I’m raising my Buy Below on CHD to $75 per share.

There are a few other Buy Below changes I want to make. Fiserv (FISV) continues to look very good. I’m expecting another good earnings report. This week, I’m lifting our Buy Below on Fiserv to $92 per share. Hershey (HSY) is another stock that just hit a 52-week high. I’m raising our Buy Below on Hershey to $120 per share. JM Smucker (SJM) is doing very well this year. The jam stock is up 24% for us so far in 2019. I’m increasing the Buy Below on SJM to $122.

That’s all for now. The first quarter ends with the close of trading today. This looks to be one of the best quarters for the stock market in years. The second quarter starts up next week. On Monday, we’ll get the ISM and retail sales reports. Tuesday is durable goods. Then on Wednesday, we’ll see the ADP payroll report. That leads up to the March jobs report on Friday. The last report was quite low. I’ll be curious to see if it gets revised higher. 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 March 29th, 2019 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.