CWS Market Review – January 13, 2017

CWS Market Review

January 13, 2017
 
“There is a danger of expecting the results of the future to be predicted from the past.”
– John Maynard Keynes

Earnings season is finally upon us. Over the next four weeks, 20 of our 25 Buy List stocks are scheduled to report Q4 earnings results. This is a crucial time for disciplined investors, because it’s when we get to see who among our stocks was naughty and who’s been nice.

It’s easy to think that stock movements are arbitrary—and it sometimes looks that way. But stocks do move for good reasons, and the most important is earnings. That’s why our Buy List is focused on high-quality companies. I’m happy to say that our Buy List already has a slight lead over the market this year.

Frankly, the “Trump Rally” is beginning to look a bit tired. Considering that the Dow has risen 22 times in 26 days, who wouldn’t be? The Dow has tried to break 20,000 several times, but it can’t seem to do it. Last Friday, the index came within 0.37 points of busting through…but no such luck. I wouldn’t be surprised to see the market pull back over the next few weeks. Nothing major. But just enough to clear out the trend-followers.

In this week’s CWS Market Review, we’ll look at what’s in store for earnings season. Next week, we’ll have our first Buy List earnings report. I also want to bring you up to speed on the latest news surrounding our Buy List stocks. Before we get to that, let’s look at some recent economic news. Small-business optimism just recorded its biggest increase in decades.

Small-Business Optimism Soars

Last Friday, the government reported that the U.S. economy created 156,000 net new jobs in December. That was below the expectations of 175,000 jobs, but it’s still largely within the previous trend. Unemployment ticked up to 4.7%. There’s still the issue of millions of Americans out of the labor force. Fortunately, though, the labor-force participation rate rose by a tad. There are, of course, major demographic trends at play in that figure. But on balance, we can say that the jobs market is improving.

The best news in the jobs report had to do with average hourly earnings. For December, AHE rose by a healthy 0.4%. That’s a good number, and it’s good news for us investors as well. That’s future revenue for our companies. Over the last year, wages have increase by 2.9%. That’s ahead of inflation, but not by much. Still, it’s good to see American workers finally get a real raise.

One of the more interesting reports we got this week was that small-business optimism soared in December. Actually, that understates it. Small-business optimism skyrocketed. It had its best monthly increase since 1980. The index jumped 7.4 points to 105.8, which is the highest since 2004.

Obviously, a good deal of that is political. Small-business people lean right, so there’s certainly comfort for them in a new administration. But I wouldn’t be quick to dismiss this as solely political. Optimism, especially newfound optimism, is an important ingredient for an expanding economy. These will be the people who will approve new construction plans or give the go-ahead to hire new employees.

There’s an erroneous belief that economic expansions must die of old age. I’m not so sure about that. Australia hasn’t had a recession in 25 years. Even eight years into our expansion, I think there are many reasons to believe that growth will accelerate this year.

Last Friday, the Dow reached an intra-day high of 19,999.63. The index came within a hair’s breadth of 20,000. Of course, it’s an arbitrary number, and an even more arbitrary index, but it’s an important milestone for people to see. It’s the kind of thing that people who don’t follow the markets will notice. To add some perspective, the Dow first closed above 200 on December 18, 1927, and Dow 2,000 fell on January 8, 1987. (Is there something about years ending in 7?)

Quietly, the market has slipped into a narrow trading range over the past month. In fact, for the Dow, this has been one of the narrowest ranges on record. Since December 9, the index has finished every trading day somewhere between 19,756 and 19,974. That’s 22 days locked in a range that’s a little over 1%.

The Nasdaq, by contrast, had its first down day of 2017 on Thursday. The S&P 500 Tech Index got to its highest point since September 2000. The index is still below its high from nearly 17 years ago. The coming earnings season will be important because we’ll be able to see if companies have witnessed any real improvements in their sales and earnings. I think we’ll have impressive results from companies like Microsoft (MSFT) and CR Bard (BCR). Now let’s take a look at our first Buy List earnings report, which comes next week.

Earnings Preview for Signature Bank

Now that we have 25 stocks on our Buy List, let me explain the earnings-reporting cycle. Companies are required to report their earnings each quarter. Most companies follow the March/June/September/December reporting period. On our Buy List, 20 of our stocks do just that. (Please note that that doesn’t necessarily mean their fiscal year ends in December. Microsoft, for example, has a fiscal year that ends in June.)

Four of our Buy List stocks; JM Smucker (SJM), Ross Stores (ROST), Hormel Foods (HRL) and HEICO (HEI), follow the January/April/July/October cycle. One of our stocks, RPM International (RPM), follows the cycle of February/May/August/November. RPM reported its November earnings recently.

Banks tend to report their earnings early in the reporting cycle. When it was on our Buy List, Wells Fargo traditionally kicked off earnings season for us. Now with Wells off the Buy List, that honor falls to Signature Bank (SBNY). I don’t know the exact date yet that SBNY will report, but going by previous years, it will likely be sometime next week.

Signature had a decent Q3 report in October. They made $2.11 per share, which beat the Street by seven cents. The key stat for any bank is net interest margin. For SBNY’s Q3, that came in at 3.14%, which is pretty good.

Obviously, the bum-medallion loans are still a problem for SBNY. The ride-sharing boom has decimated that business. Fortunately, Signature has taken steps to resolve the issue.

Signature is a good example of something you see a lot. It was a cheap stock, and the shares were doing absolutely nothing. Nada. The numbers were clear—the bank was a bargain. But all through the late summer and fall, the shares snoozed away. In October, SBNY was going for around $115 per share. Then came the election, and suddenly people realized, “hey, this bank thing stock is really cheap.” Within a few days, the stock shot to $150 per share.

The lesson is that many of our investments go against the tide. That means that it may take a while for the world to catch up to us. A great investment can have it all, but if it doesn’t have a catalyst, it won’t move. As prudent investors, we follow the sage words of Sir Mick: “time is on our side.”

Buy List Updates

When looking for superior companies, you want to search out firms that have strong pricing power. You probably regularly buy some product that you’re afraid to admit you’d keep on buying, even if they doubled the price. I certainly know I do.

This doesn’t mean the company should or will raise its price, but they know they have the ability to do so if they want to. As investors, that’s what we want to find. This tells us they have a locked-in market and few competitors.

On our Buy List, Moody’s (MCO) is a good example. In fact, Warren Buffett said that it’s actually difficult to judge Moody’s management, because its pricing power is so strong.

This week, JM Smucker (SJM) said they’re raising the cost of their packaged coffees, like Folgers and Dunkin’ Donuts, by an average of 6% in the U.S. The company said (what else?) they’re just passing on costs. But we’ll soon see how devoted those coffee drinkers are. I suspect SJM will do just fine.

A few of our stocks had ratings changes. Axalta Coating Systems (AXTA) was cut to neutral by Citigroup. Piper Jaffray started Hormel Foods (HRL) with an “overweight” rating. It takes a mature adult not to make a Spam joke here. I am not that man. Moody’s (MCO) was downgraded by UBS and Barclays.

Stryker (SYK) won’t report their earnings until later this month, but this week, they gave us a sneak preview. Stryker said that Q4 revenue rose by 16.3%. That’s 16.8% in constant currency. For the year, sales rose 13.9% to $11.3 billion. That’s a growth of 14.3% in constant currency.

“I am pleased with our performance in both the fourth quarter and the full year 2016,” said Kevin A. Lobo, Chairman and Chief Executive Officer. “Fourth-quarter organic growth of 6.7% versus a strong prior year is impressive, and was balanced across Orthopaedics, MedSurg and Neurotechnology and Spine. In addition, we executed well on acquisitions and delivered leveraged adjusted earnings gains. We enter 2017 with good momentum across our businesses and look forward to building on this success.”

Stryker said that based on these numbers, they expect final 2016 EPS to be at the high end of their $5.75 to $5.80 range. That range translates to Q4 results of $1.73 and $1.78 per share. In October, Stryker raised the low end of their forecast by five cents per share. Forex costs are expected to knock 10 to 12 cents per share off their full-year bottom line. The company will report earnings on January 24.

That’s all for now. The stock market will be closed on Monday in honor Dr. Martin Luther King, Jr.’s birthday. On Wednesday, we’ll get the CPI report for December. It will be interesting to see if there have been any signs of incipient inflation. I doubt it, but will reserve judgment until we see the data. Also on Wednesday, the Fed will release its “beige book,” which offers a detailed overview of the economy. 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!

– Eddy

P.S. If you can’t get enough of me, I was on CNBC here and here on Thursday.

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Named by CNN/Money as the best buy-and-hold blogger, Eddy Elfenbein is the editor of Crossing Wall Street. His free Buy List has beaten the S&P 500 eight times in the last ten years. This email was sent by Eddy Elfenbein through Crossing Wall Street.
2223 Ontario Road NW, Washington, DC 20009, USA
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