CWS Market Review
September 14, 2018
“A lot of people with high IQs are terrible investors because they’ve got terrible temperaments. You need to keep raw, irrational emotion under control.”
– Charlie Munger
On Thursday, our Buy List broke the double-digit barrier. We’re now up 10.41% for 2018 (not including dividends). So far this year, sixteen of our 25 stocks are beating the S&P 500. Here’s something to consider. In this day of tech media giants, our two best performers this year are a freight-services company and a wallboard company. Boring, sure, but we’ll take those gains any day.
In this week’s CWS Market Review, I want to cover some recent economic news, including last week’s jobs report and this week’s subdued inflation report. I also want to touch on an overlooked issue, which is the spreading chaos in emerging markets. This isn’t getting the attention it deserves. I’ll also cover some recent news impacting our Buy List. (BTW, have you noticed the big rally in Snap-on? Up 30% since May!) But first, let’s take a closer look at the August jobs report.
The “Raise-Less” Recovery
Last Friday, the government reported that the U.S. economy created 201,000 net new jobs in August. That’s basically in line with the current trend. Over the last seven years, the economy has created 17.3 million new jobs. That’s an average of 205,000 per month. Officially, the unemployment rate is 3.9%. The current unemployment rate is lower than it was in every single month during the 1960s, 1970s and 1980s.
While that’s good news, there are some weak spots to note. Not as many Americans are in the workforce as there were a few years ago (although this trend isn’t as bad as some alarmists would lead you to believe). This trend may soon change. This week’s report on job openings was an all-time record. There were 6.9 million job openings in July. That’s the highest since the data series started in 2000. Another report from small businesses showed that more companies are having trouble finding new workers, and Thursday’s initial jobless claims report was another 49-year low.
The other weak spot in the economy is wages. You would think that with emerging labor shortages, there were would be an increase in worker pay. While there’s been some improvement here, it’s not much to celebrate. In the last year, average hourly earnings are up 2.9%. The last economic recovery was described as a “jobless” recovery. This one seems to be a “raise-less” recovery.
As investors, wage growth is important to us because that’s where future business revenue comes from. We want to see more shoppers. This leads us to the issue of inflation. With subdued wages, there hasn’t been much pressure on consumer prices. On Thursday, Wall Street had been expecting the August CPI report to show an increase of 0.3%. Instead, it came in at 0.2%. In the last year, inflation is running at 2.7%. The number is a bit skewed because inflation ran slightly hot in late 2017. Over the last six months, inflation is running just under 1%. Expect to see that 2.7% number trend lower over the next few months,
I also like to look at the inflation report for “core prices,” which excludes food and energy prices. In August, core inflation rose by just 0.08%. That’s the second lowest report since January 2015. This really tells me that inflation isn’t a problem. The bond market continues to be quite happy with the current state of things. The 10-year Treasury is still below 3%. I don’t think a lot of bond watchers thought that would happen.
All this leads us up to the next Fed meeting, which is scheduled for September 25-26. The odds are roughly 99.9999999% that the Fed will raise rates at this meeting, though I could be low-balling it. Another rate increase would bring the target for Fed funds up to 2% to 2.5%. That would bring real rates (meaning, after inflation) all the way up to 0%. Real interest rates have been negative for 14 of the last 17 years.
There’s also a chance another rate hike could finally invert the yield curve. The spread between the two- and ten-year Treasuries is currently just 21 basis points. That’s close to being the lowest point in 11 years. A rate hike in December is still an open question, though I seem to be in the minority. Wall Street is nearly convinced the Fed will move again. I’m not so sure. While the economy is definitely improving, there’s still not much in the way of pricing pressures. The futures market even thinks there will be a third hike coming in May.
While I like all the stocks on our Buy List, I wanted to highlight a few that look especially good at the moment. Shares of Torchmark (TMK) dropped this week after they were downgraded by Goldman Sachs. I’m still a believer, and the lower share price helps. My Buy Below for TMK is $91, but if you can get it below $86, that’s a good deal.
I also wanted to highlight Signature Bank (SBNY). I’ll warn you that SBNY is a frustrating stock. It can be very volatile. The good news is they’ve recently started paying a dividend. The current yield is just under 2%. Signature is also going for just 10 times next year’s earnings. Any buy order below $120 is a smart move.
Chaos in Emerging Markets
While the U.S. still looks mostly good, some economies overseas are crashing on the rocks. This happens every few years, and it looks to be happening again. So far, the main culprits are Argentina, Russia, South Africa and Turkey. With any crisis like this, there’s always the worry of contagion, which means watching the meltdown spread from country to country.
All four countries have different reasons for the mess they’re in. Argentina borrowed too much. The peso got clobbered, and their Fed has had to jack up rates to 60%.
In Turkey, President Erdogan has made just about every bad economic decision you can. He recently said, “If they have dollars, we have our people, our righteousness and our God.” Apparently, the bond market prefers the dollars. On top of that, President Trump has doubled tariffs on Turkish steel and aluminum. Erdogan has also named himself the head of Turkey’s sovereign wealth fund, which I’m guessing won’t reassure foreign investors. To give you an idea of the kind of building that’s been going on, when Erdogan became president 15 years ago, there were 50 shopping malls in Turkey. Now there are over 400.
With Russia, the country has been steadily isolated from the global economy. The ruble has been hammered against the dollar. Interestingly, Russia doesn’t have that much debt relative to GDP. Their problem is that they can’t turn to financing from foreign investors. That means much of their investment must come from inside, i.e., from spending targeted for something else.
I want to be clear that these problems aren’t much of a threat to us and our Buy List. If anything, our conservatism is probably helping us when compared to the chaos of these economies. The major Emerging Markets ETF (EEM) is down about 20% from its January high.
There tends to be a familiar script with financial crises. A country borrows too much. At some point, the bond market has had enough. Bond yields soar, and the currency tanks. That leads to political upheaval as inflation takes hold and the central bank raises rates to defend the currency. There are a zillion different permutations, but that’s the general idea. The only way to solve the mess is by making hard decisions. You can’t cheat debt investors forever.
We should keep an eye on these issues. So far, I doubt they’ll continue to spread, but when markets turn manic, you never know where it will end. Now let’s look at some recent news impacting our stocks.
Buy List Updates
Checking the archives, I see that I haven’t written about Snap-on (SNA) recently. This is a terrible oversight on my part that shall be rectified immediately. For one thing, the stock has been a workhorse lately. Since early May, shares of SNA are up over 30% for us.
In July, SNA gapped up after an impressive earnings beat. For Q2, they raked in $3.11 per share. That was up 20% from last year, and it beat expectations by 16 cents per share. I was especially pleased to see a 0.3% increase in operating margins.
I think the story with Snap-on is a pretty simple one; folks got way too pessimistic. The stock got beat down in the early part of this year. To be fair, I shared some of the pessimism, but not to enough to scare us out of the stock. I had been particularly concerned about some weakness in their tool division. However, the rising economy seems to be alleviating that issue. I didn’t think this would happen so soon, but SNA is now up 6.8% this year.
Snap-on is due to report Q3 earnings in another month. Wall Street currently expects $2.85 per share. That’s an increase of 16% over last year. Even after Snap-on’s nice run, the stock is still going for less than 16 times this year’s earnings estimate. I also expect to see another dividend increase from Snap-on in early November. In the last five years, SNA’s dividend has more than doubled. This week, I’m raising my Buy Below price on Snap-on to $196 per share.
Snap-on made a new 52-week high on Thursday, as did several other Buy List stocks; Danaher (DHR), Hormel Foods (HRL), Fiserv (FISV), Check Point Software (CHKP) and Sherwin-Williams (SHW). Also, RPM International (RPM) and Church & Dwight (CHD) came very close to new highs, but fell just short.
I’ll quietly note that our problem-child stock, Ingredion (INGR), has been improving. I’m still disappointed with their performance this year, but we’ll learn a lot more soon when they report Q3 earnings. On a strict valuation basis, Ingredion looks tempting, but I want to make sure there are no more surprises.
Another problem stock that’s improved lately is been Alliance Data Systems (ADS). The stock started out terribly this year, but turned a corner in May. The recovery had been going smoothly until mid-July, when ADS got slammed for a 10% loss after a poor monthly business update. (For the record, I didn’t think it was that bad.) The Q2 earnings report was pretty good and ADS stood by its full-year forecast. ADS eventually rallied again, and on Thursday, the stock touched a seven-month high.
I used to joke that there’s probably a great investing strategy to be gleaned by investing in our most beaten-down stocks. There may be some truth to that. The reason is that our stocks tend to be very high quality. Even when they fall from Wall Street’s favor, the fall often doesn’t last long.
That’s all for now. Next week should be fairly quiet for economic news. However, I’ll be on the lookout for the housing-starts report, which is due out Wednesday morning. Then on Thursday, we’ll get existing-home sales and the jobless-claims report. The following week should be more eventful, as the Federal Reserve has a two-day meeting. Expect to see another rate increase from the central bank. 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. Dividend and income expert Tim Plaehn—whose articles and research I’ve been sharing with you over the past few months—is hosting a live interactive discussion on using his Disruptive Dividends strategy to boost your returns with little effort. He’s even going to show how to get dividend-like yield from stocks that don’t even pay dividends. Toward the end of the discussion he’ll give us four actionable trades and then wrap up with a live Q&A. The event is on Wednesday, September 26th, and I’ve arranged for free registration for Crossing Wall Street readers. Click here for details.