August 28, 2015
“Every once in a while, the market does something so stupid it takes your breath away.”
– Jim Cramer
I’m going to forego our normal format this week in order to better address this week’s dramatic stock market. Obviously, this was one of the most hectic and volatile weeks in recent stock market history.
I won’t bother to describe each of the market’s twists and turns. The short version is that the S&P 500 plunged and soared, then plunged and soared some more. Each day, the final 30 minutes of trading saw convulsions that were epic in their own right. The S&P 500 closed Thursday at 1,987.66—perhaps a tip of the cap to Black Monday 28 years ago.
Check out the action:
Instead, I want to step back and discuss how we go about investing, and why we don’t let ourselves get rattled during times like this. I didn’t predict what was going to happen this week, but our entire strategy is based on the idea that weeks like this come along, and that there’s not much you can do about it. Periodically, stocks drop. That’s all there is to it. As Hyman Roth said, “this is the business we’ve chosen.”
In another sense, we were completely prepared for this week. The 21 stocks on our Buy List were superior companies last week, and they remain so this week. That’s not to say that the Buy List didn’t go down. It did. But our style of investing doesn’t involve madly dipping in and out of the market. We don’t use exotic options or margin. Nor do we play with commodities.
Our philosophy is simple. We focus on stocks—very good stocks—and we hold onto them through the storms. Sometimes stocks drop for no good reason. As Jim Cramer said, “Every once in a while, the market does something so stupid it takes your breath away.”
I’ll give you an example. Let’s look at Express Scripts (ESRX). I should probably spend more time explaining how our Buy List stocks are in the top tier of publicly traded companies. Our stocks are the best of the best. That’s not easy to express without disappearing into a mess of numbers, but I’ll try.
At its low on Monday, ESRX was going for $68.06 per share. That’s a little over 11 times next year’s earnings. This is a company whose business model is barely impacted by what happens in China or at the Federal Reserve. Nevertheless, the shares plunged 20% in six minutes. It really does take your breath away.
Now for some numbers. Here are Express Scripts’s earnings-per-share since 2009; $1.79, $2.50, $2.97, $3.74, $4.33 and $4.88. I love those steady increases. A few weeks ago, Express Scripts raised their EPS range for this year to $5.46 to $5.54. How, in any sane world, could a company like this lose 20% of its value in minutes? There aren’t many companies that have consistently increased their earnings like that.
The lesson for investors is that markets move in two gears. Upward is slow and boring. Downward is fast and chaotic. Most of the market’s best days aren’t in good markets. Instead, they’re counter rallies during rough markets. When the S&P 500 is at an all-time high, the daily volatility is 36% less than normal.
This week’s market is hardly unique. We’ve had lots of periods far worse than this. What’s different is that we’ve never gone from a period as uneventful as this year’s market to one as stressful as this week’s. The S&P 500 had a six-month run of never leaving a 90-point band. You often heard me talk about how long the trading range had lasted. For so much of this year, the market was flat as a pancake. Then—WHAMMO! The S&P 500 lost 212 points in four days, and then soared 120 points in the next two days!
Here’s an interesting stat. If we took all 919 trading days since the beginning of 2012, the S&P 500 had consecutively its ninth-worst, second worst, worst and 41st worst days. That was followed by the best and fourth-best.
Let me warn you that the chaos isn’t over just yet. We’re in for some more twists and turns. As impressive as the rallies were on Wednesday and Thursday, they were narrowly focused. In fact, 65% to 70% of companies in the S&P 500 lagged the index on both days.
I won’t even bother adjusting any of our Buy Below prices this week, since I’d probably have to turn around and raise a bunch next week or the week after. The short version is that every stock on the Buy List is currently a buy. If you’ve got idle cash sitting around, there are lots of bargains. I’ll have more on that in a bit. The only exception is Stryker (SYK), which closed a few cents above its Buy Below. It could dip below at any moment, and it probably will.
A very important point to understand about this market is that it’s a market event much more than it is an economic event. This is an instance of financial markets impacting financial markets. Meanwhile, the overall economy appears reasonably healthy. A few weeks ago, I said that I expected Q2 to come in quite strong. I thought it could be as high as 3.0% to 3.5%. Unfortunately, the initial report showed growth of just 2.3%.
So was I wrong? Not so fast! This week, Q2 GDP was revised up to 3.7%. That was the third-best quarter for GDP since the start of 2012. Not only that, but Wednesday’s durable-goods report was quite strong. Orders for durable goods rose 2% last month, and that comes after a 4.1% increase for June. This week, the Census Bureau said that new-homes sales for July rose 25.8% over last year. The economy, of course, is still far from robust. But it is improving, and there’s no sign of a recession.
I’ve given up trying to predict when the Fed will raise rates. All we need to know is that rates are going up soon. Exactly when isn’t so important. Some people seem to think that this week was Wall Street’s way of telling Janet Yellen to back off. Yeah, I’m not so sure. The Fed seems to have made up its mind. The two-year Treasury yield, which is one of the most sensitive to a rate increase, fell from 0.7% last week to below 0.55% on Monday. Now it’s back up to 0.7%.
One of the more arresting facts of this past week was that there was almost no company-specific news for our Buy List stocks. We had no earnings reports or dividend announcements. There were a few analyst upgrades. CR Bard (BCR) was upgraded to a buy at Goldman Sachs. Keefe, Bruyette and Woods raised AFLAC (AFL) to outperform. They have a $68-per-share prices target on AFLAC. Ross Stores (ROST) was upgraded to a buy at Buckingham Research. Perhaps the most intriguing news is that Ford Motor (F) is thinking about bringing back the Ford Bronco.
You’ll often hear investors say that they’re “waiting for the dust to settle.” But that’s an event that never occurs. No one rings a bell and tells you, “the dust, my lord, has settled.” A shortcut to watch is the Volatility Index (^VIX). The VIX closed Thursday at 26.10. I would say that the coast is clear once the VIX closes below 20. Closing below 15 would be better.
The VIX is the market’s implied volatility over the next month. I’ll make it simple. Take the VIX and divide it by 3.46. That’s the market’s view of one standard deviation over the next 30 days. Volatility doesn’t cause bad markets. Rather, bad markets cause volatility. Personally, I don’t mind some price swings. They help turn good stocks into bargains.
Speaking of which, let me discuss a few of the stocks on our Buy List. As I said, I consider any stock below our Buy Below to be a buy. Remember that our Buy Belows are not price targets, so don’t go thinking that the biggest gap between the current price and the Buy Below represents the best bargain.
I’ve harped on Ford Motor (F) many times before, but this is a very attractive price ($13.56). Ford now yields 4.4%. A few weeks ago, they beat earnings by 10 cents per share.
Earlier, I mentioned Express Scripts (ESRX). This is a very solid company. The stock has recovered since it’s Monday morning swan dive, but it’s still 10% below its 52-week high.
Signature Bank (SBNY) also looks quite cheap here. The shares are nearly 15% below their 52-week high. Signature is head and shoulders above most other banks.
Microsoft (MSFT) closed Thursday at $43.90 per share. That gives the shares a yield of 2.8%. Plus, the dividend will probably be raised again next month.
I also like AFLAC (AFL) below $60 per share. Before some downgrades, the stock finally had some traction. The duck stock is now down 6% since it raised guidance.
That’s all for now. Next week is the last trading week before Labor Day. Expect more market volatility next week. We’re going to get some of the key turn-of-the-month econ reports. The ISM report comes out on Tuesday. Productivity and factory orders are on Wednesday, as is the Fed’s Beige Book. That leads us up to the big August jobs report on Friday. This could be the last jobs report before the Fed raises rates at their September meeting. 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!