The Falling Yen
Posted by Eddy Elfenbein on November 4th, 2014 at 12:11 am

Nothing profound to say here, just stunned by the dramatic fall of the yen versus the dollar.

UK Government to Pay Off Old War Debts
Posted by Eddy Elfenbein on November 3rd, 2014 at 7:14 pm

The Wall Street Journal has an interesting story today. Her Majesty’s government is preparing to pay off some of its debts…some of its reeeeally old debts.

In 1927, Winston Churchill, Chancellor of the Exchequer, consolidated a bunch of outstanding war debt into one big bond. The bond was a callable perpetuity, meaning it never matured but the government could call it in at any time. That’s what they’re doing now. The coupon is 4%.

A bond with infinite maturity is often referred to as a consol bond (or a perpetuity), but the name comes from consolidation, which the government did a few times with a mass of outstanding debt.

The 4% Consols includes debt dating back to the Napoleonic War. Now that interest rates have dropped, it’s in the government’s best interest to get rid of the higher-yielding bonds. The WSJ adds that the War Loan from 1932 may be next to be bought out.

The 1932 War Loan has a complicated history. That year, Neville Chamberlain announced that the government would call its 5% War Loan. Bondholders were given the option of taking cash or continuing to hold the bond, but at 3.5%. This was technically legal, but some say that it was a default by the UK government. There’s about 2 billion pounds left of this bond.

A reader writes in to say:

Sorry, but you have botched this story. Don’t worry, because almost everyone does, including Reinhard and Rogoff.

The correct story is that the 1917 War Loan was issued at 5% as a callable Bond 1929/42. In other words callable any time after 1929 and before 1942. That was specified in the Prospectus, so everyone knew they were buying callable Bond.

In 1931 the Government announced that it was calling the Bond – note, not changing the coupon – by redeeming it at full face value, and holders had a choice of being paid out in cash, or in a new 1932 War Loan at 3.5%. I sort of assume we don’t call redeeming a Bond at full face value a “default”, do we?

The reasons for calling the Bond was simple; by 1932 interest rates had fallen from 1917’s 5% to 3.5%.

When the Bond was called, 8% of the holders chose to be paid out in cash, and 92% exchanged the 1917 loan for the 1932 loan. Why? it’s simple; if they took cash, they would only be able to invest it at 3.5% anyway, so taking the new 1932 Bond was a wash.

As for the ‘some say”, well of course some say. “Some say” because they want to be able to pin a default on an otherwise perfect record. Now ask yourself why the UK would want to pin a default on its own perfect record.

I’m remind of the saying that nothing’s as surprising as the past.

The Strong Dollar Trade Is Back
Posted by Eddy Elfenbein on November 3rd, 2014 at 5:44 pm

A few weeks ago, I wrote a lot about the Strong Dollar Trade. This was a shift in the market characterized by a surge in the U.S. dollar, lower bond yields, lagging small caps and energy stocks and plunging gold.

The Strong Dollar Trade softened up the market for what I’ll call our brief Ebola Panic, which came as quickly as it went. But the S&P 500 hit an all-time on Friday and reached another one today. The index got as high as 2,024.46 during today’s trading, although today’s close was just a hair below Friday’s close.

But we’re still seeing much of the Strong Dollar Trade in action. Small-caps lagged today. Energy stocks are as weak as ever. Gold had a brief rally, but that’s fallen on its face. Gold is now the lowest it’s been in more than four years.

In Japan, the government announced new stimulus measures which weakened the yen even further. Note how AFLAC ($AFL) sat out Friday and Monday’s rally, despite last week’s good earnings report. Two years ago, the yen was going 80 for the dollar. Now it’s down to 140 to the dollar. That’s a stunning fall.

A few quick notes to add: CA Technologies ($CA) has rallied 14.3% since October 13. This stock drives me crazy but that’s a nice rebound. Also, shares of Bed Bath & Beyond ($BBBY) have been slowing crawling their way back. Today, BBBY closed at its highest price in nearly seven months. Lastly, I dropped JPMorgan Chase ($JPM) from this year’s Buy List. At the time, it was a tough call. Given today’s news of a criminal probe, I’m so relieved they’re no longer on the Buy List. The shares are down more than 4% for the year.

October ISM = 59.0
Posted by Eddy Elfenbein on November 3rd, 2014 at 10:15 am

It’s the beginning of November and that means this week is dedicated to the important turn-of-the-month econ reports.

First up is the October ISM report. The Street had been expecting 56.9 and the actual number was 59.0. That’s a good showing. It ties August for the strongest ISM since April 2011.

We never follow just one report, but the ISM has a pretty good track record of lining up with recession. A reading of about 45 is the danger area. So far, it looks like a recession is not on the horizon.

Morning News: November 3, 2014
Posted by Eddy Elfenbein on November 3rd, 2014 at 6:41 am

Cheaper Tomorrow? Bank of Japan Battles Entrenched ‘Deflation Mindset’

China Oct PMIs Point to Cooling Economic Momentum, Growth Target At Risk

Man Running World’s Biggest Wealth Fund Tackles China Riddle

Eurozone Manufacturing Growth Slows, Survey Shows

Europe Shifts on Priorities for Telecoms

Argentina Suspends P&G’s Operations After Accusing It Of Committing Tax Fraud

Gold Bulls Retreat With $1.3 Billion Pulled From Funds

Apple Plans Investor Call Ahead of Potential Bond Sale

HSBC Logs Rising Profits, Takes $378 Million Hit for Forex Scandal

What Did Publicis Buy in $3.7 Billion Deal for Sapient?

Diageo Rules Out New Talks With Beckmanns on Cuervo Brand

Alibaba’s First Earnings to Test Mettle, Investor Enthusiasm

Monster Moves to Restore a Faded Job Search Brand

Howard Lindzon: My Predictions for 2015…Quantitative Socialism

The Epicurean Dealmaker: Quis Custodiet Ipsos Custodes?

Be sure to follow me on Twitter.

The Hidden Ball Trick
Posted by Eddy Elfenbein on November 1st, 2014 at 10:56 pm

S&P 500 = 2,018.05
Posted by Eddy Elfenbein on October 31st, 2014 at 4:21 pm

The S&P 500 closed the week and month at 2,018.05. That’s the highest close ever. The S&P 500 is up 9.18% for the year. The total return index, which includes dividends, is up 10.99% for the year.

Six of our Buy List stocks hit new highs today: CR Bard ($BCR), Fiserv ($FISV), Medtronic ($MDT), Moog ($MOG-A), Ross Stores ($ROST) and Stryker ($SYK).

The Stock Market Soars Above 2,000
Posted by Eddy Elfenbein on October 31st, 2014 at 11:54 am

Today is a very good day for stocks. The big news was that Japan announced massive new stimulus measures.

The S&P 500 has been as high as 2,017.45 this morning which is less than two points away from its all-time intra-day high. The index is on track to close above its all-time high close of 2,011.36 set on September 18.

Thanks to its good earnings report, Moog ($MOG-A) is leading the Buy List today. The shares have been as high as $79.24 which is a gain of 6.2%. I also see that Ross Stores ($ROST) hit $82 per share which is a fresh high for them.

Moog Earns $1.12 per Share
Posted by Eddy Elfenbein on October 31st, 2014 at 9:16 am

Moog ($MOG-A) just reported earnings of 93 cents per share for its fiscal fourth quarter (the September quarter). That includes a 19-cent charge, so the adjusted figure is $1.12 per share which beat estimates of $1.08 per share.

“Fiscal ’14 was a very respectable year for our company, given the challenging market conditions we faced,” said John Scannell, Chairman and CEO. “Earnings were up and cash flow was very strong. Our financial position allowed us to buy back 4 million shares of stock. In a year with little top-line growth, our employees put in a tremendous effort to deliver on our commitments to both our customers and our investors and I thank them for their hard work and dedication. As we look forward, we are projecting a stronger fiscal ’15 with earnings per share of $4.25, up 21% from fiscal ’14 on sales growth of about 1%.”

CWS Market Review – October 31, 2014
Posted by Eddy Elfenbein on October 31st, 2014 at 7:08 am

“Sometimes the hardest thing to do is to do nothing.” – David Tepper

I’m happy to report that my favorite investment strategy, doing absolutely nothing, has been very successful of late. The S&P 500 has rallied on nine of the last 11 trading days. On Thursday, the index closed at 1,994.65, which is a dramatic turnaround from the intra-day low of 1,820.66 which we hit just two weeks ago.

The stock market has regained nearly everything it lost during the mini-panic of early October. On Thursday afternoon, the S&P 500 came within 0.6 points of touching 2,000 for the first time in more than a month. Several of our Buy List stocks, like CR Bard, Stryker and Medtronic, recently broke out to new 52-week highs. The sudden reversal clearly upset a lot of market bears. I’m often surprised by how many people are disappointed that the world didn’t end.

The big economic news this week was that the Federal Reserve announced that Quantitative Easing will finally come to an end. This has been a hugely misunderstood policy. I’ll tell you what this means for the market and our portfolios. We also had some very good Buy List earnings this week. AFLAC not only beat earnings, but it raised its dividend as well. Fiserv beat earnings, raised guidance and broke out to a new 52-week high. Later on, I’ll preview our remaining Buy List earnings reports. But first, let’s look at what Janet Yellen and her friends at the Fed had to say this week.

QE Finally Comes to an End

The Federal Reserve met earlier this week, and as expected, the central bank announced the end of Quantitative Easing. This was hardly a surprise since the Fed has been gradually tapering its asset purchases for nearly a year.

Let’s take a step back and review what QE was all about. Since the economy was in such poor shape, the Fed responded to the financial crisis by lowering interest rates. The problem was that rates were already near 0%, and they couldn’t go any lower, yet the economy needed more help. Several models indicated that interest rates need to be negative by a few percentage points.

The Fed then decided that the best way to simulate negative rates would be by buying bonds. Lots and lots of bonds. The Fed had tried bond-buying twice before but had exited both efforts. Then in September 2012, Ben Bernanke embarked on round three, but this one was different. The Fed said it would buy tons of bonds, and it wouldn’t stop until things got better. No timeline. That was a strong message the market needed to hear. The Fed’s plan was that each month, it would buy $45 billion worth of Treasuries and $40 billion worth of mortgage-backed securities.

The goal of QE was to lower interest rates and thereby help the housing market. Economists are divided on the efficacy of all this bond-buying. Of course, economists are divided on nearly everything. Personally, I’m a pragmatist. I don’t know if QE helped, did nothing or even caused more pain, but I can’t help noticing that the stock market liked QE a lot. Any pro-QE announcement (or rumor) could send shares soaring, while any hint that it would end would cause a rash of sell orders. That’s all the evidence I need.

In addition to helping the stock market, I think QE also gave a boost to riskier assets at the expense of more secure ones. Or at least, those that are perceived as being more secure. Gold, for example, has not done well over the third round of QE. The yellow metal rallied to over $1,920 per ounce three years ago, and it’s been a painful ride ever since. On Thursday, gold closed below $1,200 per ounce.

We’re in an unusual situation for the market and the economy. For the last few years, the market has done well while the economy has experienced a very tepid recovery. Now it looks as if the economy is poised to do better, but the market probably won’t be able to repeat such stellar gains.

On Thursday, the government announced that the economy grew by 3.5% in the third quarter. That’s a good number, but some of the details were pretty mediocre. Personal consumption only grew by 1.8%. Frankly, that’s kinda blah. Here’s what’s happening: At first, the economic recovery was held back by the dead weight of the housing market. Then it was held back by austerity by state and local governments. Fortunately, we’re now past both those hurdles, so I expect to see better economic growth in the months ahead.

In fact, the economic growth rate of the last two quarters was the best for back-to-back quarters in more than a decade. It doesn’t end there. On Tuesday, we learned that Consumer Confidence jumped to a seven-year high. The initial jobless claims reports are still quite good. The only bump this week was a lousy report on Durable Goods.

I’m even going to say something that might be blasphemous on Wall Street, and that’s that the monthly jobs reports aren’t so important anymore. (GASP!) Of course, they’re important in the sense that people are getting more jobs, and we can see that companies are expanding. But don’t expect to see any dramatic inflexion points soon. The jobs-growth trend has been established, and that’s what the Fed wants to see.

The next question for the market and the Fed is, “When will the central bank finally raise interest rates?” That’s a tough one. So far, every forecast (mine included) has been far too premature. Initially, Janet Yellen said that the first rate hike would be about six months after the conclusion of QE. That was a rookie mistake, and she’s disavowed those comments ever since.

The futures market currently sees the first rate hike coming in August 2015. I’m a doubter, but I can’t say I have a strong conviction either way. The problem is that the Strong Dollar Trade, which I’ve discussed in recent issues, has held back inflation and economic growth. That gives the Fed a little more breathing room. As a result, that could put off a rate increase for a few more months. I wouldn’t be surprised if the first rate hike doesn’t come until 2016.

What does this all mean? The overall climate remains the same. As long as rates are low, stocks are the place to be. It’s just that simple. This earnings season has been a good one for the market. The latest numbers show that nearly 72% of the stocks in the S&P 500 have topped earnings expectations, while 53.7% have beaten on sales. I should add that these are reduced expectations compared with a few weeks ago. The earnings growth rate is currently tracking at 6.5%. That’s not great, but it sure beats anything you’d see in the bond market.

Until interest rates become competitive with stocks, stocks are the best place to be. I encourage investors to keep focusing on high-quality stocks like you see on our Buy List. Now let’s turn to our recent earnings reports.

Ford Motor Is Still a Buy

First, though, let me mention Ford Motor ($F) which reported Q3 earnings shortly after I sent you last week’s CWS Market Review. The automaker reported earnings of 24 cents per share which topped estimates by five cents per share.

Despite the earnings beat, Wall Street was not pleased with Ford. The company has been plagued by costly recalls and the impact of the strong greenback. For the first time since 2010, Ford had negative quarterly cash flow. The stock dropped 4.3% last Friday. Ford’s stock already got beat up a month ago when they said they wouldn’t meet their profit goals for this year.

I feel bad for Ford because a lot of this isn’t their fault. The automaker has been squeezed by the strong dollar, higher operating costs and weaker economies overseas. I also think investors are nervous that former CEO Alan Mulally is no longer running things.

Still, the big issue facing Ford is the new F-150 with an aluminum body. This is a ballsy move by Ford; the truck is their biggest moneymaker. To get ready for the new production, Ford had to convert some factories and that costs money. Right now, the success of the F-150 is a giant question mark that’s weighing on the shares. For its part, Ford has made it clear that they’re going ahead with their plans. In fact, they just started with mass production of the truck.

I’m sticking with Ford. The shares currently yield over 3.5%. I admire companies that are trying to change things up.

Strong Earnings from AFLAC, Fiserv and Express Scripts

On Tuesday, AFLAC ($AFL) reported Q3 operating earnings of $1.51 per share. That was eight cents more than estimates. That was even better than the guidance they gave us three months ago, $1.38 to $1.47 per share. Operationally, AFLAC is doing well. The problem has been the weak yen. Fortunately, forex only cost them four cents per share last quarter.

For Q4, AFLAC expects operating earnings to range between $1.28 and $1.37 per share. That assumes the yen stays between 105 and 110 to the dollar. It’s currently at 109.29. That brings the full-year earnings estimate to $6.14 to $6.23 per share. For 2015, AFLAC aims to increase their operating earnings by 2% to 7% on a currency-neutral basis.

But the best news was that AFLAC’s board decided to raise the quarterly dividend from 37 to 39 cents per share (I had been expecting a one-cent increase). This is the 32nd year in a row that AFLAC has increased its dividend. On Thursday, the shares closed over $60 for the first time in more than seven weeks. AFLAC remains a solid buy up to $63 per share.

Fiserv ($FISV) reported Q3 earnings of 86 cents per share, which was two cents better than expectations. The company also raised expectations. Fiserv now expects 2014 earnings per share between $3.34 and $3.38. The old range was $3.31 to $3.37. For 2013, Fiserv earned $2.99 per share. The new guidance implies Q4 earnings between 86 and 90 cents per share. The Street had been expecting 89 cents per share.

The stock came close to breaking $70 on Wednesday. Fiserv has been on our Buy List all nine years. In the last three years, the stock is up 133%. This week, I’m raising my Buy Below on Fiserv to $72 per share.

Express Scripts ($ESRX) posted earnings of $1.29 per share, which matched expectations. The pharmacy-benefits manager also narrowed their full-year range to $4.86 to $4.90 per share. The previous range was $4.84 to $4.92 per share. The new full-year guidance means that the guidance for Q4 is $1.36 to $1.40 per share. The Street had been expecting $1.38 per share. Basically, the company delivered what was expected, and I’m fine with that. Express Scripts is a buy up to $77 per share.

Moog ($MOG-A) is due to report earnings later this morning. I’ll have details on the blog. The consensus on Wall Street is for earnings of $1.08 per share. The stock reached an all-time high on Wednesday.

Earnings Next Week from Qualcomm, Cognizant and DirecTV

Earnings season is almost over, but we have a few more to go. Next Wednesday, November 5, Cognizant Technology Solutions and Qualcomm are due to report.

Cognizant ($CTSH) was our big dud last earnings season. The stock dropped more than 12% after its earnings report. As is often the case, the earnings were quite good: 66 cents per share versus estimates of 62 cents. No, what troubled traders was the guidance. In fact, it wasn’t even the earnings guidance, but rather the sales. Cognizant said they see Q3 earnings of at least 63 cents per share, and sales between $2.55 billion and $2.58 billion. Wall Street had been expecting sales of $2.66 billion. Basically, CTSH lowered their full-year sales growth from 16.5% to 14%. That’s still very strong growth. Cognizant isn’t one to worry about.

Qualcomm ($QCOM) is in an unusual spot. Three months ago, the company crushed earnings. They beat by 22 cents per share. The problem was news out of China. The company is involved in a nasty anti-trust suit with the Chinese government, and they’re simply not going to win. Why is the PRC doing this? Because they can.

The company wisely wants to put this dispute behind them, but it’s going to be costly. As a result, Qualcomm had rather weak guidance for the September quarter (their fiscal Q4). Qualcomm said it expects earnings between $1.20 and $1.35 per share. That’s less than I had been expecting. Time is on Qualcomm’s side, and the shares have perked up recently. Look for an earnings beat here.

DirecTV ($DTV) is due to report on Thursday, November 6. The satellite-TV company has been doing just fine lately. The problem hasn’t been with them but with their merger partner, AT&T ($T). Shares of T recently fell below the lower bound of $34.90. That, in turns, lowers the merger price for DTV. Fortunately, shares of AT&T have rebounded and may soon go back into the safe range, which would once again value DTV at $95 per share. For the time being, these two stocks are joined at the hip.

That’s all for now. The big news next week will be the mid-term elections. Control of the Senate may change hands. On Monday, the ISM report comes out. On Thursday, we’ll get a look at the productivity report for Q3. Then on Friday is the big jobs report for September. This is still the biggest economic report, but as I said before, its importance has greatly diminished. We also have many more earnings reports. 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