• CWS Market Review – October 12, 2012
    Posted by on October 12th, 2012 at 8:05 am

    “Go for a business that any idiot can run – because sooner or later, any idiot probably is going to run it.” – Peter Lynch

    Earnings season is finally here. This is when we find out who on Wall Street has been naughty and who’s been nice. This earnings season could be the first one in eleven quarters that corporate profits come in below where they were the year before. The analyst community currently expects a 1.7% drop in earnings. That’s not much, and I should add that that’s well within the margin of error, so we may end up seeing a small earnings increase. Unlike last quarter, analysts have largely stopped slashing their earnings forecasts, so that may be a positive sign.

    We continue to get evidence that the economy may have turned around. I’m not saying things are good, but the sluggish GDP numbers we’ve seen in 2012 may not last into next year. The biggest news came last week when the Labor Department reported a big drop in the unemployment rate. The jobless rate fell from 8.1% in August to 7.8% for September. We had more good news on Thursday with the lowest jobless claims report in four-and-a-half years.

    Until the election passes, I continue to urge caution with the stock market. Investors must think defensively. Focus on high-quality names, solid dividends and companies with decent guidance. In this week’s CWS Market Review, I’ll highlight some names I like on our Buy List. I’ll also discuss some of the upcoming earnings reports. But first, let’s look at what’s happening with the broader market.

    The S&P 500 Just Put in a Double Top

    After hitting a multi-year high on September 14, the S&P 500 pulled back, then put on another rally that petered out last week just shy of the highs from mid-September. Market technicians call that a “double top,” and it’s usually a bad sign. A triple top may follow. I’m careful not to place too much emphasis on these chart patterns, but I think it’s telling us that the bulls didn’t have enough confidence to keep the rally going. In fact, they were much more confident when the news was much worse.

    Another reason I think the economy may be doing better than a lot of folks suspect is that the cyclicals continue to lead the market. Since cyclical stocks tend to be choppy, their outperformance has been rather haphazard. Still, economically sensitive stocks have led the rest of the market since August 2. During that time, there were two counter moves, one in late August and another in late September, when investors rushed towards safer names.

    The larger trend is that investors are now willing to take on more risk than they had been. It’s hard to reason with a market where a 10-year Treasury goes for 1.7% (and that’s actually 31 basis points above its summer low) while a stock like Johnson & Johnson ($JNJ) yields a hefty 3.59%.

    We have two earnings reports due next week, plus JPMorgan Chase’s ($JPM) is due out later today. (I incorrectly said in last week’s newsletter that JPM was scheduled to report on Thursday.) I’m writing this on Friday morning, so you may already know JPM’s earnings. I’ve been expecting a major earnings beat. Also, Wall Street carefully watches their earnings report because the company is the first of the major banks to report.

    The stock had done well lately and on Thursday, JPM reached its highest close in five months. I currently rate JPM a buy up to $43 per share, and it’s very close to that. But I don’t want to make any changes to my Buy-Below price until I’ve had a chance to digest the earnings report. JPM is a very profitable bank. Yes, Jamie Dimon is a loudmouth, but that fact shouldn’t affect the stock as much as it does. (By the way, Bethany McLean at Reuters dissects the case against JPMorgan and finds many problems with the government’s case.) Stick by JPM.

    Stay Tuned for Earnings from Stryker and J&J

    On Monday, Johnson & Johnson ($JNJ), the mega healthcare conglomerate, is due to report their third-quarter earnings. This company is in the beginning stages of what could be an impressive turnaround. The new CEO, Alex Gorsky, has only been on the job for only a few months, but investors have been impressed so far. Before Gorsky, it seemed like JNJ made two things—lots of money and lots of bad press.

    For Q3, Wall Street expects $1.21 per share. In July, JNJ lowered their full-year guidance to a range of $5 to $5.07 per share. I think that’s a very reasonable target. One of the problems with JNJ is that it’s been squeezed this year by the strong dollar. However, the currency market took back a lot of the dollar’s gain this year. That could be good for JNJ’s bottom line.

    My take: Blue chips don’t get much bluer than JNJ. I really like the dividend which gives JNJ a rich yield of 3.59%. Johnson & Johnson is a high-quality buy up to $70 per share.

    Stryker ($SYK), the medical devices stock, will report earnings on Tuesday, October 16th. I like this company a lot. Three months ago, Stryker missed the Street’s consensus by a penny per share, but that was largely due to weakness in Europe. For Q3, Wall Street expects 98 cents per share, which again could be slightly too high, but I’m not very worried about a stock like Stryker missing by a hair.

    The important news is that in July, Stryker reiterated its forecast for double-digit earnings growth for this year. Not many companies are doing that in this environment, and that guidance translates to full-year earnings of $4.09 per share. Stryker should be able to hit that. The stock has been fairly disappointing this year; it’s been locked in a trading range between $52 and $56. Prudent investors should take notice whenever a sluggish stock has superior earnings. Stryker is a top-notch company. Buy up to $57.

    Top Values on Our Buy List

    Each week, I like to highlight a few stocks on the Buy List that are exceptionally good values right now. I continue to think Moog ($MOG-A) is a very inexpensive stock. Don’t overlook boring stocks. Moog is a solid buy any time you see the shares below $45.

    I’ve noticed that CA Technologies ($CA) has slid down in recent weeks. Going by Thursday’s closing price, the stock yields 4%. That’s a good deal. CA Technologies is a good buy up to $30 per share.

    Another stock that’s been drifting lower has been Oracle ($ORCL). The last earnings report didn’t impress Wall Street much. I think this is a good opportunity to pick up shares of Oracle below $31, which is just over 10 times next year’s earnings estimate. (Here’s a good interview with CEO Mark Hurd.) Oracle is a very good buy up to $35.

    Hudson City ($HCBK) continues to march higher. On Thursday, the stock got as high as $8.24, which is a new 52-week high. The stock is up over 30% on the year for us. I’m raising my Buy-Below price to $9.

    Before I go, many of you have asked me about a stock not on our Buy List, Apple ($AAPL). The stock has pulled back over the last three weeks. I can’t predict if all the selling is done, but on a pure valuation basis, Apple is very reasonably priced. The stock is going for less than 12 times next year’s earnings. On top of that, Apple’s cash-and-investments position currently stands at $117 billion. That’s a staggering figure. In my opinion, the stock is easily worth $800 per share.

    That’s all for now. Next week will be dominated by more earnings news. Several major companies are due to report. 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 12, 2012
    Posted by on October 12th, 2012 at 2:04 am

    IMF, World Bank Meetings In Tokyo

    Spain Says Downgrade Won’t Affect Plans

    Yuan Gains Steam in Global Trade

    Indian Industrial Output Up 2.7% In August; Too Early To Celebrate, Say Analysts

    U.S. Trade Gap Widens As Exports Fall Again

    USDA Sees Tightening Corn, Soy Supplies

    Biden, Ryan Clash as Both Pledge Unemployment Below 6%

    U.S. Struggles to Rescue Green Program Hit by Fraud

    Moment Of Truth Approaching For U.S. Manufacturers

    Sprint Nextel In Talks For Possible Takeover By Japan’s Softbank

    Infosys Profit Disappoints, Shares Fall

    Icahn Seeks Oshkosh Takeover

    Can AMD Mount a Turnaround in the Server Space?

    In Fight for a Mexican Company, a Peek Into a Tycoon’s World

    Joshua Brown: In The Thick of It

    Roger Nusbaum: 10/11/12

    Be sure to follow me on Twitter.

  • When Will the Fed Raise Rates?
    Posted by on October 11th, 2012 at 11:37 am

    According to the latest pronouncements from the Fed, the central bank doesn’t have plans to raise short-term interest rates for a few more years. But going by some economic models, a rate increase may not be that far away.

    In January, I posted an interest rate model developed by Greg Mankiw. According to his model, this is where the Fed funds rate ought to be:

    Federal funds rate = 8.5 + 1.4 (Core inflation – Unemployment)

    For the last few years, the model has indicated negative rates and since the Fed can’t lower rates below 0%; that’s why we’ve had the QE policies.

    Here’s how the Mankiw model looks compared with the Fed funds rate.

    What’s more is that the surprising fall in the jobless rate we saw last week brings us even closer to a rate increase. We don’t yet have the September figure for core inflation but there’s a very good chance that it will finally signal positive interest rates for the Mankiw model.

    The math works like this: With an unemployment rate of 7.8%, which we had in September, a year-over-year core rate of inflation of 1.8% would cause the model to signal interest rates of exactly 0%. Any core inflation rate greater than 1.8% would cause the model to show positive interest rates. The year-over-year core rate ending in August was 1.92%. The next consumer inflation report comes out on Tuesday.

    Of course, this is just one model and it doesn’t mean that the Fed will follow it. I would think some members of the FOMC are troubled by the weak labor market participation rates, which is a fancy way of saying that lots of folks have stopped looking for a job. But still, the Mankiw model has fairly accurately shown what the Fed has done over the past several years.

    In 2010, Paul Krugman crunched the numbers and came up with different coefficients for the model:

    Federal funds rate = 9.0 + 1.8 (Core inflation – Unemployment)

    Krugman’s model has interest rates lower than Mankiw’s. Still, the drop in the unemployment rate will push Krugman’s model to -1.6% (assuming 1.9% y-o-y core rate for September). That’s low but the Krugman model was signaling -9% two years ago.

    I think it’s far too early to say that the Federal Reserve has “won” or that a rate increase will be coming soon. But it may be the case that a rate increase could happen before the Fed’s current timeline of 2015.

  • Morning News: October 11, 2012
    Posted by on October 11th, 2012 at 6:04 am

    S&P Downgrade May Nudge Spain Bailout Along

    IMF Lagarde Seeks More Time for Greece Austerity

    Under Chinese, a Greek Port Thrives

    EADS-BAE Failure Shows Road to United EU Ends in Berlin

    Should a Government Official Blacklist a Foreign Company?

    Drop in Openings Signals Limited U.S. Job Growth: Economy

    Fed Says Economy Grows ‘Modestly’ on Housing, Autos

    U.S. Sets Anti-Dumping Duties on China Solar Imports

    Toyota Recall Of 7.5 Million Autos May Slow Its Rebound In U.S.

    Ebay Unveils Major Redesign And Same-Day Delivery Service

    FedEx Relies on Express Revamp to Meet $1.7 Billion Goal

    With Tapes, Authorities Build Criminal Cases Over JPMorgan Loss

    Shell Faces Lawsuit Over Niger Delta Pollution

    Edward Harrison: My Comments on Spiegel’s Post on How Monetary Policy Threatens Savings

    Howard Lindzon: Apple – A Bull and Bear Case

    Be sure to follow me on Twitter.

  • Anniversary Time
    Posted by on October 10th, 2012 at 3:18 pm

    Gary Alexander notes that the media is highlighting that yesterday was the fifth anniversary of the top. But that’s not all. There was a major low on October 9, 2002. There were also lows on October 11, 1990 and October 8, 1998.

    It’s interesting but what’s the reason behind this? Nothing. It’s just finding patterns in noise.

  • The Big Picture Investment Conference
    Posted by on October 10th, 2012 at 12:07 pm

    I’m at Barry Ritholtz’s Big Picture Investment Conference. I got here a little late so I missed the first speakers. I was able to hear James P. O’Shaughnessy, the author of “What Works on Wall Street.” James takes a very long approach to investing and he’s currently very bullish on stocks, especially compared with bonds. It’s hard for me to disagree. He pointed out that TIPs buyers are locking in 91 cents on the dollar by 2022. That doesn’t sound like a good plan.

    Next up is Barry Ritholtz. He’s riffing on behavioral finance which is basically the area of science that looks at the many ways our brains actively work to trick us. They make us think we’re smarter than we truly are. We have to rationalize certain ideas.

    The media is very savvy at giving us people who sound like they know what they’re talking about. Audiences rally around confidence. Speakers who convey nuance aren’t liked by audiences. Furthermore, the greater self-confidence of the expert, the worse track records are. I always find these facts disquieting because we expect our brain to be our guard against irrational beliefs. But the truth is, our brain doesn’t do a terribly good job of this. We prefer nice neat stories.

    Lunch!

    David Rosenberg is up. He defends himself against the perma-Bear charge. I like how he describes himself as the firm’s chief worrywart.

    Rosenberg called the Fed minutes as being from La-La Land. The lists of worries aren’t from a recovery, especially considering the stimulus. He’s going through the numbers and says they’re dismal. He says that going by previous cycles, real growth in this cycle should be closer to 8% instead of the 1.5% we’re getting.

    Rosenberg says that we’re still going through a deleveraging cycle and it’s not nearly done. We have to go back to long-term ratios of debt to equity and debt to income. Rosie says that we’ll eventually get to the Holy Grail of sustainable growth without massive government aid. He said we’re probably about halfway there.

    Now is the HFT panel. Josh asks the panelists how they came to be HFT critics. They said that around 2007, they noticed unusual behavior. They claim that there are unfair predatory practices and the rise of private exchanges. The glue that holds them all together is HFT.

    The other panelist said that he wanted to write about HFT and his editors were stunned to learn that HFT controls 70% of the trading volume. At first, he thought HFT was ok in that they provided liquidity. In 2010, he went to an HFT firm. Soon after was the Flash Crash. He called some HFT firms and they said they had pulled out of the market. He then realized that this was a major structural problem for the markets. The panelists also point out that spreads have not narrowed. Since 2007, they’ve actually expanded.

    I think the best anti-HFT point is about the integrity of the capital markets. No one cares about a fraction of a penny. But the key about HFT is that it has squeezed out smaller firms. There are no more second- or third-tier firms, and that has hindered new IPOs. HFT is now going into other markets like currencies.

  • The Wrong 73 Years
    Posted by on October 10th, 2012 at 11:13 am

    I’m often called a buy-and-hold investor. That’s true but I’m not in favor of locking in on an index and forgetting about it.

    Here’s an interesting fact. Between September 20, 1929 and October 9, 2002, the Dow Utility average grew by 16% not including dividends. That’s 16% over 73 years. Ten years ago yesterday, the Utes reached the trough of an awful bear market.

    I’m buy-and-hold but it depends a lot on what you buy and what you hold.

  • Morning News: October 10, 2012
    Posted by on October 10th, 2012 at 7:23 am

    Europe Still at Odds Over the Workings of Its Bailout Fund

    Greek Reform Pledge On Trial As State Sales Resume

    Japan Calls China PBOC Chief Skipping IMF Meeting ‘Regrettable’

    China Slams Congressional Charges Against Its Telecom Firms Huawei And ZTE

    India’s Embrace of Foreign Retailers

    U.S. Stocks Drop Before Alcoa Report as IMF Cuts Growth Forecast

    Fiscal Cliff May Be Felt Gradually, Analysts Say

    Government Sues Wells Fargo For Reckless Lending Practices

    Wal-Mart and AmEx in Prepaid Card Deal

    Bain Capital Buys Maker of Craftsman Tools in $1.6 Billion Deal

    GOLDMAN: A Significant Tax Hike Is Coming, And Neither Party Is Even Talking About Stopping It

    EADS, BAE In Last-Ditch Struggle To Save Merger

    Facebook Fought SEC to Keep Mobile Risks Hidden Before IPO Crash

    Joshua Brown: Fast Money: The Apple Dip Debate!

    Cullen Roche: Is The Volatility Index Really That Low?

    Be sure to follow me on Twitter.

  • The Market Top Five Years On
    Posted by on October 9th, 2012 at 12:21 pm

    Five years ago today, the S&P 500 had its all-time high close of 1,565.15. The index closed yesterday 6.98% below its all-time high close.

    Here’s a look at how sector ETFs have done since the market top. These returns include dividends.

    Staples ($XLP) +47.1%
    Discretionaries ($XLY) 34.6%
    Healthcare ($XLV) 24.0%
    Technology ($XLK) 18.0%
    Utility ($XLU) 6.9%
    Energy ($XLE) 4.6%
    S&P 500 ($SPY) 3.2%
    Industrials ($XLI) -2.2%
    Materials ($XLB) -4.5%
    Financials ($XLF) -49.9%

  • 4% of Trading Activity Last Week Was Due to a Mysterious Algorithm
    Posted by on October 9th, 2012 at 11:50 am

    From John Melloy at CNBC:

    A single mysterious computer program that placed orders — and then subsequently canceled them — made up 4 percent of all quote traffic in the U.S. stock market last week, according to the top tracker of high-frequency trading activity. The motive of the algorithm is still unclear.

    The program placed orders in 25-millisecond bursts involving about 500 stocks, according to Nanex, a market data firm. The algorithm never executed a single trade, and it abruptly ended at about 10:30 a.m. ET Friday.

    “Just goes to show you how just one person can have such an outsized impact on the market,” said Eric Hunsader, head of Nanex and the No. 1 detector of trading anomalies watching Wall Street today. “Exchanges are just not monitoring it.”

    Hunsader’s sonar picked up that this was a single high-frequency trader after seeing the program’s pattern (200 fake quotes, then 400, then 1,000) repeated over and over. Also, it was being routed from the same place, the Nasdaq.

    “My guess is that the algo was testing the market, as high-frequency frequently does,” says Jon Najarian, co-founder of TradeMonster.com. “As soon as they add bandwidth, the HFT crowd sees how quickly they can top out to create latency.” (Read More: Unclear What Caused Kraft Spike: Nanex Founder.)

    Translation: The ultimate goal of many of these programs is to gum up the system so it slows down the quote feed to others and allows the computer traders (with their co-located servers at the exchanges) to gain a money-making arbitrage opportunity.

    The scariest part of this single program was that its millions of quotes accounted for 10 percent of the bandwidth that is allowed for trading on any given day, according to Nanex. (The size of the bandwidth pipe is determined by a group made up of the exchanges called the Consolidated Quote System.) (Read More: Cuban, Cooperman: Curb High-Frequency Trading.)

    “This is pretty out there to see this affect this many stocks at the same time,” said Hunsader, adding that high-frequency traders are doing anything to “tip the odds in their favor.”