November 20, 2015
“Stock market: a place where events with a <1% probability are discussed >90% of the time.”
“Wall Street hates uncertainty”: so goes the old saying. Until recently, investors feared an interest-rate hike. Now that a December rate hike seems quite probable, investors may fear that it won’t happen.
After the awful events in Paris, there was some concern that the Federal Reserve could delay an interest-rate hike. Now that some time has passed, that doesn’t appear to be the case. This week, the Fed released the minutes of its last meeting, and all the signs are in place for a rate hike. We also got an inflation report this week which suggests that deflation has run its course.
According to the latest futures prices, there’s a 71.7% chance that the Fed will raise interest rates at its December meeting. We’ve had false alarms before, but the Fed seems quite serious this time. This would be the Fed’s first interest-rate hike in nearly a decade. The financial world is finally getting back to normal.
In this week’s CWS Market Review, we’ll take a closer look at the recent economic data. Corporate earnings pulled back again during Q3, but there are signs of improvement for Q4. Initial jobless claims have been under 300,000 for the last 39 weeks in a row. That’s the longest streak in more than 40 years.
We just had a nice earnings report from Ross Stores (ROST). The deep discounter had given us tepid guidance, so it’s good to see it beat expectations. Later on, I’ll preview next week’s earnings report from Hormel Foods (HRL). The Spam company just hit a new high—it’s a 32.1% YTD winner for us. I’m also expecting Hormel to raise its dividend next week, which would be its 50th straight annual dividend increase. I’ll also update some of our Buy List stocks. But first, let’s take a closer look at the economy and stock market at the midway point of Q4.
The Global Economy Is out of Sync
We’re heading into the final stretch of the calendar, and in recent years, that’s been a good time for stocks. The S&P 500 has been positive over the final 30 trading days of the year for the last 12 years. Santa is clearly a bull.
What’s interesting is that over the last month, the stock market has developed an unusual pattern. Each day, the market either falls, or it rises by a lot. There haven’t been many modestly positive days.
Here are the numbers: In the last 23 trading sessions, the S&P 500 has fallen 15 times and rallied eight tines. But of those eight positive days, six have been greater than 1.1%. Just two of the last 23 days have seen either a loss less than 0.1% or a gain less than 1.1%. In other words, there’s no more middle ground. To borrow from Yeats, “Things fall apart; the center cannot hold; mean reversion is loosed upon the world.”
What does this mean? Hard to say, but I suspect that the market now assumes each day to be a negative until it’s proven bullish. Obviously, the Paris attack rattled nerves, especially in European markets, but that’s past us, and terrorism’s track record of disrupting financial markets has been a big fat zero. On Wednesday, the S&P 500 rallied over its 200-day moving average, and the French market is positive for the week.
So what’s the economic outlook for the U.S.? On Wednesday, the Federal Reserve released the minutes from its October meeting. I’m afraid these minutes always make for pretty dry reading, even for academics. Yet one part stood out. After the Fed laid out what would have to happen for rates to go higher, “most participants anticipated that…these conditions could well be met by the time of the next meeting.”
Whoa, that’s a big deal. I have to explains that the Fed’s minutes are a case study in the use of indefinite pronouns (“some” said this, “many” said that, “others” felt this). So when they say “most,” they mean it.
Pardon me for a brief nerdy digression, but the Fed is in the midst of a very wonky debate over the “natural interest rate.” This refers to the rate at which everything comes into balance. So when the Fed goes below the natural rate, it’s stepping on the gas. When it goes above it, it’s stepping on the brakes.
But here’s the tricky thing about the natural rate—no one knows what it is. In fact, there are some economists who think the whole idea is bogus. So the idea is that there’s this weird conceptual interest rate that’s floating around somewhere out in the ether, yet we can’t see it or hear it. But it drives everything. And here’s where it gets truly weird: the natural rate has likely gone down. Way down. The staff at the Fed thinks the natural rate went negative during the financial crisis, and it’s probably hanging just above 0% right now. (If you’re curious, here’s a post I did last year about the natural rate and gold.)
I think that’s right. It probably explains why gold and silver have taken such a beating, even though rates are still so low. If your currency’s interest rate is above the natural rate, then, all things being equal, commodities will fall. Silver just snapped its 15-day losing streak. U.S. crude inventories are the highest they’ve been at this time of year since 1930.
Fortunately for the Fed, the vagaries of the natural rate aren’t quite so vital at the moment, but it’s a very big deal to Mr. Draghi and his friends at the ECB. Bond yields in Europe are getting absurdly low. Germany just sold off some two-year bonds at -0.38%. In other words, investors are paying the government to borrow money from them. Stay tuned. I think the ECB will take further steps to get the European economy back on its feet. The euro may soon reach parity against the dollar.
Here’s what investors need to understand: the driving force in the world economics at the moment is that the U.S. and the rest of the world are out of sync. We’re heating up, while they’re still trying to get started. That’s what’s been driving the dollar higher.
On Tuesday, the U.S. government reported that inflation rose by 0.2% last month. That may not sound like much, but in seasonally adjusted terms, it was the most inflation since June. The “core rate,” which excludes food and energy, rose by 0.2%. In the last year, the core rate is up by 1.9%. Officially, the Fed’s inflation target is 2%. The sudden deflation that we saw late last year clearly made the Fed rethink any rate-hike plans. That’s no longer an issue. The next test for the Fed will be the November jobs report, which comes out on December 4. Now let’s take a look at our Buy List earnings report from this week.
Ross Stores Earns 53 Cents per Share
Last week, I told you that I was a bit puzzled by the weak guidance from Ross Stores (ROST). The numbers they gave us simply didn’t add up. Were they low-balling us (as they like to do), or are they seeing real problems ahead?
We’ve also seen a lot of weakness across the retail sector. Macy’s (M), for example, got clobbered after a lousy report. Last week, the Census Bureau said that retail sales were sluggish in October.
In August, Ross said they saw Q3 coming in between 48 and 50 cents per share. After the closing bell on Thursday, they reported Q3 results of 53 cents per share. So maybe they were being extra conservative.
Ross said that Q3 sales rose 7% to 2.783 billion. The key metric, comp-store sales, rose 3%. They had been expecting a gain of 1% to 2%.
Last week, I told you I expected Ross to raise their estimates for Q4. No such luck.
Looking ahead, Ms. Rentler said, “In the upcoming fourth quarter, we face challenging prior-year comparisons, ongoing uncertainty in the macro-economic environment, and a holiday season that will be highly promotional. Therefore, while we hope to do better, we believe it is prudent to maintain our prior guidance for this period. For the 13 weeks ending January 30, 2016, we continue to project same-store sales to be flat to up 1%, versus a strong 6% gain in the prior year, with earnings per share of $.60 to $.63 compared to $.60 in last year’s fourth quarter. For fiscal 2015, earnings per share are now forecast to be in the range of $2.45 to $2.48, up 11% to 12% from $2.21 in fiscal 2014.”
The shares rose about 6% in after-hours trading. Ross Stores remains a good buy whenever you see it below $54 per share.
Expect a 50th Straight Dividend Increase from Hormel
Hormel Foods (HRL) has been one of the best new additions to this year’s Buy List. On Thursday, the shares hit another 52-week high. We now have a 32.1% gain in Hormel, making it our second-best performer YTD.
The Spam company is due to report its fiscal Q4 earnings on Tuesday, November 24. For Q3, the company beat earnings and raised guidance for the full year. That was actually the second time it had raised their guidance. Hormel now sees full-year earnings coming in between $2.57 and $2.63 per share. That implies earnings growth of 15% to 18% over 2014, which itself was a record year.
But what I’m really looking forward to is the dividend announcement. Hormel usually raises its dividend with its Q4 earnings report. The company has increased its dividend for the last 49 years in a row, and the healthy profit increase tells us to expect #50 on Tuesday.
Hormel currently pays out 25 cents per share each quarter, or $1 per share for the whole year. I think it can easily be bumped up to 29 or 30 cents per share. Hormel Foods is a very solid company.
Buy List Updates
On Thursday, shares of AFLAC (AFL) touched a new 52-week high. The stock got as high as $65.42. You may recall how hard the stock was hit during August. But the worriers were wrong. Last month, the duck stock not only beat earnings, but it gave investors their 33rd dividend increase in a row. AFLAC remains a good buy up to $67 per share.
Shares of Bed Bath & Beyond (BBBY) got caught up in the retail storm. The stock finished Thursday below $54 per share, which seems quite cheap to me. Let’s look at the numbers. Last fiscal year (ending in February), the home-furnishings store made $5.03 per share. They said they expect to increase that by 0% to 5% this year. At the halfway mark, EPS is up 2.1%. Note that a lot of that is driven by share buybacks. I’m lowering our Buy Below on BBBY to $58 per share.
This week, Fiserv (FISV) announced a 15 million-share repurchase program. That’s about 7% of the company’s outstanding shares. All things being equal, I’d rather have the company pay shareholders in dividends, but this announcement is a reflection of how strong Fiserv is. Last month, the company beat earnings and raised guidance. Fiserv expects full-year earnings of $3.84 to $3.87 per share. This is another very good stock.
Every time I think the news can’t get worse for Qualcomm (QCOM), the news gets worse for Qualcomm. This week, the company said the South Korean government is investigating it for anti-trust violations. The stock dropped 9.4% and hit a four-year low. Qualcomm denies any charges, but I doubt that will get it far, especially in a country where Samsung, one of its top competitors, is based. I think we’ll soon hear more news about Qualcomm breaking itself up.
That’s all for now. Next week is Thanksgiving, so there will be no issue of CWS Market Review. The stock market will be closed next Thursday for Thanksgiving. The market will close at 1 pm on Friday. This is usually the slowest trading day of the year. There’s not much reason for the market to be open, but the NYSE hates to have the exchange closed four days in a row. The only interesting economic report will come on Tuesday, when we get the first revision to Q3 GDP. The initial report said that the economy grew by 1.5% for Q3. 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!