CWS Market Review
December 9, 2016
“Investment success does not require glamour stocks or bull markets.” – John Neff
The Trump Rally keeps on trumping. Since Election Day, the Dow has set 13 new highs. Remarkably, just one stock—Goldman Sachs—is responsible for 30.2% of the Dow’s entire advance.
Remember how the start of 2016 was one of the worst market starts in Wall Street history? Howard Silverblatt noted this stat: At the market’s February low, the S&P 500 was down 10.5% YTD, yet the Financials were down 17.7%. Since then, the S&P 500 has rallied 21.5%, while the Financials are up 45.6%. It’s as if the entire market were the dog being wagged by the banking sector’s tail.
I’ve been pleased to see the Trump Rally broaden out recently. On Wednesday, one-quarter of the stocks in the S&P 500 closed at a new 52-week high. That’s the most in two years.
In this week’s CWS Market Review, we’ll take a look at the recent jobs report, plus we’ll preview next week’s Federal Reserve meeting. For the second time in a decade, the Fed looks set to raise interest rates. I’ll also preview the upcoming earnings report from HEICO. This quiet stock is now a 50% winner for us this year. We also got a nice 12% dividend increase from Stryker. The stock has increased its dividend every year for more than 20 years. But first, let’s see if the Fed has plans to kill the Trump Rally.
The Federal Reserve Will Finally Raise Interest Rates
Last Friday, the government reported that the U.S. economy created 178,000 net new jobs for the month of November. I try to take the government stats with a very big grain of salt. Instead, I prefer to zero in on the overall trend, which, as it turns out, has been very close to 178,000 new jobs each month.
The unemployment rate dropped down to 4.6%, which is the lowest in nine years. The workforce participation rate is still too low, and I’d like to see that come up some. Still, the overall trend has been slow improvement in the labor market.
All this sets us up for next week’s two-day meeting of the Federal Open Market Committee. I’m afraid I’m going to ruin the suspense for you—the Fed’s going to raise rates. This will be the second December in a row in which the Fed has hiked interest rates.
So will the Fed’s move be a rally killer? Not at all. For one, interest rates are still very low. As low as they are, they’re actually positive, which we can’t say for much of the world. Even after the rate increase, the Fed funds rate will be below the rate of inflation. To be blunt, this is less a rate increase than it is fine tuning from the Fed.
To be sure, the Fed usually kills rallies in their sleep, but that would require a lot more action than what we’re seeing. Interest rates would have to be 2% or 3% more than inflation. That’s hardly a fear at the moment.
It also appears that the economy is gaining a little momentum. Q3 was pretty good for the economy, and the earnings recession ended for Corporate America. This week, we learned that the ISM Non-Manufacturing Index rose to 57.2 for November. That’s very good.
The market this year has been very difficult for a lot of Wall Street bigwigs. The Financial Times notes that more hedge funds will shut down this year than in any year since 2008. This market has thrown us a couple false starts, quiet reversals and head fakes.
For example, stocks are becoming much more correlated with each other. In previous years, when the S&P 500 rose, say, 1%, you could pretty much guess that most stocks would be near 1%. Now that’s not so true. In fact, even the Dow and S&P 500 have parted ways. Since the Dow is loaded with more heavy-industry industrial stocks, it’s enjoyed the Trump Rally far more than the broader S&P 500.
This has been a great time for U.S. stocks. Since Donald Trump got elected, about $2 trillion has rotated out of bonds and into stocks. On Thursday, the S&P 500 set another record closing high of 2246.19. At some point, this surge will come to a halt, but don’t try to guess when. For now, we should enjoy the ride. Our Buy List stocks are doing very well. Now let’s take a look at the smallest stock on our Buy List, which just so happened to close Thursday at a fresh 52-week high.
Earnings Preview for HEICO
Who would have guess that little HEICO (HEI) would turn out to be our top-performing stock this year? Through Thursday’s close, shares of HEI have gained more than 50% this year.
If you’re not familiar with HEICO, the company makes replacement parts for the aircraft industry. They’ve raised their earnings guidance three times this year.
HEICO is due to report their Q4 earnings next Tuesday, December 13, after the closing bell. Earnings for the first three quarters of this year are up 18%, while sales are up 19%. The company only provides guidance for net income, instead of EPS. In the Q3 earnings report, they said they forecast net income to rise by 13% to 15%.
Let’s bust out some math. Last year, HEICO earned $1.97 per share. That means an increase of 13% to 15% works out to a range of $2.23 to $2.27 per share. However, HEICO’s shares outstanding are 0.4% higher this year, so that will dilute that range by about one penny per share. Since the company has already made $1.64 per share so far this year, we can expect 58 to 62 cents per share for Q4. Wall Street’s consensus is for 62 cents per share.
The stock is currently well above our $76 Buy Below price, but I want to hold off increasing that price until we see the Q4 earnings report. I like HEICO a lot.
Stryker Raises Dividend by 12%
We got very good news this week from Stryker (SYK). The orthopedic company announced a 12% dividend increase. Stryker’s quarterly payout will rise from 38 cents to 42.5 cents per share. The company has increased its dividend every year since 1993.
“Our 12% increase in the dividend for 2017 reflects the strength of our balance sheet and our consistent capital-allocation approach, which uses acquisitions, dividends and share repurchases to drive shareholder value,” said Kevin A. Lobo, Chairman and Chief Executive Officer. “Our continued strong performance should enable us to continue to drive future dividend increases roughly at or above our earnings growth.”
The annualized dividend is $1.70 per share, which comes to 1.5% based on Thursday’s closing price. The dividend is payable on January 31, 2017 to shareholders of record at the close of business on December 30, 2016. Stryker remains a buy up to $119 per share.
Express Scripts Drops on Short-Seller’s Tweet
I’ve been getting more impressed with Express Scripts (ESRX), although the stock hasn’t done particularly well this year. ESRX was starting to recover until Thursday, when a prominent short-seller dinged the stock with a pair of tweets.
On Thursday afternoon, Andrew Left of Citron Research tweeted, first:
$ESRX is Philidor of the pharma industry. @therealdonaldtrump promises to fix drug pricing? Two words: EXPRESS SCRIPTS
Which was followed by:
When @realdonaldtrump tells $ESRX ‘you’re fired’ heads will roll. The culprit behind pharmaceutical price gouging. Price Target $45
I’m not sure if the president-elect read Left’s tweets, but enough traders did. The stock reacted immediately. Within minutes, shares of ESRX fell from $74 to about $68. The stock recovered a bit later in the day and closed at $70.75.
I’m always a bit reluctant to comment on other people’s research. I still like Express a lot and see no reason to worry. The problem is that drug companies are pushing back against the flap about high drug prices by shifting the blame to companies like Express Scripts. It might be good PR, but it’s bad economics.
From the last earnings report, Express said they expect full-year earnings of $6.36 to $6.42 per share. That means the stock is currently going for about 11 times earnings. That’s quite cheap.
Three New Buy Below Prices
Thanks to the post-election rally, a few of our stocks have jumped well above their Buy Below prices. I suppose that’s a good problem to have. I wanted to adjust a few of our Buy Belows before the end of the year. In this week’s issue, I’m raising our Buy Below on Alliance Data Systems (ADS) to $250 per share. The stock has rallied impressively over the last month.
Another big winner recently has been Snap-on (SNA). SNA had a great earnings report in October. The stock has rallied more than 18% in the last two months. This week, I’m raising our Buy Below on Snap-on to $181 per share.
But Signature Bank (SBNY) has been our biggest winner lately. The stock is up close to 40% from its September low. After the October earnings report, I lowered our Buy Below on SBNY to $125 per share. The stock quickly blew past that, so three weeks ago, I raised the Buy Below to $150. SBNY is still climbing, so now I’m raising our Buy Below to $165 per share.
That’s all for now. A reminder that I’ll unveil the 2017 Buy List in the CWS Market Review two weeks from today. Next year’s Buy List will be expanded to 25 names. The big news next week will be the Federal Reserve’s meeting on Tuesday and Wednesday. The Fed will almost certainly raise interest rates for just the second time in the last decade. I suspect that the Fed will lean towards doing very little over the first six months of 2017. 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!