August 14, 2015
“Forecasts may tell you a great deal about the forecaster;
they tell you nothing about the future.” – Warren Buffett
In the past few weeks, several concerns of investors have been resolved. The mess in Greece didn’t become a larger problem. The selloff in China hasn’t metastasized. At least, not yet. Second-quarter earnings were pretty good. The strong dollar did some damage but not as much as feared.
Even worries about the Federal Reserve are beginning to subside. The Wall Street Journal surveyed several economists and found that 82% of them expect the Fed to raise rates next month. Only 13% expect the Fed to wait until December. It’s finally going to happen, and is the bond market scared? Not at all. Long-term rates have been falling.
Given the resolution of these previously uncertain issues, that leaves us with a fairly dull market. Fine by me! I like dull markets. In this issue, I’ll go into a little more detail on the market’s recent behavior, and why higher rates are nothing to fear. I’ll also preview two Buy List earnings report for next week. Later on, I’ll update you on two Buy List stocks that just announced big new share buybacks. But first, let’s look at the July jobs report.
Don’t Let Higher Rates Scare You out of Stocks
Last Friday, the government reported that the U.S. economy created 215,000 net new jobs in July. That was basically in line with what economists had been expecting. The unemployment rate stayed at 5.3%.
For me, the bigger news isn’t so much the jobs news as that it almost certainly confirms that the Fed is due to raise rates next month. Earlier, I cited the WSJ’s poll of economists. One caveat is that the September meeting will be followed by a press conference from Fed Chairwoman Janet Yellen. No press conference is scheduled for the October meeting. The assumption is that Yellen wants to raise rates in conjunction with a press conference. That makes sense, and it’s why only 3% of economists think the Fed will make a move in October.
This would be the first time in nine years that the Fed would raise rates. To borrow a phrase from the Harding administration, a rate increase will be an important step in our “return to normalcy.” Zero-percent rates and all the bond buying were emergency measures. That time has passed.
But I want to remind investors that a rate hike is by no means awful news for stocks. Let’s remember that short-term rates will still be quite low. In fact, they’ll still be below inflation, and will most likely remain that way for quite some time.
From 2004 to 2006, the Federal Reserve raised interest rates by 0.25% at 17 consecutive meetings. Yet, the stock market kept on rallying. Stocks rallied through higher rates in 1988-89, and again in 1999-2000. In the latter example, the market survived the first four 0.25% rate hikes. The fifth, however, was too much to bear—and for good measure, the Fed added a sixth increase, which was 0.5%. The market soon nosedived.
My point is that the beginning of a rate-hike cycle is nothing to fear. Investors should understand that this will alter some fundamentals of business. For example, yield spreads will narrow. What we need to be concerned with is the possible excesses of a tightening cycle. When that happens, short-term rates run 3% or 4% more than inflation. We’re a long way off from that happening.
If anything, the commodity markets are working to hold down inflation. July was a terrible month for commodities. The CRB Index (see above) is toying with a 40-year low. Sugar, for example, is at a multi-year low. Oil prices are now at a six-year low. Yesterday, light sweet crude fell to $42.23 per barrel. That’s the lowest price since March 2009, when the bull market began. The rout may not be over. OPEC countries are continuing to pump out oil at a very rapid clip. The old cartel might be finished. Now let’s look at some earnings reports coming out next week.
Earnings Next Week from Hormel Foods and Ross Stores
We have two Buy List stocks that ended their quarters in July, Hormel Foods and Ross Stores. Both stocks are due to report earnings next week.
Hormel Foods (HRL) will report its fiscal third-quarter earnings before the opening bell on Wednesday, August 19. Hormel is shaping up to be one of our better stocks this year. Through Thursday, the shares are up 16.1% YTD. I always enjoy watching these humdrum stocks thrive.
There had been concerns that avian flu would ding Hormel’s earnings. The company conceded that it was a problem, but the damage was limited. I like hearing companies give us bad news straight. For fiscal Q2, Hormel made 67 cents per share, which was four cents better than estimates. For now, the company is sticking by its full-year EPS forecast of $2.50 to $2.60 per share. I think they can hit it.
Wall Street expects fiscal Q3 earnings of 55 cents per share. My numbers say that’s about right. Don’t expect a big earnings beat here. Last week, the shares touched a new 52-week high of $61.32. This is a solid, long-term investment.
In the last year, Ross Stores (ROST) has been a huge winner for us. From July 16, 2014 to Thursday’s close, the deep discounter’s stock is up more than 70%.
I was a little concerned about Ross’s latest guidance. The company said it expects earnings to range between $1.19 and $1.24 per share. Frankly, I think they’re low-balling us. I know Ross likes to do that, and naturally, we know how this game is played.
Perhaps as much as earnings, I want to see same-store sales. This is huge for all retailers. In their last report, Ross had same-store sales growth of 5%. But they told us to expect 2% to 3% growth for this coming report. Incidentally, the Commerce Department released a good retail-sales report this week. For July, retail sales rose by 0.6%. The report for June was revised higher from a 0.3% drop to flat. This may bode well for Ross’s earnings.
Shares of Ross split 2-for-1 in June, and the stock has continued to climb higher. Last Thursday, Ross broke $55 per share for the first time. For now, I’m going to keep our Buy Below at $52 per share. I’ll also certainly raise it next week, but I want to see their numbers first.
Buy List Bargains and Additional Updates
Periodically, I like to highlight some of our Buy List stocks that look especially attractive at the moment. Bear in mind that I consider any Buy List stock that’s below its Buy Below price to be a buy.
Last month, I mentioned that Bed Bath & Beyond (BBBY) is cheap below $65 per share. But that’s a more speculative buy. The shares have performed terribly since April. I think the selling is overdone.
Microsoft (MSFT) continues to be a good buy here. I thought the last earnings report was quite good, but the stock hasn’t done much. My Buy Below is at $49, but if it you can get it below $46, you got a good deal. The current yield is 2.65%.
I also like Signature Bank (SBNY) below $142. The bank had another solid earnings report, but the shares dropped nearly 12% from the July high to the August low. Take advantage of any pullback.
By the way, the only three stocks that have been Buy List members are ten years are AFLAC, Bed Bath & Beyond and Fiserv (FISV). Since the Buy List started in 2006, Fiserv has gained 312% for us. On Thursday, it made another new high.
I also wanted to pass along a few updates to some other Buy List stocks.
This week, Moog (MOG-A) announced that it’s expanding its share-buyback program by four million shares. Their original program authorized them to repurchase nine million shares of their stock. They had already plowed through 8.3 million. The total is now being expanded to 4.7 million.
“Our cash flow has been strong over the last few years,” said John Scannell, Chairman and CEO. “This has afforded us the opportunity to return nearly $600 million of value to our shareholders in the form of a share-repurchase program that we initiated in early 2014. We are pleased to have the flexibility to continue this program.”
Moog had a good earnings report recently. They earned $1.05 per share for their fiscal third quarter, 11 cents better than estimates. Unfortunately, the company lowered its full-year forecast for the third time. Moog now expects full-year earnings of $3.50 per share.
The good news is that Moog said it expects to make $4 per share next fiscal year (ending September 2015). That’s impressive, and I didn’t see it coming. It’s no secret that I haven’t been impressed with Moog this year, but the new guidance and expanded share buyback are positive signs. I’m keeping my Buy Below on Moog at $72 per share.
AFLAC (AFL) also announced a big share buyback. Let me add that one of my criticisms of share buybacks is that it too easily lets companies put out feel-good press releases. But when high-quality companies like Moog or AFLAC do it, I don’t feel quite so manipulated. These companies have the cash flow to back it up.
AFLAC said it´s adding 40 million shares to its current program, which is down to a puny 16 million. This means the company plans to buy back 56 million shares, which is about 13% of the outstanding stock. That’s a nice chunk of change.
Commenting on the news, Chairman and Chief Executive Officer Daniel P. Amos stated: “I am very pleased with this action by our board of directors. Whether we’re talking about our operations in Japan or the U.S., as an insurance company, our primary mission is to fulfill our obligations to our policyholders. At the same time, we are listening to our shareholders and understand the importance of capital deployment. In our second quarter of 2015 earnings release, we reinforced our plan to repurchase $1.3 billion of our common stock in 2015 and believe that over the next few years, we’ll be able to increase the capital available for deployment.”
AFLAC had a good earnings report for Q2, plus they raised guidance. The stock has finally woken up from its long slumber. On Monday, AFL closed at $64.92 per share ,which is its highest close in 17 months.
Speaking of all these buybacks, on Wednesday, the S&P 500 had its biggest intra-day turnaround in three years. What caused all the buying? Apparently, companies were in on it. Goldman Sachs said that they had their busiest day since 2011 buying back shares for their corporate clients. Since the bull market began, companies have bought back more than $2 trillion worth of stock.
When PayPal (PYPL) split off from eBay, I set our initial Buy Below at $42 per share. I wanted to give the Buy Below a little “air,” just in case the shares popped after the spin-off, and that’s pretty much what happened on the first day. Now that a little time has passed, I want to lower our Buy Below on PayPal to $40 per share. Don’t misunderstand me—I like PYPL a lot. I’m just reeling in our Buy Below.
That’s all for now. Next week, the Fed will release the minutes of their most recent meeting. I think the evidence is clear that a rate hike is on its way. On Wednesday, the July CPI report comes out. There have been some signs that core inflation has crept higher this year. I’m curious to see if this trend is still in play. We also have two Buy List stocks due to report earnings. 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!