February 26, 2016
“The laws of probability, so true in general, so fallacious in particular.”
– Edward Gibbon
The stock market has finally been acting better. After one of the worst starts to a year in history, the bulls have recently gained the upper hoof. In the last nine trading sessions, the S&P 500 is up nearly 7%.
On Thursday, the index closed above its 50-day moving average for the first time this year. The S&P 500 went 38 straight days below its 50-DMA, which is the longest such streak in more than four years. The index is now at its highest level in seven weeks.
So far, the stock recovery is being led by a lot of defensive names. The consumer-staples sector just touched a new high, and many of our Buy List stocks are rallying as well. Fiserv is at a new 52-week high, and stocks like CR Bard and Stryker have rebounded in recent days. Heck, even Bed Bath & Beyond is doing well!
Still, I’m not ready to say that all is well, but there are signs for optimism. In this week’s CWS Market Review, I’ll survey some of the recent economic news, which has been encouraging. I’ll also highlight the good earnings report from HEICO, one of this year’s new stocks. I’ll also preview next week’s earnings report from deep discounter Ross Stores. But first, let’s take a look at what’s in store for the economy and our portfolios.
Reasons for Modest Optimism
The first quarter of 2016 may turn out to be one of the best quarters for economic growth in years. The Atlanta Fed runs a GDP predictor, and it currently forecasts Q1 GDP growth of 2.5%. Historically, that’s not terribly strong, but it’s better than what we’ve seen in recent years. Q4 came in at just 0.7% (the revision comes out later today).
In some ways, we’ve seen the opposite trend of what we’ve had in recent years, when Wall Street prospered as Main Street struggled. Lately, Wall Street has gotten rattled, but the news for consumers is slowly getting better.
The labor market, for example, continues to improve. Weekly unemployment claims are quite good. In fact, non-seasonally adjusted claims are at their lowest level since 1973. Next week will mark 52 straight weeks that claims have been under 300,000. Next Friday, we’ll get another jobs report. While the unemployment rate has improved, the labor-force participation rate has been stubbornly low. In plain English, not enough people are out there looking for work.
To be fair, some of the decline in workforce participation is due to retiring boomers. It’s a fact that the country is getting older, but the good news is that we’re finally seeing some modest improvement in wages. In January, average hourly earnings rose by 0.5%. Higher wages lead to more consumer spending, which means more sales for businesses.
This week, the Chicago Fed said that last month, economic activity improved nationally. I was pleased to see that core inflation, which excludes food and energy, picked up a bit last month. The seasonally adjusted core inflation was the highest it’s been in ten years.
The dramatic decline in oil has distorted the overall inflation picture. Inflation expectations are very low right now. In fact, they’re ridiculously low. Here’s a startling fact: A report this week by the St. Louis Fed said that oil would have to fall to $0 by mid-2019 for it to justify current inflation expectations. I think it’s safe to say that OPEC won’t let that happen.
Shoppers Are Coming Back
Of course, I don’t want to see excessive inflation, but I’d welcome some inflation. Deflation can be dangerous, as it causes consumers to delay their shopping. A lot of retailers, like Macy’s, have been struggling, but two weeks ago, the retail-sales report finally beat expectations. That was the first time in more than a year that that report topped expectations. Retail is a key area to watch in the economy. In a bit, I’ll preview next week’s earnings report from Ross Stores. That should give us an idea of how active bargain-shoppers are.
On Thursday, the Commerce Department reported that durable goods rose by 4.9% in January. That’s the biggest increase in ten months, and it nearly doubled Wall Street’s expectation. This report stands out because the manufacturing sector has been struggling for the last few months. I particularly like the capital-goods orders excluding defense and aircraft. That rose by 3.9% in January, which is quite good. On Tuesday, we’ll get the latest ISM report, which will hopefully confirm that the brief “factory recession” is behind us.
This has been an unusual market because investors have run madly from anything perceived to be as risky, and they’ve richly rewarded any asset perceived as being sage. The 10-year Treasury currently goes for 1.7%. Now compare that to the S&P 500’s indicated divided yield, which is 2.3%. That’s the yield that S&P 500 would pay out for the coming 12 months assuming the dividends stay constant. That 60-basis-point gap is very wide, and it shows us how much investors are valuing safety relative to opportunity. This is very good news for stock investors.
The bond market is even more frightened in some overseas markets. Bond yields in Europe continue their march to 0%. The numbers here are remarkable. My guess is that Switzerland’s 30-year will be the first of that maturity to go negative. Others aren’t far behind. In France, their six-year has gone negative. In Germany, their eight-year is below 0%, and in Japan, the 10-year is in the minus column. In the U.S., our 30-year is a fat and happy 2.57%.
Interestingly, AFLAC said that it significantly boosted its investment in Japanese equities. That’s not surprising when you’re in a world or low of negative bond yields. At the end of 2014, the duck stock held just $23 million in Japanese stocks. At the end of 2015, that figure jumped to $493 million. Don’t be worried that AFLAC is getting crazy with risk. Their total portfolio is $100 billion, so their position in Japanese stocks is a barely a speck. But this shows you how companies around the world are adjusting to the global rush for safety.
The yield gap between stocks and bonds in Europe is especially wide. The estimated yield of European stocks is 4.3%, which is more than seven times higher than the average European bond yield. Investors figure that if Mario Draghi is going to be buying tons of bonds, you might as well front-run him.
We can see the rush to safety operating in several markets. For example, junk bonds have been very weak. But gold, the unrivaled store of value, has done well this year. High-beta stocks have gotten hammered, while many low-volatility stocks have been left unscathed. Consumer Staples and Telecom stocks have done particularly well lately.
Investors should continue to focus on high-quality stocks. I think that you can see some good bargains in more aggressive stocks. On our Buy List, stocks like Biogen, Cognizant and Wabtec look particularly attractive. As always, please pay attention to our Buy Below prices. Now let’s look at another solid earnings report from our Buy List.
HEICO Reports Q1 Earnings of 49 Cents per Share
After the bell on Thursday, one of our quieter stocks, HEICO Corp. (HEI), reported fiscal-Q1 adjusted earnings of 49 cents per share. That’s a 20% increase over last year. Net sales rose 14% to $306.2 million.
Across the board, this was a solid quarter for HEICO. In last week’s issue, I told you I was expecting earnings of 46 cents per share. I always enjoy being proven insufficiently optimistic on our stocks.
Laurans A. Mendelson, HEICO’s Chairman and CEO, commented on the Company’s first quarter results, stating, “Our first quarter year-over-year growth principally reflects the impact of our profitable fiscal 2015 and 2016 acquisitions, overall moderate organic growth within the Electronic Technologies Group and increased demand for certain products within the Flight Support Group’s specialty products and aftermarket replacement-parts product lines.”
HEICO also increased its outlook for this year. The company now expects sales to rise between 14% and 16%. They also expect their unadjusted net income to rise between 10% and 13%.
Unfortunately, the company didn’t provide a figure for unadjusted earnings, which is what I prefer to look at. In any event, both figures are increased from their initial guidance of 8% to 10%. We’re probably looking at full-year adjusted earnings in the neighborhood of $2.30 per share.
Let me add that I often don’t trust the adjusted earnings from companies. You’ll often see “one-time” charges that come up again and again and again. But for high-quality stocks, like HEICO and the other stocks on our Buy List, I have a lot more faith in their accounting. HEICO remains a buy up to $58 per share.
Earnings Preview for Ross Stores
Ross Stores (ROST) is due to report earnings for its fiscal fourth quarter on Tuesday, March 1. This will be for the all-important holiday shopping season (November, December and January). You’ll notice that many retailers don’t follow the typical Mar/Jun/Sep/Dec reporting cycle so they can include the entire holiday season in their fiscal fourth quarter.
Ross said they expect Q4 earnings to range between 60 and 63 cents per share. Frankly, that seems too low. I’m not sure if Ross is low-balling (which they like to do) or if they had some weakness during Q4. They see same-store sales growth between 0% and 1%. That’s down from 6% a year ago.
The shares are very close to a new 52-week high. Note that Ross is currently trading above my $56 per share Buy Below price. Don’t chase it. I want to see what the earnings are like before I adjust our Buy Below.
One last thing before I go. I want to lower our Buy Below on Signature Bank (SBNY) to $144 per share. I still Signature a lot, but I want our Buy Below to reflect some of the recent volatility among the financial stocks.
That’s all for now. Leap Day is this Monday. After that, we’ll get the key turn-of-the-month economic reports. Construction spending and the ISM come out on Tuesday. We’ll also get a look at car and truck sales. On Wednesday, ADP releases its payroll report. Then on Thursday, the Q4 productivity report is revised. That leads up to the big jobs report on Friday. Last month, we finally saw some modest gains in wages. Let’s hope that continues. 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!