Russia Vs. US Defense Companies
Posted by Eddy Elfenbein on March 21st, 2014 at 9:59 am

It’s interesting to see how the Russia ETF ($RSX) has became strongly negatively correlated with defense firms Raytheon ($RTN) and Lockheed Martin ($LMT).

CWS Market Review – March 21, 2014
Posted by Eddy Elfenbein on March 21st, 2014 at 8:56 am

“…something on the order of six months.” – Janet Yellen

With those words, the new Fed Chairwoman sent world markets into a tizzy. How could that be, and what, pray tell, did she mean?

Fear not, gentle reader, for I am well versed in the convoluted sub-dialect of Fed-speak, and I’ll lead you through Wall Street’s latest hissy fit. The bottom line, as I’ll explain later, is not to worry. Traders are freaking out over nothing special.

After six painful years, the economy is slowly returning to something approaching normal. Soon, workers will be able to demand higher wages, and consumer prices will rise. This is good news—it’s what we want to happen. A side effect is that we’re soon going to return more traditional monetary policies, and that will apparently take some getting used to. In this week’s CWS Market Review, I’ll explain what you need to know.

I’ll also walk you through the latest earnings report from Oracle. The bottom line number was a tad disappointing, but that was more than made up for by rather rosy guidance. I expect the enterprise software giant soon to hit $40 per share, which it last touched 14 years ago. I’ll break it down in a bit, but first, let’s look at this week’s Fed meeting and why everyone’s scratching their heads.

The Fed Ditches the Evans Rule

Before I get into this week’s Federal Reserve meeting, let’s back up a bit and explain how we got where we are. When the economy plunged into recession, the Federal Reserve responded by dramatically cutting interest rates in an attempt to cushion the blow and hopefully turn things around. Soon, the Fed got to 0% and couldn’t cut any more. Many of the top economic models said that short-term interest rates should be negative—pay people to borrow money!

The Fed decided the best way to get below 0% was to buy bonds. Lots and lots of bonds. The fancy term for this is Quantitative Easing or QE. They tried this a few times for limited periods, but it wasn’t enough. Finally, they threw up their hands and said, “we’re going to buy bonds until things get better.” Specifically, the plan was to purchase $85 billion each month in Treasuries and mortgage-backed bonds.

The market loved the plan, and stock prices soared. But investors wanted to know: How long would the bond-buying party last? The idea floated by Charles Evans of the Chicago Fed was to lay out a specific unemployment number and say, “we won’t end QE until we hit this number.” The Fed adopted the Evans Rule and said that 6.5% unemployment was their threshold. (The Evans Rule also included 2.5% for inflation, but we’re a long way from that.)

Stock prices continued to climb, and the unemployment rated started to fall. Then some investors got nervous because we were getting close to 6.5% on jobs, but the economy obviously needed more QE. The reason is that so many people had left the workforce, and as a result weren’t counted as part of that 6.5%. In other words, the economy is weaker than that unemployment number suggests. As a result, the belief was that the Fed would soon abandon the Evans Rule (I first mentioned this in January), and that’s exactly what happened this week. The Fed ditched the Evans Rule.

Yellen Confuses the Market

Now that leads us to the next step, and here’s where things get a little complicated. Last June, the Fed signaled that it was planning to pare back on its bond purchases. The market, predictably, freaked out. This was the famous Taper Tantrum. In four months, the three-year Treasury jumped from 0.3% to nearly 1%.

Investors believed, incorrectly, that the entire rally was due to QE, so once that was gone, the market was toast. Not only did they get that wrong, but they completely misjudged the timing of the Fed’s taper decision (to be fair, the miscommunication was mostly the Fed’s fault). Ultimately, it wasn’t until December that the Fed decided to taper its monthly bond-buying by $10 billion. In January, the Fed tapered by another $10 billion, and they did it again this week.

The Fed had said they wouldn’t raise interest rates until they were done with bond-buying. Sure, that makes sense. But now that they’re tapering, here’s the big question: How long will it be between the ending of QE and the first rate increase? In Wednesday’s policy statement, the Fed said “a considerable time,” so when Janet Yellen faced the media at her press conference, someone asked, “Well…what does a considerable time mean?” Her answer was “something on the order of six months.”

The next logical question is, “Six months from when?” Yellen said of QE’s end, “we would be looking at next fall.” That totally confused reporters. Did she mean fall of 2015? Nope, Yellen clarified by saying she meant this fall. Now six months from this fall means…a rate hike next spring? Hold on! That’s earlier than the market was expecting.

As a result, stocks dropped on Wednesday, and the middle part of the yield curve bulged. The three-year Treasury yield rose by 16 basis points, and the five-year jumped by 19 points (the chart above). The two- and three-year Treasuries’ yields reached six-month highs. Utility stocks, which are highly sensitive to interest rates due to their rich yields, took a beating. On the forex market, the yen dropped against the dollar, and that took a 1.5% bite out of AFLAC’s ($AFL) stock during Wednesday’s trading. Gold, which had been doing well, has lost more than 4% this week.

When Will the Fed Raise Rates?

But does Yellen’s timetable make sense? With this latest taper, the Fed will be buying $55 billion in bonds starting with April. Follow me on this. The Fed meets again in April (they meet every six or seven weeks), so presumably another $10 billion taper would bring us down to $45 billion. Then we’d go to $35 billion at the June meeting. For July, we’d be down to $25 billion. Then in September, we’re down to $15 billion.

The next meeting would be on October 28-29. If the Fed wiped out the last $15 billion in one move, that would mean QE wraps up in November, which is indeed in the fall, as Yellen mentioned. But if the Fed tapers by only $10 billion in October, that leaves $5 billion on the table to tapered at the December meeting. That would mean that QE would be done by the end of the year. Counting six months from that, it means we’d see the first rate increase by the middle of 2015. That’s more in line with what the futures market had been expecting.

The market got tripped up by Yellen’s mention of “the fall” and “six months.” So here’s my take: I think this was a rookie mistake by Janet Yellen. I strongly doubt there’s anything close to a majority at the FOMC that thinks interest rates will rise next spring. The economy is getting better, but we still have a way to go, and the CPI numbers are barely moving.

Let’s also bear in mind that we’re only talking about one measly rate increase. On Wednesday, the one-year Treasury yield skyrocketed all the way up to the highest yield in five months—0.15%! For an investment of $1 million, that works out to about $4 per day.

Make no mistake: higher interest rates are like Kryptonite to a bull market. I think the market is paranoid that a hawkish Fed is suddenly going to spring on them. It’s as if they’ve adopted an attitude of “prove to me that you’re going to let me down.” That, combined with a few misstatements from Chairwoman Yellen, explains what happened. Higher rates are truly something to worry about, but for now, they’re still a long way off.

Stocks rebounded impressively on Thursday. In fact, the S&P 500 barely budged between Tuesday’s and Thursday’s close. But we’re in a new world. Investors need to realize that the Fed will tighten at some point. It’s no longer a distant hypothetical. Currently most FOMC members think short-term rates will be at 1% by the end of next year and at 2.25% by the end of 2016. In other words, the Fed Funds rate will still be less than inflation for a good while more.

Let me add one more point. The FOMC’s policy statements have gotten ridiculously long. Dear Lord, they run on and on, with lots of garbage text. Please. Just tell us the basics. A Fed statement should be no more than 300 words. Period.

Oracle Misses Earnings, but Don’t Fret

After the closing bell on Tuesday, Oracle ($ORCL) reported fiscal Q3 earnings of 68 cents per share. This was two cents below Wall Street’s consensus. It was also at the bottom of Oracle’s own guidance. The stock dropped sharply in the after-hours market. But as I said last week, what was more important than the actual earnings report would be Oracle’s guidance for the current quarter.

On the conference call, Oracle said to expect fiscal Q4 earnings to range between 92 and 99 cents per share. The Street had been expecting 96 cents per share, so that left open the possibility of an earnings beat.

On the revenue side, Oracle said it sees Q4 revenues coming in between $11.3 billion and $11.7 billion. Wall Street had expected $11.5 billion. New software sales and subscriptions would range from 0% to 10%. The best news was that hardware sales rose by 8%. That’s Oracle’s first increase since they bought Sun Microsystems four years ago. Total revenue climbed 4% to $9.31 billion, which was $50 million shy of Wall Street’s forecast.

At the start of Wednesday’s trading, shares of ORCL opened down more than $1. Gradually, traders realized that their guidance wasn’t so bad, and Oracle rallied throughout the day. Oracle finally made it into the green and got as high as a 12-cent gain on the day. The rally was later undone by Janet Yellen’s comments, but Oracle moved largely in line with the rest of the market.

Oracle’s business still needs to improve, but I think they’re making the right moves. I expect the shares soon to break $40, which the stock last hit 14 years ago. Oracle remains a good buy up to $41 per share.

Buy List Updates

Our Buy List continues to hold up well. I have a few updates to pass along. Microsoft ($MSFT) closed above $40 per share for the first time since 2000 (notice how a lot of tech stocks are hitting 14-year highs). The software king is planning to release Office for the iPad, and Morgan Stanley had good things to say about their prospects. I’m raising my Buy Below on Microsoft to $43 per share.

The Federal Reserve just completed its latest bank “stress test,” and Wells Fargo ($WFC) passed with flying colors. The Fed wants to make sure that if things go kablooey, the large banks won’t come running back to Uncle Sam for more bailout cash. Since Wells is so well run, there wasn’t any doubt it would do well.

The next part of the Fed’s decision comes next week when they say who’s allowed to increase their dividend. Again, I’m sure Wells will get whatever they ask for. WFC currently pays 30 cents per share each quarter. I’m expecting that to rise to 32 cents per share, give or take. Shares of WFC just broke out to another new 52-week high. I’m raising my Buy Below on Wells Fargo to $54 per share.

Shares of Qualcomm ($QCOM) have been doing well lately. The stock just hit—take a wild guess—a 14-year high. There’s a chance we might get a dividend increase soon. I’m bumping up my Buy Below on QCOM to $82 per share. This is a very good stock.

That’s all for now. Next week is the final full week of the first quarter. We’re going to be getting more economic reports that aren’t tainted by the inclement weather. On Wednesday, the Department of Commerce will release its latest report on durable goods. Then on Thursday, the government will revise the Q4 GDP report. Last month, the original report was revised downward from 3.2% to 2.4%. 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. Do you know the difference between the different types of stock orders? Don’t be embarrassed. Many experienced investors don’t. Check out my handy guide to the different types of stock orders.

Morning News: March 21, 2014
Posted by Eddy Elfenbein on March 21st, 2014 at 6:33 am

Fitch Revises Russia’s Outlook to Negative; Affirms at ‘BBB’

Sanctions Trigger Drop in Russian Shares and Rouble

Fed Hands Lifeline to Dollar Bulls

IRS Phone Scam Sweeping Nation

Missing Bitcoins Found As Mt. Gox Recovers $120 Million From Old Electronic Wallets

29 of 30 Big Banks Pass Fed’s Stress Test

‘Bond King’ Bill Gross Faces A Leadership Test As His Firm Seeks To Regain Investor Confidence

Carl Icahn’s War of Words with eBay Takes a Major Twist

Nike Warns FX Fluctuations to Slam Profit, Expects Weak China Sales

Airbnb Is In Advanced Talks to Raise Funds at a $10 Billion Valuation

Starbucks to Expand Sales of Alcohol Across the US

$80 Million for 6 Weeks for Cable Chief

Symantec Fires CEO Bennett as PC Slump Erodes Antivirus Sales

Jeff Carter: How Would You Vote On This Proxy?

Joshua Brown: Fed’s Community Theater Production of “Stress Test!” Delights Audiences Young and Old

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The Market Recovers Post-Janet
Posted by Eddy Elfenbein on March 20th, 2014 at 3:21 pm

The stock market is recovering nicely from yesterday’s Fed-induced jitters. The S&P 500 has been as high as 1,873 today. We’re now living in a world where tightening is to be expected. Not yet, but it’s on the horizon. Currently, most Fed members think interest rates will be at 1% by the end of next year and at 2.25% by the end of 2016.

We had some economic reports this morning. The initial claims report came in at 320,000. That’s a good number. The Philly Fed’s report on manufacturing was much stronger than expected. Their “diffusion index” of current activity was expected to rise from -6.3 to 3.2. Instead, it rose to 9.0.

On our Buy List, Microsoft ($MSFT) is doing very well today after positive comments from Morgan Stanley on the planned Office software for the iPad. MSFT is at a 14-year high. Wells Fargo ($WFC) and Qualcomm ($QCOM) are also at new highs.

Morning News: March 20, 2014
Posted by Eddy Elfenbein on March 20th, 2014 at 6:55 am

EU Reaches Deal on Banking Union

Merrill’s Irish Bank Rescue Estimate EU47 Billion Off Mark

In Hong Kong, Betting Big on Bitcoin

Morning MoneyBeat: Janet Yellen Goes Off Script

Yellen Assertion of No Rate Change Doubted as Yields Rise

Speed Trader Sees Sisyphean Task in High-Frequency Crackdown

PayPal + eBay Better Together — eBay Inc. Statement March 19, 2014

China Telecom Profit Gains on High-Value Customers

China’s Alibaba Invests $215 Million in Startup Tango

Oracle Reports Gains, But Rivals Grow Faster

Toyota is Fined $1.2 Billion for Concealing Safety Defects

Ex-IMF Chief Strauss-Kahn-led Hedge Fund Aims to Raise $2 Billion

Starbucks CEO: ‘I Am Concerned About Dairy’

Jeff Miller: Using Your NCAA Bracket to Help Your Investing

Roger Nusbaum: What If Grantham Is Right?

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“Six Months” Freaks Out the Market
Posted by Eddy Elfenbein on March 19th, 2014 at 5:08 pm

This was a rather odd day on Wall Street today. At 2 pm, the Fed came out with its policy statement, and it was pretty much as expected. People expected more tapering. Well, that’s what we got. People expected they’d ditch the Evans Rule. We got that, too.

The stock market fell shortly after 2 pm, and the near-term part of the yield curve showed some weakness, particularly the 2s and 5s. The S&P 500 dropped from around 1,873 to around 1,865. So it was not a huge drop; it was probably traders selling on the news.

One newsworthy item was the “blue dots” in the Fed’s guidance. There’s now a solid majority at the FOMC that believes that interest rates will rise next year. In fact, 10 of the 16 FOMC members think rates will be 1% or higher by the end of next year. That seems pretty hawkish, but I’d be careful not to read too much into that. The end of next year is still 21 months away. The stock market soon had second thoughts and the S&P 500 quickly came back to the high 1,860s.

Then Janet Yellen began her press conference, her first as Fed chair, and the market quickly headed south again. Even though she spoke for an hour, she made one small comment that the market latched onto. While the Fed statement said that it would be a considerable time between the end of QE and the first rate increase, she defined that as “around six months.” Well, that kind of freaked people out.

Let’s back up. If the Fed continues on its current tapering path, that would end QE around December of this year. Six months after that places us around June 2015. I think that’s earlier than people were expecting. In fact, this is so odd that I suspect that Yellen misspoke, and the market is making too much out of this. The S&P 500 bounced off 1,850 and rallied up to close at 1,860.77 for a loss of 0.61%.

The utility stocks dropped the most today, which makes sense because investors like to buy utes as an interest rate play. Defensive areas like healthcare and staples were down the least.

Let me also touch on Oracle ($ORCL). The stock was down sharply in yesterday’s after-hours session. I think it was off by more than 5%. Their guidance on the conference call wasn’t so bad. Sure enough, the stock opened at $37.80 and got as low as $37.40, but by early afternoon ORCL rallied as high as $38.96 per share. Yes, Oracle was positive by 12 cents! But due to Janet’s “six months” comment, ORCL closed lower by 29 cents or 0.75% which was basically inline with the overall market.

The Fed’s Updated Guidance
Posted by Eddy Elfenbein on March 19th, 2014 at 2:43 pm

Here’s the Fed’s updated guidance. They make it clear that this is not a matter of policy.

The important part is the blue dots in figure 2. Thirteen of the 16 FOMC members see the Fed raising interest rates next year.

The Fed Tapers Again
Posted by Eddy Elfenbein on March 19th, 2014 at 2:02 pm

The Evans Rule is gone! Here’s the statement.

Information received since the Federal Open Market Committee met in January indicates that growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions. Labor market indicators were mixed but on balance showed further improvement. The unemployment rate, however, remains elevated. Household spending and business fixed investment continued to advance, while the recovery in the housing sector remained slow. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.

The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in April, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $25 billion per month rather than $30 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $30 billion per month rather than $35 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.

The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. (Now here comes the newsy stuff so pay attention – Eddy) In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. The change in the Committee’s guidance does not indicate any change in the Committee’s policy intentions as set forth in its recent statements.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Richard W. Fisher; Sandra Pianalto; Charles I. Plosser; Jerome H. Powell; Jeremy C. Stein; and Daniel K. Tarullo.

Voting against the action was Narayana Kocherlakota, who supported the sixth paragraph, but believed the fifth paragraph weakens the credibility of the Committee’s commitment to return inflation to the 2 percent target from below and fosters policy uncertainty that hinders economic activity.

Morning News: March 19, 2014
Posted by Eddy Elfenbein on March 19th, 2014 at 7:20 am

West Readies Tighter Sanctions After Russia Seals Crimea Claim

Goldman Sachs Rules at the Bank of England

Vietnam Ramps Up Measures to Clean Up Bad Banking Debt

What to Watch From the Fed Meeting

Trading Probe Breaks String of Gains for U.S. Exchange Operators

New Alliances in Battle for Corporate Control

Snowden Has One Very Important And Potentially Devastating Question to Answer

J.P. Morgan Agrees to Sell Commodities Business

Toyota and Justice Department Said to Reach $1.2 Billion Settlement in Criminal Case

The Biggest Threat To The U.S. Auto Industry From GM’s Recalls

BMW Sees ‘Clear Growth’ in 2014 Pretax Profit

Oracle Quarterly Results Disappoint Wall Street; Shares Fall

Luck Vs. Skill: What Bill Gross and Bill Miller Have in Common

Cullen Roche: Will the Bank of England’s Report on Endogenous Money Change Anything?

Howard Lindzon: The Era of Curation and Verticalization…My Interview with Michael Covel

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Oracle’s Q4 Guidance: 92 to 99 Cents Per Share
Posted by Eddy Elfenbein on March 18th, 2014 at 11:14 pm

From Oracle‘s ($ORCL) conference call.

As we said before, we are committed to returning value to our shareholders through earnings growth, stock repurchases and a dividend. This quarter we repurchased 55.4 million shares for a total of $2 billion.

Over the last 12 months we have repurchased nearly 360 million shares for a total of $10.7 billion and reducing our — reduced our share count by 5%. We also paid out more than $1.6 billion in dividends this fiscal year so far.

Stock repurchases and dividends have totaled more than 85% of free cash flow over the last 12 months and the Board of Directors declared a quarterly dividend of $0.12 per share.

Now to the guidance and if currency were to stay where it is today than the impact of currency would be minimal, of course, this could change quickly. New software license and cloud subscription revenue growth is expected to range from zero to 10%. Hardware product revenue growth is expected to range from zero to 10%.

As a result, total revenue growth on both GAAP and non-GAAP basis is expected to range from 3% to 7% in reported dollars. Non-GAAP EPS is expected to be somewhere between $0.92 and $0.99 in constant dollars and in reported dollars. GAAP EPS is expected to be $0.79 to $0.86.

Now I want to remind you the last year we recognized an acquisition-related benefit of $269 million in connection with the Pillar Data Systems earn-out, excluding that benefit GAAP EPS last Q4 would have been $0.74.

This guidance assumes a GAAP tax rate of 21.5% and a non-GAAP tax rate of 23.5%, and of course it may end up being different.

Wall Street had been expecting 96 cents per share.