January 8, 2016
“Everyone has the brainpower to make money in stocks.
Not everyone has the stomach.” – Peter Lynch
Santa apparently decided to cancel his rally this year. Perhaps Wall Street has been naughty this year (believable). Through Thursday, the S&P 500 is already down 4.93% for the year. That’s the index’s worst four-day start in history!
The Dow is down over 910 points, or 5.27%, which is its worst four-day start as well. As rough as that’s been, the U.S. market has been a lot better than many overseas markets. Brand new “circuit breakers” in China shut down their stock market twice this week. In response, the authorities there decided to ditch the circuit breakers. In other words, the circuit breakers have themselves been circuit broken!
What’s going on? The answer is complicated, but most of it boils down to a spreading economic/fiscal mess in China. The good news is that this shouldn’t become a major problem for us. At least, not yet. The U.S. economy is not very dependent on China. The bad news is that some market jitters may hang around for a few more weeks.
In this issue, I’ll break it all down for you. I’ll also bring you up to speed on Bed Bath & Beyond’s (BBBY) Q3 earnings report. It wasn’t good, but we already knew not to expect too much. Still, I like the beaten-up stock here. More on that in a bit.
We also have Q4 earnings season coming our way. Next week, Wells Fargo (WFC) will be our first Buy List stock to report earnings for this season. The big bank has seen its shares pull back for the last few days. I’ll give a preview of what to expect. But first, let’s take a closer look at what’s been rattling Wall Street this week.
China Shakes the U.S. Stock Market
In America, the trading day begins at 9:30 am ET, but investors have recently adopted the habit of waiting for the market in China to open because that’s where all the drama has been.
At the start of this year, China unveiled new “circuit breakers” for its stock markets. The rules were simple: If any index fell by 5% in a day, trading would be suspended for 15 minutes so everyone could chill out. If the index fell by 7%, trading would be halted for the entire day.
Well, the authorities didn’t have to wait long. Trading was first halted on Monday. Then on Thursday, the 5% trigger was reached 13 minutes into the trading day. That gave everyone 15 minutes to relax. Then trading resumed for one minute before they hit the 7% barrier and trading was shut down for the rest of the day. Trading on Thursday lasted for all of 14 minutes.
You don’t have to be a rocket surgeon to figure out that people were dumping stocks ahead of the circuit breakers because they didn’t want to be caught holding their positions during a shutdown. So instead of calming the market as intended, the circuit breakers actually inflamed volatility. You may not be surprised to learn that China has now suspended those rules. In America, by the way, the exchanges aren’t shut down unless there’s a 20% plunge.
Let me caution you not to read too much into the Chinese market. Trading there is closer to a puppet show than an open market. I simply don’t trust how those markets operate, and there seems to be a lot of rigging going on. I don’t blame China. It’s a young stock market (only 25 years old). Ours was horribly manipulated for decades, and we still have work to do.
The catalyst for the drama in Chinese stocks is coming from the government’s willingness to let its currency, the yuan, depreciate. This is a big deal. The government knows that the economy is getting weak, so it needs its currency to adjust. At first, the government tried fiscal stimulus, but that was mostly a bust, so it shifted towards managing the currency,
It’s almost as if the government feels it can lower the bar on the yuan a few millimeters at a time. The Chinese government likes to think it can control everything, so it’s not used to dealing with the international currency markets. Not surprisingly, very smart currency traders saw what the PBOC (the Chinese Fed) was up to, and they beat them to the punch.
There are actually two markets for the yuan—the “onshore” official rate and the “offshore” more freely traded rate. (Take a wild guess which one you ought to pay attention to.) Investors are betting that the government has just started devaluing the currency and that it’ll have to keep letting the yuan sink lower. The weaker yuan ought to help China’s exports. The problem is that there are enormous spillover effects. For example, purchasers of Chinese exports will demand discounts to reflect the cheaper yuan, and that could spark a currency war.
In November, the IMF added the yuan to its official basket of currency reserves. To borrow a term from the Mafia, that’s roughly the equivalent of being a “made currency.” You belong. You’re part of a crew. That probably gave cover to the government to start toying with the currency markets to help its economy.
Like I said, the government thinks it can lower the currency slightly each time, and no one in the world can predict what will come next. There’s a lot of smart money out there. To add some perspective, the volume of the global forex market is more than $5 trillion every day. The PBOC actually had to jump back in and start buying yuan just to stop the bleeding. With more than $3 trillion in currency reserves, they have plenty ammo to fight this war. It’s hard for me to escape the conclusion that the PBOC is clueless about how bad the problem is, and what to do about it.
All attempts at currency manipulation come to an end. Many of those endings are unpleasant. To be clear, not much of this drama affects us. Don’t let the news from China scare you out of buying U.S. stocks. The government leaders in China could do their citizens and the world a favor by learning to cede control to free enterprise. Now let’s take a look at our Buy List earnings report from this week.
Bed Bath & Beyond Earns $1.09 per Share
I know many readers were certain that I was going to give Bed Bath & Beyond (BBBY) its walking papers this year, but I decided to keep the home-furnishings store on the Buy List for another year. It’s true that BBBY has been a disappointment. The latest earnings warning certainly didn’t help things. But there’s always the issue of price, and I think BBBY’s current price is worth a buy.
After the market closed on Thursday, Bed Bath & Beyond reported earnings of $1.09 per share for its fiscal Q3 (September, October and November). That’s not that good, but it’s basically what we expected. Two weeks ago, the company had told us to expect earnings between $1.07 and $1.10 per share. BBBY earned $1.23 per share for last year’s Q3.
Quarterly sales rose 0.3% to just under $3 billion. The key metric to watch here is same-store sales. Initially, the company had been expecting same-store sales to rise between 1% and 3%. They later downgraded that to -0.4%. Thursday’s results confirmed the downgrade—Q3 same-store sales fell by 0.4%, but adjusted for currency, same-store sales were flat.
Now for their Q4 guidance (bear in mind that Q4 is nearly half over). BBBY sees same-store sales rising by 0% to 2%. They see earnings coming in between $1.72 and $1.86 per share. That’s actually not as bad as it could have been. Wall Street had been expecting $1.85 per share, but I suspect a lot of people on the Street had been expecting a much larger miss.
Since the company has already made $3.19 per share for the first three quarters of its fiscal year, the current guidance works our to a full-year range of $4.91 to $5.05 per share. That’s compared with $5.03 per share last year. Basically, the company has been having a flat year, which is also what much of the rest of the corporate world has had.
I should also mention share buybacks. BBBY has been gobbling up its own stock at a pretty fast clip. Diluted share count is down 11% in the past year. That certainly makes the per-share results look better. Some people think this is somehow cheating. I don’t see why, as long as your cash flow keeps on flowing. Still, I’d prefer the company pay out a cash dividend.
To be clear, Bed Bath & Beyond is having some business trouble, but they’re not in dire straits. Going by Thursday’s close of $46.51 meanings the company is going for about nine times this year’s earnings. The important news here is that same-store sales growth seems to have bottomed out. Bed Bath & Beyond remains a buy up to $53 per share.
Preview of Fourth-Quarter Earnings Season
Fourth-quarter season kicks off next week. This is an important one for Wall Street, because it could snap our four-quarter streak of declining earnings. I usually discount Wall Street’s consensus earnings projections, except in the very near term.
Wall Street currently expects the S&P 500 to report earnings of $29.00 per share. That’s the index-adjusted figure (every one point in the S&P 500 is worth about $8.7 billion). That would give an increase of 8.41% over Q4 of 2014. Earnings had fallen in the previous four quarters by increasing amounts: 5%, 6%, 11% and 14%.
Despite the expected rebound for Q4, it looks like earnings slightly fell last year. For all of 2015, operating earnings are expected to drop by 5.9%. Yet if we ignore energy, then earnings rose by 5.7%. The pain isn’t over for energy. For Q4, the Street expects earnings in the energy sector to fall by 59%. That’s on top of a 28% earnings drop for the previous Q4.
Given that oil fell this week to a 12-year low, I expect pain in the energy patch to continue awhile longer. On Thursday, the spot price for West Texas Crude closed at $33.26 per barrel. Dear Lord! In last 19 months, oil has dropped by almost 70%. Crude is now at its lowest price since February 11, 2004. Oil is also lower than where it was when it peaked during the energy crisis 36 years ago.
For 2016, Wall Street now expects the S&P 500 to earn $125.56 per share in 2016. That would be an increase of more than 18% over 2015’s bottom line. It also means the index is currently going for about 15.5 times this year’s earnings estimate. I wouldn’t say that’s obviously overpriced.
Wells Fargo Is a Buy up to $56 per Share
Shares of Wells Fargo (WFC) have been taking a surprising beating recently. The shares are down six days in a row, for a loss of nearly 9%. I say that this is surprising because Wells is normally such a steady stock.
The company is due to report Q4 earnings before the opening bell next Friday, January 15. Wall Street currently expects Wells to report earnings of $1.03 per share, which is only a one-penny increase over Q4 from 2014.
I’ve said many times that I think Wells is the best large bank in America. Unfortunately, this has been a tough environment for banks. It’s tough to make a living in a low-rate world. Also, Wells has had some bum loans in the energy sector.
On the plus side, the slowly improving economy has helped its community-banking unit. Mortgages have been a drag, but that ought to get better. Wells is in much better shape than most banks. This report should reflect a quiet quarter for Wells, which is good as far as I’m concerned. Good banking is boring. Wells Fargo remains a buy up to $56 per share.
Current Buy List Bargains
Thanks to the recent downturn, there are several compelling values on our Buy List. I especially like Ford Motor (F) below $13 per share. Ford currently yields 4.7%. Look for good earnings later this month.
I also like AFLAC (AFL) below $58 per share. The duck stock gets hurt by the strong yen, but they’ve shown how resilient their business is. AFLAC is going for about nine times 2016’s earnings.
Wabtec (WAB) looks quite good below $65 per share. The stock is down by more than one third since this summer. I’m expecting decent earnings.
Biogen (BIIB) is a nice value if you can get it below $290 per share. It’s one of the best names in a very weak sector. Don’t let the high share price scare you.
That’s all for now. I’m writing this on Friday morning ahead of the big jobs report. Now that the Fed has already raised interest rates, I think the monthly jobs reports aren’t quite as important as they were before. Still, the Street will be paying close attention. The current estimate for nonfarm payrolls is for an increase of 200,000. There’s a very good chance the unemployment rates dipped below 5% for the first time in eight years. 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
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