January 15, 2016
“Planet Earth is blue and there’s nothing I can do….”
This is easily the worst start to a year in stock market history, and on Thursday, it somehow managed to get even worse. The S&P 500 broke below 1,880 before a dramatic reversal pushed the index to 1,921.84 by the closing bell.
Unfortunately, we’re still in the midst of the storm. The good news, however, is that we’re still in the midst of the storm—meaning the mass selling has led to a lot of good values out there (Biogen at $180!). I’ll give you some examples later on.
In this week’s CWS Market Review, I’ll go into more detail on Wall Street’s latest bout of the willies. Investors need to understand that there’s been a giant divide between “high beta” and “low vol” stocks. I’ll explain what it all means.
I’ll also cover some good news from our Buy List. Ford Motor (F) just announced a special 25-cent dividend. Cognizant’s (CTSH) stock popped this week after the company reiterates its earnings forecast. Also, Stryker (SYK) raised its full-year earnings forecast for the third time. But first, let’s look at the growing divide on Wall Street.
The High Beta Bear
There’s a reason I avoid making short-term forecasts, because I could have never anticipated such a poor start to 2016. In last week’s CWS Market Review, I explained how nervousness stemming from China’s money problems had spooked investors. I noted that despite China’s size, it truly doesn’t have a major impact on our economy.
That didn’t stop the bears. They took full advantage of the scary headlines to cause a mad rush for the exits. Since December 29, the S&P 500 is down 7.5%. Traditionally, a market “correction” is defined as being a drop of 10%. Measuring the S&P 500’s May high, the correction line is at 1,921.25. We dipped below that in August and we did it again this week. Interestingly, Thursday’s close was just barely above the 10% correction line. (There’s always somebody playing these relationships.)
But what’s interesting about the current market is how divided it is. Energy and Materials stocks are still doing very poorly. The average stock in the S&P 500 is 24% below its 52-week high. That’s bad, but for the energy sector, the same number is 56%.
The Energy ETF (XLE) is nearly half of what it was 18 months ago, and it’s no surprise why. It’s not that oil has plunged; it’s that it can’t seem to stop plunging. This week, West Texas Intermediate fell below $30 per barrel for the first time in 12 years. In the last 15 months, oil is down 70%. Crude finally closed higher on Thursday, which snapped an eight-day losing streak. So much of the world economy is based on oil revenues of X. We now know that in reality, those revenues will be 0.3X. Let’s just say that the realization won’t be smooth.
This impacts the equity markets in several ways. I like to watch small-cap indexes because they tend to be skewed towards domestic manufacturers. Wow, these little guys have been taking a beating. Since the Russell 2000 peaked on June 22, it’s lost 22%. That’s double the loss of the S&P 500.
We can drill down another level by looking at the huge and growing divide between high beta and low vol stocks. But first, a small digression.
(Enter Professor Elfenbein.)
A beta measures a stock’s risk relative to the entire market. So if a stock has a beta of 1.2, it will rally 1.2% for every 1% the market rallies. Conversely, it will fall 1.2% for every 1% the market falls.
The theory is that High Beta stocks are riskier and will outperform the market. In a sense, an investor needs to “buy” better returns by shouldering more risk. It’s a beautiful theory, and it won the Nobel Prize.
But there’s a small problem—it doesn’t work. There’s no correlation between a stock’s beta and its return. Actually, that’s not quite right. There is a correlation, and it’s negative. Over the long haul, stocks with low betas, so-called low vol stocks, have done the best.
That’s why I like to watch the relationship between the S&P 500 High Beta ETF (SPHB) and theS&P 500 Low Vol ETF (SPLV). The divergence lately has been astounding. The high-beta names have been getting clobbered, while the low vol stocks haven’t been hit that hard. In the chart below, notice how dramatically the black line (SPHB) fallen in the last few weeks. SPHB is currently 29% below its 52-week high, while the low vol is only 6% off its high.
Even stalwart names like Apple (AAPL) and Walmart (WMT) are down more than 25%. But some consumer stocks like Coke (KO), McDonald’s (MCD) and Kellogg (K) are still less than 5% off their high. Just looking at the overall market doesn’t tell us the whole story.
We can see this effect on our Buy List, as stocks like Hormel Foods (F) have largely sidestepped the bear. But even conservative industrials like Wabtec (WAB) have been taken down. It’s really about where you stand in the economy, and how exposed you are to plunging commodity prices.
Here’s my view: I don’t think this divergence can last, and I expect to see high beta areas like biotech regain some love. On our Buy List, I particularly like Biogen (BIIB), Ford (F) and Snap-on (SNA). I know Ford has been a painful ride, but all value stocks start out as unloved losers. Speaking of Ford, let’s look at this week’s news from the automaker, and a few other of our Buy List stocks.
Buy List Updates
Thanks to the market’s recent headache, many of our Buy Below prices are out of date. But with earnings season so close, I want to hold off on adjusting our prices until I have a chance to see how well our companies did last quarter. I think it’s very likely that many of the beaten-down names will bounce back quickly.
On Tuesday, Ford Motor (F) announced that it’s paying out a special 25-cent dividend to shareholders. This is in addition to the company’s regular 15-cent quarterly dividend. This means that going by Thursday’s closing price, Ford yields nearly 7% for the coming 12 months. That’s a very nice deal. The special dividend will be paid on March 1 to shareholders of record on January 29.
More than a few Wall Streeters dismissed the special dividend. They think it’s an admission from Ford that the auto cycle is about to turn lower. The belief is that Ford opted to pay out a special dividend in lieu of raising its current dividend, as GM recently did. Call me a doubter on that one. Ford easily could have bypassed a dividend altogether.
Wall Street was also unnerved by Ford’s guidance for 2016. Personally, I don’t think the guidance was so bad. Ford said they expect 2016’s profits to be equal to or better than 2015’s. For 2015, they see pre-tax profits coming in in the upper half of their range of $10 billion to $11 billion.
“As we close out 2015, we are benefiting from six consecutive years of consistently strong results, and our performance is allowing us to reward our shareholders,” said Mark Fields, Ford president and CEO. “This pattern of strong returns gives us a great platform to build on as we enter the year with a focus on strengthening our core business and engaging aggressively in emerging opportunities through Ford Smart Mobility.”
I understand the apprehension, but Ford has done a commendable job. The company is also much healthier in fiscal terms. In fact, they could initiate a big share buyback if they wanted to. I still think the long game is on Ford’s side. Look for a good earnings report on January 28.
Cognizant Technology Solutions (CTSH) is our top-performing stock this year! But don’t get too excited. CTSH is sitting on a measly 0.31% YTD gain, and it’s our only Buy List stock in the black, which shows you how unpleasant the past two weeks have been.
But Cognizant had very good news this week. The company reported that it hasn’t been materially affected by the horrible flooding in Chennai, India. The best news is that Cognizant reports that all of its employees are safe.
Cognizant also stuck by its 2015 full-year earnings forecast for earnings of at least $3.03 per share. It also reiterated its guidance for revenue of at least $12.41 billion. The stock jumped more than 6% on Tuesday, and pushed even higher on Thursday. The shares broke above $60 for the first time this year. The company usually reports Q4 earnings during the first week of February. I expect more good news.
I wanted to follow up on Bed Bath & Beyond (BBBY). Last week, we learned that the home-furnishings company earned $1.09 per share last quarter. That was basically what we expected. The stock, however, continues to sink lower. On Thursday, in fact, BBBY dipped below $44 per share.
Let’s take a step back and remember that BBBY expects earnings of $4.91 to $5.05 per share for this year (ending in February). It’s early, but I think they should be able to earn $5 per share next year. One of the best valuation metrics is Enterprise Value/EBITDA. (I did a post on the subject). For BBBY, the ratio is down to 4.89, which is very inexpensive. Don’t give up on BBBY.
We also had good news from Stryker (SYK). After the closing bell on Tuesday, the company narrowed its full-year range for 2015. The previous range was $5.07 to $5.12 per share. Now it’s $5.09 to $5.12 per share. By my count (and I could be missing one or two), this is the third time Stryker has revised its full-year guidance.
In January, the initial guidance was $4.90 to $5.10 per share. Then in April it went to $4.95 to $5.10 per share. In July, Stryker brought it up to between $5.06 and $5.12 per share. In October, they raised the low end by one penny per share, and now in January, they’ve raised it by another two pennies. Stryker’s earnings will be out on January 26.
The bad news for our Buy List came from Express Scripts (ESRX), or more specifically, it came from Anthem (ANTM). This week, Anthem threatened to ditch Express Scripts unless it can pass along major cost savings. Anthem’s CEO used the figure of $3 billion. C’mon! This is absurd, and everyone knows it.
I think Anthem is simply using this as a negotiating tactic. But it was enough to rattle investors. Shares of ESRX fell nearly 7% on Wednesday. Ironically, Anthem is making a big fuss over this because they want to do a deal with Express. One analyst estimates that Anthem accounts for 14% of Express’s $100 billion annual revenue. This Anthem news shouldn’t be a major concern for us, but I hope it gets resolved soon.
We have one Buy List earnings report coming next week. Signature Bank (SBNY) is due to report on Wednesday, January 20. Wall Street expects $1.93 per share. Guess what? They’ll beat that. SBNY is particularly attractive below $140 per share.
That’s all for now. The stock market will be closed on Monday in honor of Dr. Martin Luther King’s birthday. Get ready for more earnings reports next week. On Wednesday, we’ll also get the CPI report. We already know commodity prices have been falling, but I’ll be curious to see if there’s been any sizeable increase in the “core” inflation, which excludes food and energy. I doubt it, but an increase could lead the Fed to be more aggressive this year. 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!