CWS Market Review
May 8, 2015
“The stock market is going to fluctuate. Sometimes it will
fluc down; other times it will fluc up.” -Louis Rukeyser
This week, Fed Chairwoman Janet Yellen spooked Wall Street when she said, “I would highlight that equity market valuations at this point generally are quite high.”
Uh-oh. Look, I’ve got nothing against Dr. Yellen. She’s a first-rate economist. But I’ll point out that Fed Chairs don’t exactly have a sterling record with their market calls. Remember when Alan Greenspan famously warned of the market’s “irrational exuberance” in 1996? The market doubled over the next three years. Just last summer, Yellen warned us that valuations for social media and biotech stocks were “substantially stretched.” The Nasdaq Biotech ETF (IBB) is up a cool 33% since then. I won’t even go into their dismal economic projections.
In one sense, Yellen is correct that valuations are high, if we assume that the strong dollar’s hit to earnings is going to last. But if the strong greenback’s damage is temporary, which the market’s betting on, then I don’t think we have anything to worry about.
With high valuations, the question that must always be asked is, compared to what? With bond yields so low, stocks need to be higher to compete for the investor’s money. The difference now is that the bond market has recently started to turn south.
In this week’s CWS Market Review, we’ll take a closer look at the bond market’s recent grumpiness. I’ll also cover our recent Buy List earnings reports. Moog (MOG-A) pulled back on poor guidance, but both Cognizant (CTSH) and Fiserv (FISV) jumped higher on their strong earnings reports. I’ll have details in a bit. But first, let’s look at what’s got the bond market so annoyed.
Whither the Bond Market?
Suddenly, everyone’s worried about the bond market. The yield on the 10-year Treasury rose seven times in eight days. On Wednesday and Thursday, the yield got to 2.25%, which is the highest in two months.
Of course, some of this needs to be put in context. Bond yields are hardly high; they’re just higher than where they were a few weeks ago, and that was pretty darn low. The 10-year yielded 3% in early 2014, and we’re still well below that.
The 10-year yield gained 31 basis points in eight sessions. That’s enough to get people’s attention. This may sound like blasphemy, but I think some of the strength in bonds is due to a stronger economy. The evidence isn’t in just yet, but I suspect the bond market is already placing its bets.
GDP for Q1 was bad. This week’s trade data indicates that the revisions will be even worse. In fact, it’s very likely that Q1 was negative. But that data is already somewhat aged. The first quarter ended more than five weeks ago. The recent initial jobless claims have been quite strong. These are some of the lowest numbers we’ve seen in decades.
We’re also seeing that commodity prices are on the rise. Oil, in fact, has been hot. On Wednesday, West Texas Intermediate got as high as $62.58 per barrel. That’s up $20 per barrel from the March low. (Anyone else remember in February when Citigroup said oil could fall to $20 per barrel? Yeah, me neither.)
The sour mood for bonds has been mirrored in the stock market by an increase in cyclical stocks. The chart below shows how the relative strength of Tech Stocks (XLK, black line) has closely followed the path of the 10-year Treasury yield (blue line). You can see it’s a pretty close fit.
I think this suggests some hidden strengths in the economy. Or at least, that it`s stronger than people currently expect. It also means that investors are willing to leave safe havens behind and dip their toes in riskier areas of the market. It’s interesting to see that the safe and secure Utility Sector (XLU) has lagged of late.
I doubt the change in risk perception has much, if anything, to do with the Fed and the endless guessing about interest rates. The dollar’s been trending down, and gold hasn’t done much.
My advice is to ignore the bond worries. That could be an issue at some point, but we’re still a long way away. A red flag is when the 2-year yield exceeds the 10-year. The 10-year still beats the 2-year by more than 150 basis points. The smart companies are taking advantage of low yields. Just this week, Oracle (ORCL) floated $1.25 billion in 40-year bonds. Microsoft (MSFT) floated $2.25 billion of 40-year paper in February.
Investors should continue to focus on high-quality stocks like you’ll find on our Buy List. I think growth stocks will be more in favor over the next few months. Some names I especially like right now are Ford Motor (F), Ross Stores (ROST) and Wells Fargo (WFC).
Moog Beats Earnings but Lowers Guidance Again
Last Friday, Moog (MOG-A) reported fiscal-Q2 earnings of 96 cents per share. That was five cents more than estimates. Revenue came in at $637 million, which was down 2% from last year’s Q2.
Frankly, this wasn’t a good quarter. As in Q1, Moog was hurt by currency. In particular, sales dropped 15% at their Industrial Systems segment. Moog’s CEO, John Scannell, noted that the company had some unusual charges last quarter: “Excluding these charges, our underlying business performed well in the face of an adverse shift in our aircraft sales and on-going macroeconomic headwinds. As we navigate through these challenges, we continue to focus on operational improvements, strong cash flow and allocating capital to create value for our shareholders.”
In January, Moog lowered its full-year guidance from $4.25 to $3.85 per share, but that`s potentially $3.95 with share buybacks. They just lowered it again. Moog now sees full-year earnings of $3.55 per share. That includes 24 cents in special adjustments.
The market didn’t like this news at all. The shares were over $72 last week. This week, they dropped under $66. I’m not pleased with Moog’s performance this year. I’m lowering my Buy Below to $72 per share.
Cognizant Technology Solutions Earned 71 Cents per Share
On Monday, Cognizant Technology Solutions (CTSH) released a very good earnings report. The IT outsourcer earned 71 cents per share last quarter, one penny more than estimates. Their guidance had been for EPS of at least 69 cents. (CTSH is a fan of using “at least” in their forecasts.) Revenue rose 20.2% to $2.91 billion. Guidance had been for at least $2.88 billion.
For Q2, Cognizant forecasts earnings of at least 72 cents per share on revenue of at least $3.01 billion. For the whole year, they see earnings of at least $2.93 per share. That’s an increase of two cents per share from their earlier guidance. They also increased their revenue guidance from at least $12.21 billion to at least $12.24 billion.
The stock reacted very well to the earnings report. Bear in mind that CTSH had been weak going into the earnings, despite a strong year overall. I think some traders were worried the CTSH was about to drop an earnings dud. They were wrong. The stock gapped as much as 11% higher on Monday and reached a new 52-week high. The stock pulled back later in the week but finished the day on Thursday at $61.31 per share. It’s our top performer this year, with a gain of 16.43%. Not bad for early May! Cognizant remains a strong buy up to $66 per share.
Fiserv: 30 Straight Years of Double-Digit Earnings Growth
After the closing bell on Tuesday, Fiserv (FISV) reported Q1 earnings of 89 cents per share. That’s a very good number. That’s a 9% increase over last year’s Q1, and it’s three cents better than expectations. Adjusted revenue grew by 4% to $1.19 billion.
“We are pleased with our strong start to the year,“ said Jeffery Yabuki, President and Chief Executive Officer of Fiserv. “Results for the quarter were consistent with our full-year expectations, highlighted by strong operating performance and excellent growth in free cash flow.”
Fiserv reiterated their revenue and earnings forecasts for this year. They expect internal revenue to grow by 5% to 6% and EPS to range between $3.73 and $3.83. Since Fiserv made $3.37 per share last year, this year’s guidance works out to an earnings-growth rate of 11% to 14%. If that’s right, this will be Fiserv’s 30th-straight year of double-digit earnings growth. That’s simply amazing.
The shares gapped up in early trading on Wednesday. At one point, FISV hit $80.79 per share, which is just shy of a new 52-week high. I like this stock a lot, but I urge investors not to chase Fiserv. Be patient and let good stocks come to you. Fiserv is an excellent buy up to $80 per share.
Buy List Notes
That’s the end of earnings season for our 16 Buy List stocks that have quarters ending in March. We have two Buy List stocks, Hormel Foods (HRL) and Ross Stores (ROST), which ended their quarters in April. Hormel will report Q2 earnings on Wednesday, May 20th, and Ross Stores follows the next day. I’ll have more details in next week’s issue.
I also wanted to comment on last Friday’s big spike in Wabtec (WAB). The shares jumped more than 6.1%. The reason for the rally was new rules out of Washington. As it turns out, Wabtec is one of only two companies that make electronically controlled pneumatic (ECP) brakes for trains. The Department of Transportation said that trains with more than 70 tank cars will have to have ECP. If not, they can’t go more than 30 mph.
The back story is that shipping oil by rail has skyrocketed in recent years. This year, it’s projected that 374 million barrels of oil will be shipped by rail. That’s up from 30 million in 2010. More shipments means more accidents, so the Feds are trying to improve safety—and that means ECP. Wabtec is a good buy up to $103 per share.
That’s all for now. Earnings season winds down next week. There will be a few key economic reports coming our way. The retail sales report is on Wednesday. Wholesale inflation follows on Thursday, and industrial production is on Friday. Industrial production has been in a troubling downward trend since November. The March report was especially poor. I’m curious to see if this continues. 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!