CWS Market Review
November 11, 2016
“We’re blind to our blindness. We have very little idea of how little we know.
We’re not designed to know how little we know.” – Daniel Kahneman
Wow! That was a shocker. I have to admit that I didn’t think Donald Trump would win the election. Please don’t mistake that for a political opinion. I simply took the pollsters’ word for it.
But it wasn’t just the pollsters who were wrong. It was the pundits, the media, and Wall Street as well—and the wrong calls kept coming. On Tuesday night, world markets plunged on the news of Donald Trump’s victory.
At one point in the overnight markets, futures for the Dow were down 862 points! In the New York Times, Paul Krugman wrote, “If the question is when markets will recover, a first-pass answer is never.”
A second-pass answer would be, a few hours later, because by morning, the bears were nowhere to be found. On Wednesday, the Dow rallied 257 points, plus another 216 points on Thursday, to close at an all-time high. In the space of 18 hours, we went from President-elect Hillary to President-elect Donald to worldwide crash to new highs.
In this week’s CWS Market Review, I’ll try to make sense of it all. I’ll also cover the good earnings report we got from from Cognizant Technology Solutions. Plus, I’ll preview the upcoming earnings report from Ross Stores. But first, let’s look at these eventful few days.
Trump Stuns the World
One of the benefits of being in the stock market biz is that it forces pragmatism on you. As a result, I have no time for broad theories on how the market ought to behave, or what “fair value” truly is. Contrary to what many people think, investing isn’t about being able to predict the future.
It’s odd that this needs stating, but predicting the future is impossible. Time and time again, experts come along with reams of data and bold predictions about what’s going to be—and they routinely fall flat on their faces. In ancient times, people read entrails; now we have pundits.
I’ll get to the election in a second, but it’s not just pundits. No one at the Fed saw the financial crisis coming. Brexit surprised the markets. The Arab Spring caught most experts off guard. In the 1990s, Long-Term Capital Management used sophisticated models to make tons of money. The firms were stuffed full of PhDs and Nobel Prize winners, yet none of them foresaw Russia’s defaulting on its debt. Since it had never happened, it was never thought possible. Yet it did happen, and within a few weeks, the hedge fund was totally wiped out.
Your humble newsletter guru certainly isn’t immune to big mistakes. I spend tons of time looking at our Buy List stocks, and I missed the troubles facing Wells Fargo this year. You may be familiar with Nassim Taleb, who has written about the impact of improbable events. This week, I suppose, we experienced an Orange Swan.
That’s why I’m conditioned to take unforeseen events in stride. A Trump victory certainly doesn’t have me panicked about the Buy List. Our companies will be just fine. (Please note: I’m not referencing any of his policy views.)
The starting point of my investing philosophy is precisely that I can’t predict the future. Therefore, I go for very, very high-probability events. I don’t know what the Fed will do tomorrow, but I’m pretty sure Hormel is going to sell a lot of Spam next year. I don’t know who will win the Super Bowl, but I’m pretty sure AFLAC will continue to do its thing. A well-run, financially sound business has a very good chance of remaining one.
One of the big mistakes investors make is thinking, what will be big in the future? Green energy! Biotech! Robots! That leads them to pay outrageous prices for this week’s theme of the century. But the future rarely turns out as planned. If in the early 1980s, you correctly foresaw the digital revolution, you probably would have invested in IBM, Wang and DEC. Even if you’re right, you can still be wrong. That’s why investing takes a great deal of humility.
Now let’s turn to the markets because the reaction to the election has been fascinating. High Beta stocks have continued to outpace the overall market. On Wednesday, the S&P 500 High Beta Index gained 3.60%, while the S&P 500 Low-Vol Index lost 0.57%. That’s an unusually wide gap. The same pattern continued into Thursday. The yield spread between two- and 10-year Treasuries widened to 123 basis points. That’s the widest it’s been in a few months, and it’s a good sign for economic growth. In the last week, the yield on the 10-year has risen 30 basis points. Basically, everyone’s jumping out of the safe stuff and taking on riskier stuff.
This has been a subdued year for our Buy List. It may turn out to be one of the few times we’ve trailed the S&P 500. Yet, in the past two weeks, our Buy List has sprung to life. Since October 27, our Buy List is up 4.16% compared with 1.61% for the S&P 500. That’s a sizeable gain for such a short time period, especially for a diversified portfolio,
Here are some interesting stats: On Wednesday and Thursday combined, Biogen (BIIB) gained 10%, Wells Fargo (WFC) was up 13% and Signature Bank (SBNY) rallied more than 14%. Why did it take a post-election rally for our Buy List to start beating the market? I have no idea, but I can say that our portfolio was in place for it to happen. Predicting which stock will do what is futile. Time and chance happeneth to them all.
Cognizant Technology Is a Buy up to $57 per Share
On Monday, our final Buy List stock reported earnings for the third quarter. Cognizant Technology Solutions (CTSH) said they made 86 cents per share last quarter. That was two cents better than Wall Street’s estimates, and it topped the company’s own guidance of 82 to 85 cents per share. For context, the IT outsourcer earned 76 cents per share in last year’s Q3. Cognizant’s quarterly revenue climbed 8.4% to $3.45 billion. Operating margin was 19.3%.
“We see ongoing client demand for our services across industries and geographies,” said Francisco D’Souza, Chief Executive Officer. “As the physical and digital worlds converge, we have made it easier for clients to work with us by aligning our organizational structure and capabilities around the broader focus of assisting clients drive digital transformations. Our new President, Raj Mehta, who has been a key member of our senior leadership team for two decades, and the broader team of executives are leading our strategic initiatives. They have a proven track record of innovation, execution and an unwavering focus on client service and satisfaction.”
Now for guidance. For Q4, Cognizant sees revenues between $3.45 billion and $3.51 billion, and EPS ranging between 85 and 88 cents. That works out to full-year revenue of $13.47 billion to $13.53 billion, and 2016 EPS between $3.38 and $3.41. That’s an increase from their previous guidance range of $3.32 to $3.44 per share.
“Third-quarter revenue was within, and non-GAAP EPS was slightly above, our guided range, indicating that we continue to execute well on our stated strategy,” said Karen McLoughlin, Chief Financial Officer. “Our solid performance was also reflected in another strong quarter of cash flow generation as cash and investments, net of debt, increased by $390 million.”
On September 30, shares of CTSH fell sharply after the company said it may have been involved in some illegal activities. An internal investigation revealed that some senior managers may have taken “potentially improper payments” of about $5 million. That’s much less than I feared.
I think this is a relief. It shows that CTSH is on top of their staff, and it doesn’t appear to be a very large deal in financial terms. Bear in mind that CTSH plunged more than 13% when the news first came out on September 30. Cognizant’s president, Gordon Coburn, resigned that same day without giving any reasons.
Shares of CTSH jumped over $55 after the earnings, but pulled back some after the news of Donald Trump’s victory. This week, I’m lifting my Buy Below on Cognizant Technology Solutions to $57 per share.
Ross Stores Earnings Preview
Now that earning season is over, it’s already time for earnings reports from our small group of off-cycle stocks. A lot of retailers prefer to end their fiscal years at the end of January so they can squeeze the entire holiday shopping season in Q4. That means companies such as Ross Stores (ROST) have third quarters that end in October. Ross is due to report its fiscal Q3 earnings on Thursday, November 17.
In August, the deep discounter reported Q2 earnings of 71 cents per share. That was a 13% increase over last year, and it was four cents more than expectations. They also beat their own expectation of 64 to 67 cents per share.
Ross’s quarterly sales rose 7% to $3.181 billion, and same-store sales increased by 4%. Operating margins expanded from 13.9% to 14.4%. Maintaining margins is crucial in retail, especially for price-conscious consumers. During Q2, Ross bought back 3.1 million shares of stock for $176 million. They plan to buy back $700 million worth of their own stock this fiscal year.
Ross’s CEO, Barbara Rentler, gave optimistic guidance for Q3 and Q4.
Looking ahead, Ms. Rentler said, “For the third quarter ending October 29, 2016, we are forecasting a same-store sales gain of 1% to 2% on top of a 3% increase in the prior year, and earnings per share of $.52 to $.55, compared to $.53 in last year’s third quarter. For the fourth quarter ending January 28, 2017, we are also projecting same-store sales to grow 1% to 2% versus a 4% increase last year, with earnings per share expected to be $.73 to $.76, up from $.66 in the 2015 fourth quarter. Based on our first-half results and second-half guidance, fiscal 2016 earnings per share are now planned to increase 7% to 10% to $2.69 to $2.75, on top of a 14% gain last year.”
Last year, Ross Stores earned $2.51 per share, and they’re forecasting to make $2.69 to $2.75 per share this year.
That’s all for now. I can safely predict that there will be no more election news next week. There will be some important economic reports. The retail-sales report is on Tuesday. The consensus is for a 0.6% gain. Industrial production is on Wednesday. IP has gradually started to recover. The CPI report comes out on Thursday. Core inflation is close to an eight-year high, which still isn’t very high. 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. Modern Trader had a nice feature about me in their November issue. You can access the December issue here. At the top, you can see the archives and select the November issue. The passcode is “crowdsourcing.”