CWS Market Review
June 24, 2016
“The second Vice is Lying; the first is running in Debt.” – Ben Franklin
I’m writing this to you early on Friday, and the big U.K. Brexit vote is still up in the air. Going into the vote, traders had been expecting a victory for Remain, which helped pushed the S&P 500 to within 1% of its all-time high. The index has now gone 54 days in a row without a 1% drop.
The buoyant market is also helping to lift some of our favorite Buy List stocks. Just this week, both Stryker and CR Bard made new 52-week highs. They’re turning into big winners for us this year. Thanks to the strong Japanese yen, shares of AFLAC just broke out to a new all-time high. The duck stock is a now a 20% winner on the year for us. I don’t think many people on Wall Street were expecting that.
In this week’s CWS Market Review, I’ll discuss this week’s earnings report from Bed Bath & Beyond. It wasn’t as good as I had hoped. I’ll have all the details in a bit. Also, Janet Yellen also went to Capitol Hill to give her semi-annual monetary policy testimony. I’ll focus on what she said, and what it means for us. But first, let’s look at the Brexit vote and how it’s impacting world markets.
The UK Votes
I tried to get the most current news on the Brexit Referendum for this issue, but I had to call for a deadline at some point, so some of this may already be dated. The vote simply appears to be too close to call. The initial news suggested that Remain was going to pull it out, but the early results indicate that it’s all up in the air.
As usual, I’ll withhold my political opinion on such matters, but I will address the investment implications. Financial markets were clearly nervous leading up to the big vote. A Leave decision, it’s believed, will cause a recession, and some damage will spill over to U.S. markets. Honestly, that’s probably overhyped, but rhetoric around political campaigns tends toward stoking fears. Since a Remain win had been expected, a Leave victory will probably unravel the market’s recent moves.
Every time a poll came out showing Leave ahead, the British pound would drop against the dollar and other major currencies. Then, quite suddenly, over the last few days, the British pound started to rally strongly. The pound jumped from roughly $1.40 to $1.50 in just a few sessions. This was a sign that world markets expected Remain to pull it out. Every rumor or new poll sent the pound careening back and forth. The implied volatility involved in betting on the pound reached the highest levels since the financial crisis.
As I’m watching the latest results, the pound is bouncing up and down like a tech stocks from the 1990s. With this vote, there’s a large asymmetry. That’s a fancy way of saying that a Remain victory would be taken in stride, while an Exit win would freak everybody out. That’s actually quite common with investing. The Great Rule of investing is that things crash quickly, and recover slowly. In fact, by the time people realize that something bad is happening, it’s probably too late. In this case, the Exit forces were in full view.
As I write this, the S&P futures are down about 1.3%, which basically erases the entire gain from Thursday. As I said, these results aren’t final. The BBC reports that the Electoral Commission will have their results on Friday, “around breakfast time,” which may be the most British thing ever.
I don’t think a Brexit victory would hurt the U.S. economy, but it could spur other countries to ditch the EU. George Soros, who famously broke the Bank of England in 1992, said the pound could fall 15% to 20%. I would also expect money to flee to the perceived safety of U.S. assets.
My advice is don’t panic. Either result should have minimal effect on our Buy List stocks. I’ll have more to say once the outcome is clearer.
Yellen Still Sees the Need for Rate Hikes
This week, Janet Yellen headed to Capitol Hill to give her semiannual testimony on monetary policy. This comes after last week’s Fed meeting, in which the central bank decided to forgo raising interesting rates.
I’ll briefly summarize her comments. Yellen said that the pace of improvement in the jobs market has slowed down. While she was careful to say that it may not be the start of a larger trend, there does seem to be evidence that wage growth is picking up. If so, that would be very good news.
Yellen also noted that the strong dollar has weighed down the economy in recent quarters. That’s certainly been evident in the financial markets. (You may remember how much I spoke of the Strong Dollar trade.) Recently, business investment has been quite weak. On the plus side, Yellen said that Q2 GDP will probably be better than Q1, and that consumer spending appears to be rising.
Overall, Yellen said she’s optimistic for the economy, and she believes that gradual rate hikes may be needed. Hmmm. I’m not so sure about that, and the market doesn’t buy it either. Inflation is still quite low. Yellen also mentioned that the Chinese economy isn’t as healthy as it could be. That’s undoubtedly true.
Just look at the futures market. Traders currently think there’s a 63% chance the Fed will hold rates steady through the next three meetings. I would also think the pressure to do nothing will grow as Election Day gets closer. The yield on the two-year Treasury is currently at 0.78%. Sure, that rate has tripled in the last three years, but it’s gone from next to nothing to barely above next to nothing. The markets are clearly not concerned with any rate hikes.
With yields so low, the focus remains on stocks. In a few weeks, Q2 earnings season will begin. For the first time in a while, operating earnings are rising. The upcoming earnings season is projected to break our six-quarter run of lowering earnings.
According to S&P, analysts on Wall Street expect the S&P 500 to earn $28.41 for Q2. That’s the index-adjusted number. The estimate is down from $31.02 at the start of the year. Wall Street now expects the S&P 500 to earn $114 this year, and $134 for next year. Based on trailing earnings, the stock market looks a bit pricey. However, analysts expect this profit recession to end. If the profit estimates for next years are anywhere close to accurate, then the stock market is still quite reasonable.
Sluggish Quarter for Bed Bath & Beyond
We had one Buy List earnings report this week. After the closing bell on Wednesday, Bed Bath & Beyond (BBBY) reported fiscal Q1 earnings of 80 cents per share. That’s down from 93 cents per share for last year’s Q1. Wall Street had been expecting 86 cents per share.
This is not a strong report. Net sales were almost exactly the same as last year, while comparable-store sales fell by 0.5%. Digging into comparable-store sales, those from digital channels grew by over 20%, while in-store sales were down in “the low single-digits.”
One bright spot is that the company continues to buy back tons of its own stock. In the past year, shares outstanding dropped by 10%. You can expect the share count to continue to shrink. The company still has over $2 billion left in its current authorization. Bed Bath is also standing by its full-year profit range of $4.50 to $5 per share. Previously, they had said they expected to be at the high end of that range. Now they say they’ll be “comfortably within” that range. I’m not sure if that counts as lower guidance.
The shares dropped 5% in Wednesday’s after-hours market. Fortunately, the bears ran away in time for Thursday’s trading, as shares of BBBY gained 1.5%. I think the earnings call assuaged some investor fears. For example, the company seems to be very optimistic about its recent acquisition, One Kings Lane. On the conference call, Bed Bath updated its assumptions for the rest of this fiscal year. They expect comparable store sales to grow by 0% to 1%.
I also think there’s the simple fact that the negative sentiment was so strong that just about any news would be seen as positive. Quite frankly, I’m disappointed with Bed Bath’s performance. Perhaps there needs to be more pressure from shareholders to shake up management. I could be wrong, but I believe this is the first time they’ve taken questions on an earnings call. If I don’t see better performance here, I doubt BBBY will return to next year’s Buy List.
Top Buy List Bargains and New Buy Below Prices
I wanted to highlight a few Buy List stocks which I think look particularly attractive at the moment. I really like Ford Motor (F) below $13.50. It pays a generous dividend, and I expect a good earnings report in a few weeks. I also like Cognizant Technology Solutions (CTSH) here. This stock can move fast. In the banking sector, I really like Signature Bank (SBNY) when it’s below $135 per share. The bank has delivered 26 record quarters in a row.
Since this has been a fairly quiet time for our Buy List, I wanted to adjust a few of our Buy Below prices this week. Biogen (BIIB) continues to be weak, but I’m expecting a decent earnings report. This week, I’m lowering my Buy Below on Biogen to $265.
I also want to pare back Wabtec’s (WAB) Buy Below from $87 to $83. This isn’t a negative for either stock. I simply want the Buy Below prices to reflect the market’s current activity.
With Stryker’s (SYK) new high, I’m going to lift its Buy Below from $114 to $122 per share. Stryker is up 27% for us this year. I’m also going to raise our Buy Below on Fiserv (FISV) to $110 per share.
I also wanted to touch on AFLAC (AFL). As the yen has gained ground, the duck stock has quacked higher. When the yen was getting smacked around in 2014-15, I cautioned investors not to read too much into it, and that AFLAC is a well-run company. Now that we’re getting rewarded by forex, I still hold the same view.
AFLAC based this year’s earnings estimate on the yen’s being at 120.99 to the dollar. It’s now down to 104, and there’s talk of it soon breaking 100. Based on that 120.99 figure, AFLAC gave a full-year earnings range of $6.17 to $6.41 per share.
Basically, for every one yen the Japanese currency strengthens against the dollar, meaning the ratio goes down, three cents per share are added to AFLAC’s full-year profits. I estimate the yen has averaged 112 this year. That translates to a 27-cent headwind.
The shares tested $70 for several weeks in May and June, and have finally burst through. The duck stock came close to touching $72 per share on Thursday. AFLAC remains an excellent company.
That’s all for now. The first half of the year comes to a close next week. I’ll have a summary of our performance in next week’s issue. On Tuesday, the government will again revise its estimates for Q1 GDP growth. The last report said the economy grew by just 0.8% during the first three months of the year. We’ll also get key reports on personal income and spending. The big jobs report won’t be until the following Friday, July 8. 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!