March 11, 2016
“Patterns are the fool’s gold of financial markets” – Benoit Mandelbrot
This week marked the seventh anniversary of the start of the great bull market. Of course, we haven’t made a new high in more than nine months, so it’s possible that the bull market may already have ended. Traditionally, that comes with a 20% drop from the old high, which we haven’t hit yet. Still, it’s worthwhile to reflect on how impressive this long rally has been.
I’ve often referred to this bull market as “the world’s most hated bull market.” This is an important lesson for investors that ultimately, the market will do what it wants, and it can make fools of us all. That’s why, around here, we play for the long game.
The big news this week came from Europe where Mario Draghi decided to bring out the big guns to get the Eurozone economy moving again. There are still a lot of doubters out there. I’ll also preview next week’s Federal Reserve meeting. Don’t expect Janet and her friends on the FOMC to raise rates, but they may provide clues for the game plan for the rest of 2016. I’ll also update some of our Buy List stocks. But first, let’s look at the bull market’s seventh birthday.
The Bull Market Turns Seven: What Have We Learned?
On Monday, March 9, 2009, the S&P 500 closed at 676.53. That was the index’s lowest close in more than twelve years. On the previous Friday, the index reached its devilishly-low intra-day price of 666.79.
At the time, the outlook was very grim. The financial crisis had hit a few months before. The economy was in free fall. That Friday morning, the Labor Department reported that the U.S. economy had shed an astounding 651,000 jobs in February. That was on top of massive losses in December and January. I can’t remember a time when things looked so bleak.
But now, in retrospect, we can see the truth—that this was one of the greatest buying opportunities in decades. That’s not an exaggeration. The numbers bear this out. But think of the courage investors needed to look past the terrible news. More than four months before, Warren Buffett wrote in the New York Times, “Buy American. I Am.” Even Grandpa Capitalism couldn’t spark a rally. The market promptly fell another 28%.
It seemed like there was no end. Investors were still very afraid. I’ll give you two examples. At the market’s low, the Volatility Index was near 50, and the Ted Spread was still over 1%. Yet, despite all the worrying, the market soon started to climb. And climb and climb. Even as more bad news came out, the market still climbed higher. It’s really true; the market does indeed climb a wall of worry.
Here’s another important lesson for investors: At the start of market rallies, it’s common to see the market’s Price/Earnings Ratio rise even though the market is actually very cheap. That’s because the market looks ahead a few months. So even as corporate earnings are still lousy, stock prices anticipate a recovery. The P gets higher even though the E is crashing. I remember many investors shied away from the initial stages of the rally because they expected it to fall apart. Just as it had every other time.
Many pundits deemed the whole thing phony since the market was being propped up by the Federal Reserve. They expected that once the Fed shut off the printing press, the house of cards would soon crumble. Like Linus in the pumpkin patch, they waited and waited for the Great Reckoning.
This week, one experienced market pro said that there’s a 100% chance of a recession in the next 12 months. Not 90% or even 99%, but 100%! Count me as a skeptic, but I’ll give him credit for giving us a time horizon. I’ve always noticed that these doom-and-gloomers are very specific on what will happen (disaster!!) but they’re often quite vague on exactly when (soon I tells ya!!).
But this pattern has been common in Wall Street history—bad headlines are great opportunities. After Pearl Harbor, the stock market didn’t rally. As people realized the immense task before them, the market sank lower. Not until April 1942 did the stock market hit bottom. Interestingly, the market rallied before the Allies racked up major victories on the battlefield. Instead, the market turned on optimism and expectations.
Again we can turn to Mr. Buffett for guidance, “I will tell you the secret to getting rich on Wall Street. You try to be greedy when others are fearful. And you try to be fearful when others are greedy.”
From the closing low on March 9, 2009, the S&P 500 tripled by November 2014. Measuring from the low to the closing high on May 21, 2015, the S&P 500 gained 215% in a little over six years—and that doesn’t include dividends. The S&P 500 Total Return Index, which includes dividends, gained 259% over that same span.
You may be expecting me to say that our Buy List did even better than the rest of the market. You are correct. Our Buy List dramatically outperformed the market, especially during the early phase of the rally. We beat the market for seven straight years from 2007 through 2013. We did this by concentrating on good stocks, not on trying to pick exact tops and bottoms. It’s an old lesson that has proven itself time and time again. Now let’s look at the latest news from the European Central Bank.
Mario Draghi Goes All In
On Thursday, Mario Draghi, the head of the European Central Bank, ripped out the kitchen sink and threw it at the European economy. That’s a metaphor but it’s not much of a stretch.
The ECB is cutting interest rates again, which are already negative. They’re now even more negativer. The ECB is also stepping up its bond-buying program by 20 billion euros a month. Plus, the bond buying has been expanded to include corporate bonds.
So you’d think the euro would have dropped on world markets, right? That makes perfect sense. But on Planet Wall Street, the euro actually rallied! The fight we’re witnessing in Japan and Europe, and to a lesser extent in the United States, brings up an interesting issue. Perhaps we’ve reached the limit of what a central bank can do. The concern is that banks in Europe are hoarding their cash and they just need some incentive to start lending again.
The reality is that Europe has been behind the U.S. as authorities here responded earlier and more aggressively to an anemic recovery. Bond yields in Europe are already low, and in some cases, they’re absurdly low. One of my favorite stats is that five years ago, the five-year yield in Ireland was going for 17%. Now it’s negative.
I won’t yet pronounce on the wisdom of Draghi’s decision, but I will note that credit conditions have slowly improved in Europe. Later on, I’ll tell you about Ford Motors’ strong sales report from Europe. Ultimately, what Europe needs now is some time to regain consumer and investor confidence. This was a bold move by Draghi, and it might be the one that finally works.
Preview of Next Week’s Federal Reserve Meeting
Keeping with the topic of central banking, let’s switch to our Federal Reserve. On Tuesday and Wednesday of next week, the Fed gets together again in Washington. It’s very unlikely that the Fed will raise interest rates. But when the Fed issues the latest policy statement, the central bank will update its projections for the economy and interest rates. Unfortunately, I have to mention that the Fed’s track record has been bad. Even for economists, they’ve been bad.
Still, what stands out is how much more aggressive the Fed is compared to expectations. Many members of the Fed expect to raise rates a few more times this year. The futures market doesn’t buy it, and neither do I. The futures market expects another rate hike in September. Bear in mind that the U.S. Federal Reserve is the only central bank in the developed world whose last rate change was a hike. Everybody else, without exception, has cut. There are even some folks, including some inside the Fed, who wouldn’t mind a rate cut.
The key to watch is inflation. To reiterate a theme I’ve laid out before, I think it would be very good for the investing climate to see a modest amount of inflation. That would steer the U.S. economy clear of deflation. It would also give the Fed some room to raise rates.
Next week, the government will release the inflation report for February. This will be an interesting report because the core inflation rate for January was the highest since 2006. That may be a one-off, but it could be the start of a healthy trend. On top of that, oil prices have recovered. It’s interesting to note how closely tied oil and the stock market have been. This tells me that stocks aren’t afraid of a little inflation.
The S&P 500 has cracked 2,000 again a few times in this past week. Even though the market is still down for the year, a majority of stocks in the index are positive YTD. This tells us that the market is broadening out. That’s usually a good sign. We’ve also seen defensive sectors like Consumer Staples, Utilities and Telecom touch new 52-week highs. The next level to watch for is 2,020 which is the S&P 500 200-day moving average. We haven’t been above that all year. Now let’s look at some recent news from our Buy List.
Buy List Updates
On Tuesday, Cerner (CERN) announced that its board had approved a $300 million share buyback. The company estimates that it will repurchase 1.7% of their outstanding shares. Personally, I’d rather see that money paid out to shareholders as dividends. Still, it’s good to see shareholders get rewarded in any form. Cerner remains a good buy up to $58 per share.
This week, Goldman Sachs downgraded Ross Stores (ROST) from buy to neutral. Don’t be too concerned by this downgrade. Wall Street firms frequently change their ratings on stocks. The move is more a reflection of how well Ross has done. Remember that the deep discounter fell 23% last fall. We held on. Not only did Ross make up all the lost ground, but the stock broke out to another 52-week high on Monday, prior to the downgrade. Ross Stores remains a good buy up to $60 per share.
When you have a diversified Buy List, you never know which stock is going to go on a run. Consider the case of Stryker (SYK). The orthopaedics company raised its full-year guidance three times last year. In December, they raised their dividend by 10%. Yet the stock didn’t do much during the latter part of 2015. SYK fell from a high of $105 in August down to $86 by January. Lately, that’s changed. The stock broke $104 this week, and it’s very close to making a new high. This week, I’m increasing my Buy Below on Stryker to $105 per share.
On Thursday, Ford Motor (F) reported very good European sales results for February. Sales in Europe rose by 17% compared with last year. The automaker increased its market share to 7.3%. The company has wisely been focusing on less-expensive models that sell better in Europe. Ford is a buy up to $13 per share.
That’s all for now. The Federal Reserve meets next week on Tuesday and Wednesday. The policy statement will be released on Wednesday afternoon. The meeting will be followed by a press conference by Janet Yellen. Also on Wednesday, we’ll get the inflation report for February. The last core inflation report was the highest in nearly ten years. I’m curious to see if this is the start of a stronger trend. 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!