CWS Market Review – September 25, 2015

September 25, 2015
“I anticipate that it will likely be appropriate to raise the target range
for the federal funds rate sometime later this year.” – Janet Yellen

If the Fed were purposely trying to confuse Wall Street, they could not have done a better job. The above quote is from Federal Reserve Chairwoman Janet Yellen’s speech on Thursday in Amherst, and it’s completely changed Wall Street’s outlook. Allow me to explain.

Instead of rallying after last week’s “no go” decision, Wall Street got spooked. It looked like the Fed might put the whole higher-rates project on the back burner for several more months. There was even talk of another round of QE. The S&P 500 closed lower for the last three days in a row, and it finished Thursday at its lowest level in three weeks.


Now Janet tells us rates are going higher? Before the end of the year? What in the name of William McChesney Martin is going on here?

This has been a terrible case of bad policy communication from the central bank. In this week’sCWS Market Review, I’ll try to clean up some of the mess. I’ll also preview the upcoming third-quarter earnings season. This will be the fourth quarter in a row of declining earnings, but it looks like that streak will end next quarter. I’ll also discuss the earnings report from Bed Bath & Beyond (BBBY). Later on, I’ll highlight some good bargains on our Buy List. Thanks to the recent ruckus, several stocks have dropped down to attractive values, especially for investors with a long-term focus. But first, what’s up with the Fed and their mixed signals?

Yellen Plans to Raise Rates Soon

In the last few issues of CWS Market Review, I’ve cautioned you not to get too worked up about the Federal Reserve and its plans for interest rates. All we have to concern ourselves with is that interest rates will be going up soon. When and how much is largely irrelevant for now.

Obviously, the Fed’s September meeting was highly anticipated. Lots of observers thought there was a good chance that this would be the first time in nine years that the Fed would raise interest rates.

But then in August, we got a curveball. China shocked world markets by deciding to devalue the yuan. That gave a super atomic wedgie to several Asian markets. It also ruffled our feathers, but to a much lesser extent.

Ever since the devaluation, the market grew more and more doubtful that a rate hike was coming in September, and it was right. Last week, the Fed decided to hold off. Instead of calming the markets down, though, it caused frayed nerves to get even more frazzled. Soon, the futures markets weren’t expecting a rate hike until early next year. Maybe as far away as March. As I said in last week’s CWS Market Review, “If there’s one key takeaway from the Fed’s ‘do nothing,’ it’s that the central bank has taken a clear dovish stance.”

Apparently not! But in this case, I won’t blame myself for getting the message wrong. All of Wall Street seems to have heard the same thing. What caught a lot of people’s attention was that the Fed specifically highlighted the problems with “recent global economic and financial developments.” In other words, China.

The overriding issue impacting the global economy is commodity deflation. Name just about any commodity, and its price has been falling. Plunging! Oil is down. Copper is down. Sugar is down. The CRB Index is near a 40-year low. Check out this chart, which shows the relative strength of Materials stocks, along with the CRB Index. Sometimes a simple chart tells you all you need to know.


Stocks like ExxonMobil (XOM), DuPont (DD) and Chevron (CVX) are near 52-week lows.

Which brings us back to China. So did that mean the Fed was adding China to its list of concerns? Of course, the Fed is in charge of U.S. monetary policy, so they shouldn’t be worried about China’s mess. But Wall Street’s takeaway was that they had to look at China to get a clue as to what the Fed was going to do.

That leads us up to this week, when China released its latest PMI report. Normally, Wall Street doesn’t care too much about this report, but not this week. Suddenly, everyone wanted to know. The report was terrible. It was the worst PMI for China in more than six years. That only added to the concern that the Fed wasn’t going to move. And that’s why Janet Yellen’s Thursday speech was such a surprise.

Let me try to boil this down to simple terms. The Fed has done a very poor job of communicating its intentions to the markets. Janet Yellen is a smart economist, and I think she realized how bad it had gotten. That’s why she took the opportunity this week to state clearly that rates are going higher this year. There are only two meetings left in 2015, one in October and another in December.

Rates are going up, and that’s that. The Fed is probably moving too soon, but I don’t think one hike can cause too much damage. The open question is, Will the dollar continue to rise with higher rates? If so, that will cause even more commodity deflation, and a rotation away from Energy and Materials stocks.

There’s still a healthy demand for Treasury bonds. This week, the U.S. Treasury auctioned off three-month T-bills at 0.005%, which is the lowest yield ever. Investors paid $9,999.87 for the privilege of getting $10,000 three months from now. Some six-month bills went off at 0.115%.

For now, investors don’t have much to fear from higher interest rates. The key is for the economy to keep growing. In two weeks, the third-quarter earnings season kicks off. Let’s take a closer look at the numbers.

Third-Quarter Earnings Preview

The third quarter officially comes to an end next week. Soon after, we’ll start getting third-quarter earnings reports. Within one month, 17 of our 21 stocks will report earnings. This is a very important time for investors like us who seek out high-quality stocks.

Analysts on Wall Street have been busy hacking their earnings estimates for earnings season. Generally, I don’t pay too much attention to what the analysts think, but it’s a good way to see what the conventional wisdom is.

For Q3, Wall Street now expects the S&P 500 to earn $28.74 per share. That’s the index-adjusted number. (Every one point in the S&P 500 is worth about $8.83 billion.) To put this in perspective, at the start of the year, analysts were expecting Q3 to come at $33.35 per share. In other words, they slashed expectations by nearly 14% in nine months. Most of that is due to the strong dollar.

This is expected to be the fourth quarter in a row with a year-over-year earnings decline. In fact, the full-year earnings for 2015 will probably come in a just a hair below the earnings for last year. Once again, that’s due to the strong dollar, which has weighed heavily on commodity-based businesses.

For 2016, analysts expect the S&P 500 to earn $129.73 per share. Again, I don’t place a huge amount of faith in that figure, but it’s useful to see where Wall Street’s head is. That number means the S&P 500 is going for less than 15 times next year’s estimate. That’s hardly excessive. The key is that if the economy continues to grow, there’s no danger of the stock market falling on its face.

Until there’s hard evidence that the commodity bust is impacting employment, you can expect the economy to grow moderately over the next few months. Stocks are still the place to be. Now let’s look at our one Buy List earnings report from last week.

Bed Bath & Beyond Earns $1.21 per Share

After the closing bell on Thursday, Bed Bath & Beyond (BBBY) reported fiscal Q2 earnings of $1.21 per share. That’s not so bad. If you remember, the company had told us to expect earnings to range between $1.18 and $1.23 per share. So they’re hitting their numbers.

Like a lot of companies, BBBY has felt the sting of the strong dollar, but the impact is far less than that felt by other companies. Bed Bath reported that Q2 sales rose by 1.7% to $2.995 billion. But in constant-currency terms, sales were up 2.2%. Compare that to Oracle (ORCL), where the similar numbers for last quarter were -1.7% and +7%.

The key figure I like to watch is same-store sales. For Q2, that was up 0.7%, and 1.1% in constant currency. That’s below the company’s guidance of 2% to 3%.

Once again, Bed Bath continues to gobble up its own shares at a rapid clip. The number of outstanding shares fell from 191.5 million one year ago to 166.6 million last quarter. That’s a 13% reduction! BBBY’s net income fell by 10%, but the per-share figure rose from $1.17 to $1.21.


As I’ve said, I’m not much of a fan of share buybacks, but I’ll tip my cap to companies that truly act to reduce share count, and Bed Bath is one. They just announced that they’re adding another $2.5 billion to the existing buyback program. That’s huge. Now let’s look at guidance.

For Q3, which ends in November, BBBY sees earnings ranging between $1.14 and $1.21 per share. That’s fine. They see same-store sales for the rest of the fiscal year coming in between 1% and 3%. The previous guidance was for 2% to 3%, so that’s a small downgrade.

Once again, Bed Bath & Beyond reiterated its full-year earnings forecast. They expect earnings to rise from flat to mid-single-digits. Let’s say that’s 0% to 5%. Since BBBY made $5.07 per share last year, this year’s guidance works out to $5.07 to $5.32 per share. While I’m not crazy about the sluggish same-store sales, the full-year guidance isn’t too bad.

I’m going to keep my Buy Below at $65 per share. Although the company’s performance hasn’t been as strong as I’d like, the stock is going for a good value. If the guidance is correct, BBBY is trading at less than 12 times earnings. This will take some patience, but BBBY has long-term value.

Four Buy List Bargains

Thanks to the market’s recent case of rattled nerves, a few of our Buy List stocks look especially good at the moment. I consider any of our stocks trading below their Buy Below prices to be a buy, but these are especially good buys.

Last week, I highlighted Cognizant Technology Solutions (CTSH) and Express Scripts (ESRX), and I continue to see them as solid bargains. But don’t expect much movement from either one until earnings season. Microsoft (MSFT) continues to look good, especially with its shiny new dividend. If you can get it below $44, you got yourself a good deal. I also like Wabtec (WAB) below $90 per share.

As always, make sure that you’re diversified. Pay attention to our Buy Below prices, and don’t worry about stocks that run away from you. Wait for good stocks to come to you.

We may be in for some more turbulence. I wouldn’t be surprised if the S&P 500 tries to “retest” its low of 1,870. That often happens before the bears’ party comes to an end. I’ve said that I’m ready to give the all-clear once the VIX closes below 20. We haven’t had that yet, but we’re getting close.

I also want to lower my Buy Below prices on two of our stocks. I’m lowering Ball Corp. (BLL) to $68 per share, and Moog (MOG-A) to $60 per share. This is the second week in a row that I’m lowering Moog.

That’s all for now. The third quarter officially comes to a close this Wednesday. I’ll have a summary of how well the Buy List is doing. We still have a pretty good lead over the S&P 500. On Monday, we’ll get revised personal-income and spending reports for Q2. On Wednesday, ADP will release its payroll report. Then on Thursday we have ISM. That sets us up for Friday and the big September jobs report. I suspect it will be a good number. I also think the figure for August will be revised higher. 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

Named by CNN/Money as the best buy-and-hold blogger, Eddy Elfenbein is the editor of Crossing Wall Street. His free Buy List has beaten the S&P 500 seven times in the last eight years. This email was sent by Eddy Elfenbein through Crossing Wall Street.
2223 Ontario Road NW, Washington, DC 20009, USA


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