CWS Market Review – November 11, 2016
Posted by Eddy Elfenbein on November 11th, 2016 at 7:08 am

“We’re blind to our blindness. We have very little idea of how little we know.
We’re not designed to know how little we know.” – Daniel Kahneman

Wow! That was a shocker. I have to admit that I didn’t think Donald Trump would win the election. Please don’t mistake that for a political opinion. I simply took the pollsters’ word for it.

Big mistake!

But it wasn’t just the pollsters who were wrong. It was the pundits, the media, and Wall Street as well—and the wrong calls kept coming. On Tuesday night, world markets plunged on the news of Donald Trump’s victory.

At one point in the overnight markets, futures for the Dow were down 862 points! In the New York Times, Paul Krugman wrote, “If the question is when markets will recover, a first-pass answer is never.”

A second-pass answer would be, a few hours later, because by morning, the bears were nowhere to be found. On Wednesday, the Dow rallied 257 points, plus another 216 points on Thursday, to close at an all-time high. In the space of 18 hours, we went from President-elect Hillary to President-elect Donald to worldwide crash to new highs.

In this week’s CWS Market Review, I’ll try to make sense of it all. I’ll also cover the good earnings report we got from from Cognizant Technology Solutions. Plus, I’ll preview the upcoming earnings report from Ross Stores. But first, let’s look at these eventful few days.

Trump Stuns the World

One of the benefits of being in the stock market biz is that it forces pragmatism on you. As a result, I have no time for broad theories on how the market ought to behave, or what “fair value” truly is. Contrary to what many people think, investing isn’t about being able to predict the future.

It’s odd that this needs stating, but predicting the future is impossible. Time and time again, experts come along with reams of data and bold predictions about what’s going to be—and they routinely fall flat on their faces. In ancient times, people read entrails; now we have pundits.

I’ll get to the election in a second, but it’s not just pundits. No one at the Fed saw the financial crisis coming. Brexit surprised the markets. The Arab Spring caught most experts off guard. In the 1990s, Long-Term Capital Management used sophisticated models to make tons of money. The firms were stuffed full of PhDs and Nobel Prize winners, yet none of them foresaw Russia’s defaulting on its debt. Since it had never happened, it was never thought possible. Yet it did happen, and within a few weeks, the hedge fund was totally wiped out.

Your humble newsletter guru certainly isn’t immune to big mistakes. I spend tons of time looking at our Buy List stocks, and I missed the troubles facing Wells Fargo this year. You may be familiar with Nassim Taleb, who has written about the impact of improbable events. This week, I suppose, we experienced an Orange Swan.

That’s why I’m conditioned to take unforeseen events in stride. A Trump victory certainly doesn’t have me panicked about the Buy List. Our companies will be just fine. (Please note: I’m not referencing any of his policy views.)

The starting point of my investing philosophy is precisely that I can’t predict the future. Therefore, I go for very, very high-probability events. I don’t know what the Fed will do tomorrow, but I’m pretty sure Hormel is going to sell a lot of Spam next year. I don’t know who will win the Super Bowl, but I’m pretty sure AFLAC will continue to do its thing. A well-run, financially sound business has a very good chance of remaining one.

One of the big mistakes investors make is thinking, what will be big in the future? Green energy! Biotech! Robots! That leads them to pay outrageous prices for this week’s theme of the century. But the future rarely turns out as planned. If in the early 1980s, you correctly foresaw the digital revolution, you probably would have invested in IBM, Wang and DEC. Even if you’re right, you can still be wrong. That’s why investing takes a great deal of humility.

Now let’s turn to the markets because the reaction to the election has been fascinating. High Beta stocks have continued to outpace the overall market. On Wednesday, the S&P 500 High Beta Index gained 3.60%, while the S&P 500 Low-Vol Index lost 0.57% (see the High Beta ETF versus the Low Vol ETF below). That’s an unusually wide gap. The same pattern continued into Thursday. The yield spread between two- and 10-year Treasuries widened to 123 basis points. That’s the widest it’s been in a few months, and it’s a good sign for economic growth. In the last week, the yield on the 10-year has risen 30 basis points. Basically, everyone’s jumping out of the safe stuff and taking on riskier stuff.

This has been a subdued year for our Buy List. It may turn out to be one of the few times we’ve trailed the S&P 500. Yet, in the past two weeks, our Buy List has sprung to life. Since October 27, our Buy List is up 4.16% compared with 1.61% for the S&P 500. That’s a sizable gain for such a short time period, especially for a diversified portfolio.

Here are some interesting stats: On Wednesday and Thursday combined, Biogen (BIIB) gained 10%, Wells Fargo (WFC) was up 13% and Signature Bank (SBNY) rallied more than 14%. Why did it take a post-election rally for our Buy List to start beating the market? I have no idea, but I can say that our portfolio was in place for it to happen. Predicting which stock will do what is futile. Time and chance happeneth to them all.

Cognizant Technology Is a Buy up to $57 per Share

On Monday, our final Buy List stock reported earnings for the third quarter. Cognizant Technology Solutions (CTSH) said they made 86 cents per share last quarter. That was two cents better than Wall Street’s estimates, and it topped the company’s own guidance of 82 to 85 cents per share. For context, the IT outsourcer earned 76 cents per share in last year’s Q3. Cognizant’s quarterly revenue climbed 8.4% to $3.45 billion. Operating margin was 19.3%.

“We see ongoing client demand for our services across industries and geographies,” said Francisco D’Souza, Chief Executive Officer. “As the physical and digital worlds converge, we have made it easier for clients to work with us by aligning our organizational structure and capabilities around the broader focus of assisting clients drive digital transformations. Our new President, Raj Mehta, who has been a key member of our senior leadership team for two decades, and the broader team of executives are leading our strategic initiatives. They have a proven track record of innovation, execution and an unwavering focus on client service and satisfaction.”

Now for guidance. For Q4, Cognizant sees revenues between $3.45 billion and $3.51 billion, and EPS ranging between 85 and 88 cents. That works out to full-year revenue of $13.47 billion to $13.53 billion, and 2016 EPS between $3.38 and $3.41. That’s an increase from their previous guidance range of $3.32 to $3.44 per share.

“Third-quarter revenue was within, and non-GAAP EPS was slightly above, our guided range, indicating that we continue to execute well on our stated strategy,” said Karen McLoughlin, Chief Financial Officer. “Our solid performance was also reflected in another strong quarter of cash flow generation as cash and investments, net of debt, increased by $390 million.”

On September 30, shares of CTSH fell sharply after the company said it may have been involved in some illegal activities. An internal investigation revealed that some senior managers may have taken “potentially improper payments” of about $5 million. That’s much less than I feared.

I think this is a relief. It shows that CTSH is on top of their staff, and it doesn’t appear to be a very large deal in financial terms. Bear in mind that CTSH plunged more than 13% when the news first came out on September 30. Cognizant’s president, Gordon Coburn, resigned that same day without giving any reasons.

Shares of CTSH jumped over $55 after the earnings but pulled back some after the news of Donald Trump’s victory. This week, I’m lifting my Buy Below on Cognizant Technology Solutions to $57 per share.

Ross Stores Earnings Preview

Now that earning season is over, it’s already time for earnings reports from our small group of off-cycle stocks. A lot of retailers prefer to end their fiscal years at the end of January so they can squeeze the entire holiday shopping season in Q4. That means companies such as Ross Stores (ROST) have third quarters that end in October. Ross is due to report its fiscal Q3 earnings on Thursday, November 17.

In August, the deep discounter reported Q2 earnings of 71 cents per share. That was a 13% increase over last year, and it was four cents more than expectations. They also beat their own expectation of 64 to 67 cents per share.

Ross’s quarterly sales rose 7% to $3.181 billion, and same-store sales increased by 4%. Operating margins expanded from 13.9% to 14.4%. Maintaining margins is crucial in retail, especially for price-conscious consumers. During Q2, Ross bought back 3.1 million shares of stock for $176 million. They plan to buy back $700 million worth of their own stock this fiscal year.

Ross’s CEO, Barbara Rentler, gave optimistic guidance for Q3 and Q4.

Looking ahead, Ms. Rentler said, “For the third quarter ending October 29, 2016, we are forecasting a same-store sales gain of 1% to 2% on top of a 3% increase in the prior year, and earnings per share of $.52 to $.55, compared to $.53 in last year’s third quarter. For the fourth quarter ending January 28, 2017, we are also projecting same-store sales to grow 1% to 2% versus a 4% increase last year, with earnings per share expected to be $.73 to $.76, up from $.66 in the 2015 fourth quarter. Based on our first-half results and second-half guidance, fiscal 2016 earnings per share are now planned to increase 7% to 10% to $2.69 to $2.75, on top of a 14% gain last year.”

Last year, Ross Stores earned $2.51 per share, and they’re forecasting to make $2.69 to $2.75 per share this year.

That’s all for now. I can safely predict that there will be no more election news next week. There will be some important economic reports. The retail-sales report is on Tuesday. The consensus is for a 0.6% gain. Industrial production is on Wednesday. IP has gradually started to recover. The CPI report comes out on Thursday. Core inflation is close to an eight-year high, which still isn’t very high. 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

P.S. Modern Trader had a nice feature about me in their November issue. You can access the December issue here. At the top, you can see the archives and select the November issue. The passcode is “crowdsourcing.”

Morning News: November 11, 2016
Posted by Eddy Elfenbein on November 11th, 2016 at 7:04 am

Swinging Singles’ Day: Alibaba Holiday Drives Shoppers in China

Iran Tells OPEC It Boosted Output by Most Since Sanctions Ended

Crowds Line Up at India’s Banks to Exchange Banned Rupee Notes

Trump Win Puts a Bullseye on Elizabeth Warren’s Banking Watchdog

UAW President Says Union Agrees With Donald Trump’s View on Nafta

No Affordable Care Act? Health Insurers Weren’t Expecting That

A Top Trump Adviser Is Rebuking Obama For Giving Asia’s ‘World Bank’ the Cold Shoulder

Trump’s Transition Team Pledges to Dismantle Dodd-Frank Act

The Chicago Metro Area Just Passed a Sugary Beverage Tax

Disney Results Disappoint as Cable Revenue Declines

Macy’s Is Not Backing Down From Its Decision To Dump Trump Merchandise

Department Store Shares Get a Boost From Upbeat Macy’s and Kohl’s

Allianz’s Pimco Posts First Inflows Since 2013

Roger Nusbaum: Are Robo Advisors Really Dying?

Jeff Carter: The Election and Your Startup

Be sure to follow me on Twitter.

Morning News: November 10, 2016
Posted by Eddy Elfenbein on November 10th, 2016 at 6:32 am

Wall Street Rebounds After Donald Trump’s Victory

Markets Rise as Investors Buy Into Trump

Theresa May Promises ‘Golden Era’ in UK-Chinese Relations

Oil Output Surge Piles Pressure on OPEC as IEA Warns on Price

Egypt Issues $4 Billion Private Bond Placement, Mulls Eurobond Delay

For Mexico, a Long List of Dangers Accompany Trump’s Presidency

Trump Promised to Repeal Obamacare. Now What?

Trump Expected to Seek Deep Cuts in Business Regulations

Alibaba’s Singles’ Day Will Break Records Again This Year. Here’s What Donald Trump Can Learn From That

Why Chinese Car Sales Are Surging Faster Than Expected

Siemens Plans to Spin Off Health Unit as CEO Sharpens Focus

Why Starbucks’ Christmas Cups Are Special This Year

Yahoo Knew About the Breach in 2014

Jeff Miller: Post Election: Pause, Reflect, and Act Carefully

Howard Lindzon: The University of Donald Trump … How to Survive

Be sure to follow me on Twitter.

Morning News: November 9, 2016
Posted by Eddy Elfenbein on November 9th, 2016 at 7:03 am

Republican Donald Trump Is Elected President Of United States And Global Markets Plunge

Trump’s Victory Shakes Europe’s Geopolitical Order

What Trump’s Win Means for the Fed

News Media Yet Again Misreads America’s Complex Pulse

Why India Pulled Big Bank Bills From Circulation

China Oct Factory Prices Rise More Than Forecast, Consumer Prices Also Pick Up

Big Oil Looks Past Profit Crunch as Cash Flow Shows Recovery

Alphabet Pushes Out Leaders of Drone-Delivery Project

Carlsberg Upgrades Full Year Outlook Despite Sales Dip

Dish Network Profit Jumps; Subscriber Loss Smaller Than Expected

Warner Bros., Quietly Thriving, Recasts Its Own Story

GoPro Recalls New Karma Drone

Samsung Runs Newspaper Ads on Note 7 Fires: ‘We Are Truly Sorry’

Josh Brown: Off the Lows ™

Cullen Roche: What Does President Trump Mean for the Economy & Market?

Be sure to follow me on Twitter.

Morning News: November 8, 2016
Posted by Eddy Elfenbein on November 8th, 2016 at 6:23 am

Safeguarding As The ‘Fear Index’ Surges

Hillary Clinton and Donald Trump Keep Asia Markets Guessing

Mexico is Feeling Jitters Over the Prospect of a Trump Victory

An Idea to Revolutionize Europe’s Debt Could Be Coming of Age

Voters Take Note: China’s Trade Surplus With U.S. Is Shrinking

Iran to Sign $6 Billion Gas-Field Deal With Total, CNPC

Dubai, Hyperloop One to Study Potential for Abu Dhabi Line

Toyota Raises Operating Profit Forecast, Says Cost Cuts To Curb Yen Impact

US Senate Panel Urges FTC to Launch Antitrust Probe of Mylan

News Corp Swings to a Loss

CBS Taps Moelis, Goldman to Advise on Possible Viacom Merger

Priceline Shares Hit All-Time High After Profit and Revenue Beat Estimates

TV Networks Face a Skeptical Public on Election Night

Josh Brown: How to Become a “2%” Investor

Jeff Carter: The Oligopoly and Crony Employeeism

Be sure to follow me on Twitter.

Updates on Today’s Market
Posted by Eddy Elfenbein on November 7th, 2016 at 10:40 pm

I wanted to add a few comments on today’s market activity. The S&P 500 had its best day since March 1. The stock market had fallen nine days in a row, but those declines were quite modest. Today’s big gain won back more than 70% of what had been lost in nine days.

Gold had its worst day in a few weeks, and the Dow retook 18,000. The Dow also crossed back above its 50-day moving average.

Today was the best pre-election day for the market in 84 years. All 20 Buy List stocks closed higher. We had especially big gains from Biogen (BIIB) and Cognizant Technology (CTSH), the latter due to its impressive earnings report, and the former due to a positive drug study.

A few weeks ago, shares of CTSH fell sharply after the company said it may have been involved in some illegal activities. Until now, we haven’t had any more news. Now we have some details from Reuters:

IT services provider Cognizant Technology Solutions Corp said on Monday some senior managers may have participated in or failed to take action to prevent making about $5 million in “potentially improper payments” primarily related to real estate and procurement in India.

Cognizant, whose shares were up 4 percent at $54.18 in early trading, said the material weakness existed as of Dec. 31, 2015, and continues to exist in subsequent interim periods.

The company also said its ongoing internal investigation had identified a material weakness in its internal control over financial reporting.

If the payments are limited to $5 million, this would probably be well below investors’ worst case, Cowen and Co analysts said in a research note.

Cognizant said in September it was conducting an internal investigation into possible violations of U.S. anti-corrupt practices laws related to payments in India.

The company also said that the people possibly involved with the payments are no longer with the company or in a senior management position.

The company said in September that President Gordon Coburn had resigned, giving no reason for his departure, and that he would be replaced by Rajeev Mehta, the head of IT services.

Cognizant said in a regulatory filing on Monday that it had not maintained an “effective tone at the top”.

“We will continue the investigation until we are confident that we have tracked it all down,” Chief Financial Officer Karen McLoughlin said on a conference call, adding that it was “early days” in the investigation.

I think this is very good news. It shows that CTSH is on top of it, and it doesn’t appear to be a very large deal in financial terms. Bear in mind that CTSH plunged more than 13% when the news first came out on September 30.

The Power of One Stock
Posted by Eddy Elfenbein on November 7th, 2016 at 2:11 pm

Here’s a good lesson on what one stock can do to your portfolio.

In 1939, IBM was taken out of the Dow Jones Industrial Average. It was put back 40 years later, in 1979. Over those four decades, IBM was an outstanding stock. It gained over 220 fold!

So what if IBM had stayed in the Dow? Bryan Taylor at Global Financial Data ran the numbers. First we assume that IBM replaced AT&T. Technically, two stocks left in 1939 (IBM and Nash Motors) and two came in (AT&T and United Aircraft).

The DJIA stood at 151.1 on March 14, 1939 and 841.98 on June 29, 1979. Since the DJIA is price weighted, you can remove the impact of AT&T on the DJIA by subtracting out the price of AT&T allowing for the splits, and replacing this amount with the value of IBM stock, allowing for the splits in IBM. If you do this, you would find that the DJIA would have been at 23,582 in June 1979, not 841.98. In other words, IBM would have added 22,740 points to the DJIA had it never been removed.

(Update: Now that I’ve looked this over, I’m not sure the math is correct. I think IBM’s price needs to be adjusted for the Dow’s divisor. I’m not positive, but it’s a strong suspicion. Still, the larger point stands that one huge long-term winner can do wonders for a portfolio.)

(Update to the previous update: Dividend Investor passes along two articles (here and here) which suggest I’m correct.)

WSJ: “Why the Math Behind Passive Investing May Be Wrong”
Posted by Eddy Elfenbein on November 7th, 2016 at 12:19 pm

Wesley R. Gray has an interesting piece at today’s WSJ: “Why the Math Behind Passive Investing May Be Wrong.” It’s zeroes in on the research of William Sharpe who was an early advocate of passive investing. Here’s a sample:

A recent essay by Druce Vertes at the CFA Institute, and more formal research by NYU Professor Lasse Pedersen, suggests that Mr. Sharpe’s conclusions might be incorrect. Dr. Pedersen offers a very powerful critique in a new white paper entitled, “Sharpening the Arithmetic of Active Management.” Dr. Pedersen argues Mr. Sharpe’s arithmetic relies on the faulty assumptions that the market never changes and passive investors never need to trade.

Objectively, these assumptions are false: The market is not static, as new firms are created through IPOs, new shares are issued or repurchased, and indexes are reconstituted all the time. Additionally, passive investors must sometimes rebalance their portfolios, for instance to raise cash or reinvest dividends. In short, passive managers must, and do, trade with active investors.

As evidence for the need of passive investors to trade, Dr. Pedersen cites the case of a theoretical passive investor in 1927, who never trades. After 10 years, this investor owns only 60% of the market. And this ongoing market turnover is persistent: The average turnover for all equities from 1926 through 2015 was a whopping 7.6% per year. Last year, the Vanguard 500 Index Fund reported turnover of 10%. Clearly, the assumption that passive investors never need to buy and sell is false. And this mechanical need to trade opens passive investors up to exploitation by active investors.

Cognizant Earns 86 Cents per Share
Posted by Eddy Elfenbein on November 7th, 2016 at 7:10 am

This morning, Cognizant Technology Solutions (CTSH) reported third-quarter earnings of 86 cents per share. That was two cents better than estimates. They earned 76 cents per share in last year’s Q3. Cognizant’s quarterly revenue climbed 8.4% to $3.45 billion. Operating margin was 19.3%.

“We see ongoing client demand for our services across industries and geographies,” said Francisco D’Souza, Chief Executive Officer. “As the physical and digital worlds converge, we have made it easier for clients to work with us by aligning our organizational structure and capabilities around the broader focus of assisting clients drive digital transformations. Our new President, Raj Mehta, who has been a key member of our senior leadership team for two decades, and the broader team of executives are leading our strategic initiatives. They have a proven track record of innovation, execution and an unwavering focus on client service and satisfaction.”

For Q4, Cognizant sees revenues between $3.45 billion and $3.51 billion, and EPS between 85 and 88 cents per share. That works out to full-year revenue of $13.47 billion to $13.53 billion, and 2016 EPS between $3.38 and $3.41.

“Third quarter revenue was within, and non-GAAP EPS was slightly above, our guided range, indicating that we continue to execute well on our stated strategy,” said Karen McLoughlin, Chief Financial Officer. “Our solid performance was also reflected in another strong quarter of cash flow generation as cash and investments, net of debt increased by $390 million.”

Q3 2016 Earnings Calendar
Posted by Eddy Elfenbein on November 7th, 2016 at 7:03 am

Sixteen of our 20 Buy List stocks have been reporting Q3 earnings over these past few weeks. Here’s a list of reporting dates, Wall Street’s consensus estimates and actual reported results: