March 25, 2016
“Fate laughs at probabilities.” – Edward Bulwer-Lytton
Wall Street is closed today for Good Friday, so this is a good opportunity to look at the recent sea change on Wall Street.
Stocks are up, volatility is down and risky assets are gaining in popularity. To sum it up, things have chilled out in a major way this month.
Consider that Thursday was the ninth day in a row in which the S&P 500 closed up or down by less than 1%. In the 48 days prior to that, it happened 27 times. That’s pretty frenetic trading. At that rate, 2016 was on pace to being one of the most volatile years since the 1930s.
Then it all changed. In this week’s CWS Market Review, we’ll take a closer look at what happened, why it happened and what it means for us. I also want to preview the Q1 earnings season, which is quickly coming our way. I’ll also update you on several of our Buy List stocks. I particularly want to focus on the legal issues impacting Express Scripts (ESRX). But first, let’s look at market’s impressive resiliency in the wake of terror.
Terror Fails to Scare Investors
On Tuesday, the world was shocked by the awful events in Belgium. I’ll never understand what could lead people to such senseless acts of violence.
If there’s a silver lining, at least in the world of business, it’s that the terrorist act failed to scare investors. There was a small “flight to safety” move, but hardly similar to what we’ve seen following previous attacks.
I think this is notable for a few reasons. First, let’s remember the market’s rally since the February low has been led, in large part, by riskier stocks. By that, I mean “high beta” sectors. While many “low-vol” and defensive stocks have made new highs, those stocks were largely unscathed by the market’s nasty downturn during the first six weeks of this year. It’s the riskier assets that Wall Street has returned to.
To be very blunt, the events of Tuesday gave investors an understandable reason to rotate away from risk, and they didn’t take it. That’s a very encouraging sign. I’ll give you an example. Look at the recent performance of transportation stocks.
This is a group that had a horrible 2015, and it got really bad late in the year. But Transports suddenly became hot again in January. The Dow Jones Transportation Index, now in its 132nd year, has soared 20% in the last two months. FedEx (FDX), for example, recently popped on a good earnings report. On our Buy List, shares of Wabtec (WAB), a key supplier for the rail industry, have also rebounded impressively.
After the terror attack, some airlines and travel stocks pulled back, but it was a fairly muted response. Market watchers like to keep an eye on transports for hints of the future. It’s a key cyclical sector. After all, if companies are shipping more goods, then they expect consumers to buy them. It’s not surprising that the recovery in transports has come at the same time that we’ve seen improvement in consumer spending.
Another region that’s popped back has been Emerging Markets. Stock markets in countries like Brazil, Argentina and Russia were in a world of pain last year. Now they’re suddenly hot again. This is another example of investors being willing to step up the risk ladder and take on more-volatile stocks.
The movement in Emerging Markets is often an echo of the U.S. dollar. In short, investors want to get some extra reward for venturing into Emerging Markets. But if the dollar spurts higher, then the effect is taken away, so capital flees back to America. As a result, Emerging Markets tend to move in strong waves—everybody in or everybody out. There’s not a lot of middle ground. (Of course, I’m generalizing.)
The softer dollar has helped many Emerging Markets. I was impressed to see that the Emerging Markets ETF (EEM) pulled back only a bit this week, but not as much as I expected. This is another good sign that investors are committed to weathering greater volatility.
I’ve also noticed that high yield spreads have narrowed recently. This is the premium that investors demand in order to lend to lower-grade borrowers. Part of this trend is clearly the surge in energy prices, but that’s not all of it. If the economy is improving, as the data suggest, then defaults ought to decline. This means lenders will have more confidence to fund marginal borrowers. Of course, the lower borrowing costs also help the balance sheet of the borrowers, so it can become a self-reinforcing trend.
Most importantly, the Federal Reserve is still on the side of taking more risks. The recent Fed statement seems to be a signal that the Fed isn’t in a hurry to raise rates. Traders see a 10% chance of a rate hike in April, and a 41% chance of a hike in June. I’d place those odds at 1% and 15%. So if you can’t get income from your bank account, it becomes necessary to own stocks, especially stocks with good earnings.
Now let’s look at Q1 earnings season, which is less than three weeks away.
Preview of First-Quarter Earnings Season
The first quarter comes to an end next Thursday. Shortly after that, Q1 earnings season will start. On our Buy List, Bed Bath & Beyond (BBBY) still has to report Q4 earnings. That’s scheduled for April 6. After that, Wells Fargo (WFC) will lead off our earnings season with their report on April 14. Over the following four weeks, sixteen of our Buy List stocks will report earnings. I like to say that earnings time is Judgment Day for Corporate America, and Wall Street can be render harsh verdicts.
For Q4, more than two-thirds of the companies in the S&P 500 beat expectations. That’s roughly in line with the long-term average. (Yes, that’s right. In Wall Streetistan, companies are expected to beat expectations.) But expectations had been slashed going into earnings.
As a result, last quarter was the fifth quarter in a row of declining earnings. Earnings for the S&P 500 fell by 13.8%. I should add that this is earnings per share, and that’s a metric that’s been greatly aided by share buybacks. Companies in the S&P 500 are on pace to buy back $165 billion worth of stock this quarter. During Q4, 25% of the stocks in the index reduced their share count by more than 4%.
It looks like Q1 could be the sixth quarter in a row for declining earnings. As of now, Wall Street expects the S&P 500 to report earnings of $26.11 for Q1 (that’s the index-adjusted figure). That’s a small increase of 1.6% over last year’s Q1. I should note that earnings estimates have been slashed the past few weeks, and we’ll probably see some more paring by the time earnings season begins. On the other hand, Wall Street will most likely top expectations by a predictably modest amount.
Another factor driving this earnings season is the horrible state of many energy companies. Earnings for the Energy sector are expected to be cut in half for Q1. Analysts also expect a 12% earnings decline for Financials. Outside that, the earnings picture shouldn’t be that bad. The Tech Sector is expected to show a 4% increase for Q1, and Consumer Discretionaries are expected to be up close to 10%.
For all of 2016, Wall Street sees earnings of $118.57 for the S&P 500. That’s almost certainly too high. The index earned about $100 last year, and I’m expecting around $110 for this year. Investors should continue to focus on solid companies with consistently growing earnings. Now let’s look at some current bargains on our Buy List.
Buy List Updates
Like the rest of the market, our Buy List has shaken off a poor start to the year, and we’re close to being in the black for 2016. Stocks like Fiserv (FISV) and Stryker (SYK) have recently made new highs, and CR Bard (BCR) came close to breaking $200 per share for the first time in six months.
Be sure to take notice of my Buy Below prices. The rule is simple: any time a stock is below its Buy Below price, I consider it a buy. It’s not a price target, since I change these prices frequently.
One Buy List stock that looks particularly attractive at moment is Biogen (BIIB). Don’t be alarmed by the biotech’s poor start to the year. I’m looking forward to a good earnings report from Biogen on April 21.
My Buy Below for Cerner (CERN) is $58 per share. I’m going to keep it there, but the stock is an especially good buy if you can get it below $52 per share.
I also like Signature Bank (SBNY). If you can pick up SBNY below $140, then you made a good move.
Let’s look at some recent news affecting our Buy List stocks.
Oppenheimer downgraded Fiserv (FISV). That’s nothing to worry about. I’m looking forward to another good earnings report.
UBS shocked Wall Street by initiating coverage of Wells Fargo (WFC) with a Sell rating. No one ever says Sell! UBS says Wells faces several headwinds impacting all banking. I can’t disagree, but the bank has solid management and the valuation is still quite reasonable. Of all the stocks on our Buy List, Wells Fargo is one of the least to worry about.
Warren Buffett recently said that Mark Fields, Ford’s CEO, is doing an outstanding job. I agree. Here’s an interesting extended interview Henry Blodget recently did with Fields.
The war between Express Scripts (ESRX) and Anthem (ANTM) doesn’t appear to be cooling off. This week, Anthem filed a lawsuit in an attempt to recover what they claim were excess charges. Anthem is ESRX’s largest customer.
This feud has been going on for a few weeks, and you just knew somebody was going to throw down a lawsuit. I had thought Anthem’s public whining was part of the negotiating process. Unfortunately, the relationship may be in worse shape than I imagined.
Anthem has been throwing around pretty outrageous figures for damages, but that happens in most lawsuits. Tim Wentworth, the incoming CEO for Express, said he’s committed to keeping Anthem as a client. As I look at it, I think it would be too much of a hassle for Anthem to ditch Express, but I also don’t see the need for these theatrics. I still lean towards Anthem staying with Express, but it’s not unthinkable for them to part ways.
That’s all for now. The first quarter comes to an end next Thursday. On Monday, we’ll get the personal-income report for February. On Wednesday, ADO will release its private-payroll report. Friday will be a busy day for economic reports. We’ll get the latest construction-spending report and ISM report. It’s also Jobs Day. The last report should show unemployment to be at a eight-year low. 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!
P.S. Good news! We’re moving ahead with our plans for an ETF based on our Buy List. But we need to gauge the level of interest. Please take a moment to fill out this brief survey. Thank you!