CWS Market Review
February 17, 2017
“In finance, everything that is agreeable is unsound and everything that is sound is disagreeable.” – Winston Churchill
Recently, I’ve told you that I’ve become more bearish on the stock market in the short term, and that I expect a difficult period for February and March. So far, I’m relieved to say that I’ve been dead wrong. The stock market continues to wander higher. On Wednesday, the Dow, Nasdaq and S&P 500 all closed at all-time highs. For the first time in 25 years, the three indexes made five consecutive new highs together.
If I had told you that North Korea would launch a missile and that the National Security Advisor would resign, how do you think the market would have behaved? Now we know the answer. Wall Street continues to be as calm as could be, and quite optimistic as well.
This week, Janet Yellen went to Capitol Hill to testify on the economy and monetary policy. But that wasn’t the biggest economic news this week. Instead, we learned that in January, inflation has its biggest surge in four years. Last month, consumer prices rose at an annualized rate of 6.8%—and it wasn’t all due to gasoline. I’ll tell you what it means for us and our portfolios.
Later on, I’ll review the latest earnings report from Express Scripts. The pharmacy-benefits manager beat estimates, but guidance was a wee bit weak. I’ll go over the details. I’ll also highlight a bunch more earnings reports coming our way next week. But first, let’s take a closer look at the recent uptick in inflation.
Inflation Soars in January—What Does It Mean for Us?
On Wednesday, the Labor Department said that consumer prices rose by 0.6% last month. That’s twice what economists had been expecting. In the last year, inflation has been running at 2.5%. January’s report was the highest rate in four years. Annualized, consumer prices rose by 6.8% last month.
About half of the increase was due to higher gasoline prices, but there are other factors as well. Clothing prices, for example, rose strongly last month. If we look at “core inflation,” which strips away our food and energy prices, then we see that inflation rose by 0.3% last month, or 3.76% annualized. Still, that’s the highest rate in more than 10 years.
Does this mean that inflation is on the upswing? Frankly, it’s too early to say. With econ numbers, we always want to look at the trend instead of single points of data. I suspect that it’s not a resurgence of inflation, but I’m open to being convinced.
More importantly, inflation is now running above the Fed’s 2% target. In fact, the increase in inflation essentially nullified the Fed’s December rate hike. I’ve said that I’ve been a doubter about the Fed’s aggressive hike-rate forecast for this year, but if inflation pressures persist, then it may come about. I would expect their next rate increase to come in June.
This week, Janet Yellen went to Capitol Hill to testify on the economy. Regarding the stock market’s recent surge, she said, “I think market participants likely are anticipating shifts in fiscal policy that will stimulate growth and perhaps raise earnings.” I have to agree, and this is important because it means the Fed is no longer pulling the market along.
Fortunately, the long-end of the bond market is still relatively calm. The yield on the 10-year Treasury climbed 2.5% after the CPI report, but that’s still pretty tame. Earlier this week, the yield on the one-month Treasury got up to 0.53%. Obviously, that’s not a lot but it’s a nine-year high. The message is clear that interest rates are on the way up, but we’re a long way from them being real competition to stocks.
Other interesting economic news this week is that small-business optimism continues to rise. We saw big jumps after the election, and it’s now at a 12-year high. Retail sales did well last month. We saw a seasonally adjusted increase of 0.4%. Interestingly, the figure for December was revised higher to 1% growth. That’s very good for one month.
Express Scripts Is a Buy up to $74 per Share
After the closing bell on Tuesday, Express Scripts (ESRX) reported their Q4 earnings. This was a closely watched report for people following the issue of drug pricing. There’s been a growing war of words between drug makers and pharmacy-benefits managers about who’s really responsible for the increase in drug prices. ESRX’s CEO, Tim Wentworth, has recently pushed back at criticism of PBMs, and I think he’s right to do so.
Now to the earnings report. For Q4, Express Scripts earned $1.88 per share. That beat estimates by one penny per share. For the year, Express earned $6.39 per share, which is a nice 16% increase over 2015. Earlier, Express had said that its full-year total would range between $6.36 and $6.42 per share. Overall, this was a solid year for the company.
“We delivered another year of successful performance, not only through financial results, but by providing innovative solutions to help our patients and clients drive healthier outcomes and lower drug trends,” said Tim Wentworth, CEO and President. “In a year when the focus on drug pricing has never been greater, Express Scripts has held the 2016 growth rate in drug unit costs to 2.5% and lowered the patients’ share of total drug costs per prescription. The fundamentals of our business remain strong as our clinical focus and unwavering alignment with clients enables us to lead the industry in developing innovative value-based solutions that our country needs.”
Quarterly revenue came in at $24.86 billion, which was below estimates. For Q1, Express said it expects earnings between $1.30 and $1.34 per share. The Street had been expecting $1.35 per share. For the whole year, they see EPS ranging between $6.82 and $7.02 per share. That means the stock is going for about 10 times this year’s earnings. Express Scripts remains a buy up to $74 per share.
Four Buy Earnings Reports Next Week
I’m writing this early on Friday. Later today Moody’s (MCO) and Smucker (SJM) are due to report. Moody’s is our #2 performing stock for the year, with a YTD gain of 16.9%. On a side note, I always find it interesting that I never know what the top performers will be, and it’s usually a big surprise. Wall Street expects earnings of $1.24 per share. I’ll probably raise my Buy Below on Moody’s, but I want to see the earnings report first.
Also, Smucker will be reporting. However, their earnings reporting period ended in January. The company estimates full-year earnings (ending in April) coming in between $7.60 and $7.75 per share, “with a bias toward the middle to high end of the range.”
On Tuesday, February 21, Wabtec (WAB) is scheduled to report Q4 earnings. The rail-services company had a weak Q3 report. They also lowered full-year guidance. I think 2017 will be a much better year for them. Wall Street expects earnings of 93 cents per share.
Then on Thursday, February 23, we’ll get our final two earnings reports for this cycle as Cinemark (CNK) and Continental Building Products (CBPX) are due to report. The movie-theater chain has been doing a brisk business lately. Wall Street expects earnings of 43 cents per share. Three months ago, Continental missed earnings, but I expect a rebound. Wall Street is looking for Q4 earnings of 27 cents per share.
Also on Thursday, Hormel Foods (HRL) will report earnings, but they’re another stock on the January cycle. The Spam stock has delivered 14 record quarters in a row, and I expect to see #15. Wall Street expects Q1 earnings of 45 cents per share. Hormel gave 2017 guidance of $1.68 to $1.74 per share. The company also recently raised its dividend for the 51st year in a row.
Buy List Updates
Before I go, let me add a quick note on Cerner (CERN). In last week’s issue, I mentioned that their earnings report matched expectations. In Friday’s trading, just after I sent the newsletter, the stock got punished by traders. The market then had second thoughts, and Cerner rallied this week, and it made back everything it lost. The lesson here is not to worry too much over the stock market’s initial reaction to things. Traders prefer to sell first and ask questions later. This actually works to the advantage of us who are in it for the long haul.
Also, Sherwin-Williams (SHW) raised their dividend by one whole penny! The quarterly dividend went from 84 to 85 cents per share. Obviously, that’s not a big increase but this is Sherwin’s 38th straight year of raising its dividend. That’s a streak I like. The stock is up 15.8% on the year for us.
That’s all for now. The stock market will be closed on Monday in honor of George Washington’s birthday. The NYSE is a bit old school on such matters. They make it clear that it’s Washington’s Birthday, not President’s Day. There’s not much in the way of economic news next week. The existing home-sales report is on Wednesday. Then in Friday, the new homes sales report comes out. 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!