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

“You can get in way more trouble with a good idea than a bad idea,
because you forget that the good idea has limits.” ― Ben Graham

This week will go down as the week when the interest-rate doves finally surrendered. It’s now clear to anyone paying attention that the Federal Reserve is going ahead with a rate increase in December.

In this issue of CWS Market Review, I’ll tell you why it’s happening and what it means for the market and our portfolios. We also have Q3 earnings season starting next week. Next Friday, Wells Fargo, the naughty boy of the banking industry, will be our first Buy List stock to report. I’ll tell you what to expect.

Also in this issue, I’ll cover the recent drop on the part of Cognizant Technology Solutions (preview: don’t fret about it). I’ll also run down some of the other news impacting our Buy List stocks. But first, let’s look at why Wall Street is now convinced the Fed will soon strike.

Oh, It’s On! Expect a December Rate Hike from the Fed

The first week of every month is an exciting time for all econo-stat nerds. This is when we get several economic reports, and the thrills end on Friday when the government releases the all-important jobs report for the previous month.

What I’m calling the jobs report is actually a few different reports, but the key stats are Non-Farm Payrolls (or NFP, as the cool kids say), the Unemployment Rate, the Workforce Participation Rate and Average Hourly Earnings. The September report will be coming out later today.

Goldman Sachs says they expect to see an increase of 190,000 jobs and the unemployment rate drop to 4.8%. That sounds about right. But unless the report is absolutely dire, I strongly doubt it will deter the Fed’s plans for raising rates in December. Earlier this year, the Fed had been looking for any excuse to keep rates unchanged. (Brexit! China!) After the last meeting, it became clear that they’ve now locked in a course of hiking rates.

The Fed is serious. There were three dissents at the last meeting, and those no-votes wanted interest rates to go up immediately. There’s clearly a growing chorus of rate-hikers inside the FOMC, and the news this week has aided their cause.

In the Fed’s eyes, the key to today’s jobs report will be average hourly earnings. That number has been slowly creeping higher (finally). The equation is simple: More income means more buying. That means higher prices and more profits. It’s interesting to see how well oil has been doing lately. Oil just closed above $50 per barrel for the first time since June. Since the February low, the 36 energy stocks in the S&P 500 have added over $310 billion in market value.

Let’s take a step back and look at the news we got this week. On the first business day of each month, we get the ISM Manufacturing report. To be technical, this is called a “diffusion index.” That’s a fancy way of saying that any number above 50 is good, and below 50 is bad.

We got a bit of a surprise this week when the ISM number for September came in at 51.5. That was a very nice rebound from 49.4 for August. Wall Street had been expecting 50.4. This signals that the factory sector is gaining strength. This is important because manufacturing had been hurt for several months thanks to lower energy prices. This report is almost certainly more ammo for the hawks inside the Fed.

More evidence has been mounting. Last week, we learned that consumer confidence rose to a nine-year high. On Wednesday, the ISM services index jumped to 57.1. That’s an 11-month high. Wall Street had been expecting 53.1.

The Doves Are Throwing in the Towel

To me, the clearest sign that the interest-rate doves are throwing in the towel (I think I’m mixing metaphors, but bear with me) is the move in gold. On Tuesday, the yellow metal plunged over 3% for its worst day in nearly three years. I thought it was interesting that on Thursday, gold closed just barely below its 200-day moving average. Gold had been above its 200-DMA for eight straight months. Trust me, commodity traders do not mess around with these technical levels. Higher real rates are bad for gold.

On Thursday, we got more optimistic news on the jobs front when initial jobless claims came in at 249,000. That came very close to breaking a 43-year low. In April, there had been a report of 248,000, but I think we’ll dip below that soon. Since the jobless-claims number tends to bounce around, economists prefer to look at the four-week average. Sure enough, that’s at another 43-year low.

Futures traders currently pin the odds of a November hike at 15.5%. Let me be clear: I strongly doubt the Fed will raise rates a few days before the election. But traders see the odds of a December hike at 63.9%. I think that’s roughly 35% too low, but aside from that, it’s basically accurate.

We should also look at the internals within the market. The U.S. dollar, for example, continues to do well. In fact, the British pound just dropped to a 31-year low. Prime Minister Theresa May said she’s going ahead with plans for Brexit. Some folks thought she might take a soft approach. Apparently not.

You may remember that utility stocks got off to a great start this year. By the middle of the year, the utility sector had gained 21%. Not bad for “boring” stocks. What happened is that investors realized that the Fed wasn’t about to follow up its December 2015 rate hike with another so quickly. That led investors back into higher-yielding stocks. Well, those days are gone, and utes have been feeling the pain. The Utility ETF (XLU) has lagged the S&P 500 for the last eight days in a row.

The mirror image of that trade was the poor performance of banking stocks. Remember that banks do well in a relative sense when short-term rates rise. Banks got clobbered at the start of the year, but lately, they’ve staggered to their feet.

Let me add that I really like Signature Bank (SBNY) below $125 per share. The bank will probably earn about $8 per share this year, and $9 and change next year. Barclay’s recently raised its rating on SBNY. Obviously, the medallion loans are a problem, but it won’t last. Look for a good earnings report from SBNY later this month, along with more medallion losses.

Don’t be too concerned that higher rates will sink the market. Historically, the stock market usually does well as rates start to rise. It’s not that higher rates are good–rather that both the market and the Fed are responding to the same thing, an improving economy. The danger isn’t rising rates—it’s excessive rates, and we’re still a long way from that. The two-year Treasury is at just 0.85%.

What to expect from here? Going forward, I think we’ll see continued strength in cyclical stocks. Generally, that means commodities, energy and heavy-industry stocks. On our Buy List, HEICO (HEI) and Wabtec (WAB) are good examples of cyclicals. This is part of a larger trend of investors warming up to riskier sectors. Tech stocks, for example, did very well during Q3. High-yield bonds have also been popular, as have High-Beta ETFs (SPHB).

The key for investors is to focus on high-quality names, and not to let any market breaks rattle you. This is a good time to be in the market. Now let’s look at some news from the Buy List.

Cognizant Technology Solutions Drops—and Gains Some Back

Last Friday, Cognizant Technology Solutions (CTSH) said that an internal investigation revealed that the company may have violated the U.S. Foreign Corrupt Practices Act. Reading between the lines, I assume that means bribes to facilities in India. Cognizant notified the SEC and DOJ. The same day, the company’s president resigned.

In Friday’s trading, the stock got a super-atomic wedgie from traders. At one point, CTSH was down 17.4% for the day. By the closing bell, the stock had shed 13.3%. I was surprised it had fallen so much. After all, the company caught itself and did the right thing. There’s no evidence that this is a major scandal.

We know all too well that Wall Street likes to sell first and ask questions later. Fortunately, the shares have recovered some lost ground. From last Friday’s low to yesterday’s close, CTSH gained 12.7%. Until we know more, I’m siding with Cognizant. Remember that the last earnings report was quite good. I’m expecting more good news when the Q3 report comes out. For now, I’m lowering my Buy Below Price on Cognizant Technology Solutions to $56 per share.

In last week’s issue, I talked about how Wabtec (WAB) apparently had approval for its merger with Faiveley. This week, the EU made it official. That’s very good to see. Shares of WAB have been trending higher since the summer. This week, I’m lifting my Buy Below on Wabtec to $87 per share.

Bed Bath & Beyond (BBBY) is apparently trying to move beyond the coupon. The home-furnishings stock is well known for its coupons, but that’s been squeezing margins in recent quarters. BBBY has started testing a program where, for $29 a year, shoppers get a 20% discount, plus free shipping. If this sounds a bit like Amazon Prime, that’s not a coincidence. The new program is called Beyond+. I expect to see it rolled out for everyone soon.

Next Friday, Wells Fargo (WFC) is due to report Q3 earnings. Obviously, any announcement will be overshadowed by the terrible cross-selling scandal. I’ll repeat my desire to see John Stumpf step down. As bad as the fine is, it’s barely a speck in WFC’s overall profits. For the last 13 quarters, Wells has reported a profit between 97 cents and $1.05 per share. In all likelihood, they’ll run that to 14 quarters. Wall Street’s consensus is for $1.01 per share. That’s probably on the light side, but not by much. Any report will be bad news for Wells. If they beat earnings, they’re filthy rich. If they miss, they’re incompetent. The good news for investors is that the recent selloff has dropped WFC to a favorable price.

That’s all for now. Earnings season begins next week. Alcoa will be the first to report on Wednesday. Well Fargo reports on Friday. Also on Wednesday, the Fed will release the minutes of its last meeting. This may give us clues as to how many hawks there are inside the FOMC. Then on Friday, we’ll get the retail-sales report for September. 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

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

Russia Becomes a Grain Superpower as Wheat Exports Explode

German Industry Output Rises More Than Expected in August

Europe May Finally End Its Painful Embrace of Austerity

Sterling Recoups Some Losses After 10% Plunge

Britain’s Brexit Confusion Abounds as IMF Huddles in Washington

Fed’s Leaning Dovish Again Ahead Of Elections

US Jobs Report Is Expected to Show Solid Gain For September

Why Twitter Will Be Bought

Snapchat Parent Working on IPO Valuing Firm at $25 Billion or More

After 91 Years, Ford’s Australian Car Production Line Ends

Mars to Buy Out Buffett to Take Full Control of Wrigley

Samsung Shareholders Shrug Off Galaxy Note 7 Smartphone Recall

VW Has No Plans to Sell Brands, Raise Capital: Boersen-Zeitung

Roger Nusbaum: Can You Rationally Process Market Events?

Jeff Miller: Stock Exchange: BBD, TAN, FSLR, APD, and AAP All Deserve Consideration

Be sure to follow me on Twitter.

Morning News: October 6, 2016
Posted by Eddy Elfenbein on October 6th, 2016 at 7:14 am

UK Treasury Chief to Reassure NY Bankers Over London Future

Morocco Puts Itself at Vanguard of Solar Revolution

Venezuela Is Pawning Pieces of Iconic American Brand Citgo to Survive

Gold Loses Shine as Fed Feeling Lift Dollar

What Is A ‘Personal Benefit’ From Insider Trading? Justices Hear Arguments

A Record Number Of The U.S. Billionaires Are Immigrants

Deutsche Bank’s $14 Billion Scare

Twitter’s Fate: Marc Benioff of Salesforce Addresses Acquisition Talk

Uber Slayer: How China’s Didi Beat the Ride-Hailing Superpower

Wal-Mart’s Next Move Against Amazon: More Warehouses, Faster Shipping

Theranos Retreats From Blood Tests

EasyJet Shares Dive as Profits Are Hammered by Brexit and Terrorism Fears

Monsanto, Being Bought by Bayer, Reports Better-Than-Seen Results

Jeff Carter: Barriers to Entry

Howard Lindzon: Congratulations Twitter on the Sale To …and The First Stocktwits ‘Cashtag Award’ Goes To….

Be sure to follow me on Twitter.

7 Ways to Avoid Financial Stress Over the Holidays
Posted by Eddy Elfenbein on October 5th, 2016 at 2:08 pm

In US News and World Report, Simon Constable lists some ways to save cash over the holidays. Here’s a sample:

Leave your credit card at home.

“Spend actual physical cash,” says Eddy Elfenbein, author of the Crossing Wall Street financial blog. “When you are turning over something you can touch, it sends a message to your brain,” he says. “It might sound ridiculous, but it works.” Better still, when the cash is spent, it is spent. It becomes very clear when you have reached your limit. If you allocate $500 for gifts and knick-knacks, call it a day when your stash gets close to zero.

Set a time deadline.

Elfenbein also advocates having a deadline by which point all the shopping should be complete. “Think of gift buying as akin to stock investing, as a business,” he says. “You need a clinical approach.” Setting a time limit is part of that business-like tactic, and helps avoid last-minute impulse purchases. To some people, that method might seem to take the joy out of the season. But when it comes down to it, doing otherwise might cause financial hardship, taking the pleasure out of other parts of your life.

Dividend Growth Was Steady in Q3
Posted by Eddy Elfenbein on October 5th, 2016 at 12:52 pm

Now that Q3 is on the books, we can see that dividends continued to grow. Dividends for the S&P 500 rose by 5.24% last quarter. That was the 26th quarter in a row of dividend growth.

The chart below shows the S&P 500 in blue (left scale) and the trailing four-quarter dividends in red (right scale). I scaled the two lines at a ratio of 50-to-1, which means that whenever the lines cross, the dividend yield is exactly 2%.

Notice how much steadier the red line is compared with the blue. That’s the essence of stock investing — fundamentals are far more rational than prices.

Also notice how closely the market has followed a 2% yield. No, it’s not perfect but over time, it’s done a pretty good job of telling us where stocks ought to be. Considering how simple the dividend yield is as a metric, it’s not too bad.

Here’s a look at the growth rate of dividends. As you can see, dividend growth has decelerated (the rate of growth has slowed).

Morning News: October 5, 2016
Posted by Eddy Elfenbein on October 5th, 2016 at 7:03 am

Threat of ‘Hard Brexit’ Pulls Down Wall Street

Switzerland Asks Malaysia Again for Help With 1MDB

After Report on Yahoo, Tech Firms Deny Scanning Emails for U.S. Government

Prepaid Debit Cards Users Will Get New Federal Protections

Alaska Oil Known Reserves May Have Just Grown 80% on Discovery

Corporate Profits Take Permanent Vacation In Caymans And Bermuda

Twitter Is Expected to Field Bids This Week

AT&T Turns to Media Acquisitions as Its Video Ambitions Grow

Sompo-Endurance: Japan’s Insurance Shopping Spree Restarts With a Bang

Jack Dorsey Is Losing Control of Twitter

Toys “R” Us Sells FAO Schwarz to ThreeSixty Group

McDonald’s Set To Sell Singapore, Malaysian Franchise To Saudi Company

Micron Technology Warns of Tight Memory-Chip Supplies

Howard Lindzon: Stocktoberfest…Flying Stocks but No Flying Cars

Josh Brown: Lincoln and Roosevelt On the Need For a Federal Income Tax

Be sure to follow me on Twitter.

Utes Vs. Financials
Posted by Eddy Elfenbein on October 4th, 2016 at 2:04 pm

Here’s a point I want to stress that’s a bit difficult to explain. In the last year, the financial markets have become increasingly focused on the direction of short-term interest rates.

The chart below shows the relative strength of financial stocks (blue) and the relative strength of utilities (black). Notice that the two lines start to move in opposite directions about a year ago. Prior to that, the lines don’t appear to be terribly correlated.

After about the first of this year, the lines really become mirror images. What this means is that the axis of debate in the market has shifted towards short-term rates. If rates go up, that’s good for financials (in a relative sense). If not, that’s good for utilities and other high-yielding stocks.

It’s interesting that as recently as late 2014, the two lines appear to move the same way. Not so for 2016. On the chart above, notice the correlation difference between 2014 and 2016. It’s a changing market.

Gold Drops 2% as Fed Doves Retreat
Posted by Eddy Elfenbein on October 4th, 2016 at 11:12 am

Gold is down about 2% today. It’s now at a post-Brexit low. I think this is due to a few things. For one, I think the holdouts against the Fed raising rates in December are starting to give in. The Fed has been a lot more careful about telegraphing their intentions. Remember, there were three dissents at the last meeting.

Gold’s had a pretty strong run since late last year. However, it hasn’t been able to breakout to a new high in several weeks. That could be a bad omen. I also think the good ISM from yesterday is also working in the December Hike camp. The futures market now says there’s a 63% chance of a December hike. I think that’s too low.

Prior to Brexit, gold had been losing momentum and the Brexit vote may have given the gold trade more legs this summer. Prime Minister Theresa May has pledged to go ahead with the Brexit negotiations. Today, the pound touched a 31-year low against the U.S. dollar.

Morning News: October 4, 2016
Posted by Eddy Elfenbein on October 4th, 2016 at 7:19 am

Existential Threat to World Order Confronts Elite at IMF Meeting

Oil Prices Fall on Skepticism Over OPEC’s Efficacy

FTSE 100 Rises as Pound Slumps on EU-Exit Date

Indian Central Bank’s New Regime Cuts Rates

The Supreme Court Will Hear Its First Insider-Trading Case in 20 Years

U.S. Tech Giants Are Investing Billions to Keep Data in Europe

Apple Launches Apple Pay Payment Service in Russia

Ericsson to Cut 3,000 Jobs in Sweden as Network Demand Wanes

LVMH to Pay Over $700 Million for a Stake in This High-Tech Luggage Maker

Olive Garden Pushes Darden’s Results Past Expectations

Salesforce Agrees to Buy Marketing-Data Startup Krux

GoEuro Banks Another $70 Million to Keep Building Out Its Travel Planner Platform

Cantor Fitzgerald Gambling Affiliate Settles Investigation

Roger Nusbaum: What the FARC?

Cullen Roche: Do Trump’s Taxes Matter?

Be sure to follow me on Twitter.

Companies Tend to Show Election Anxiety
Posted by Eddy Elfenbein on October 3rd, 2016 at 4:37 pm