CWS Market Review – May 24, 2013

“Risk comes from not knowing what you’re doing.” – Warren Buffett

We’re back after a short hiatus last week. I was impressed that the stock market had the audacity to rally even without an update from me. Early Wednesday, the S&P 500 got as high as 1,687! Jeez, I thought I was being bold last year when I said the stock market would break 1,500 sometime early in 2013. Well, we ran right past that and starting knocking on the door of 1,700. Goldman Sachs recently said they see the S&P 500 getting to 2,100 by 2015!

Here’s an amazing stat: The Dow hasn’t had a three-day losing streak all year. Bespoke Investment Group notes that the S&P 500 has already run past the year-end target that every single Wall Street had at the start of the year. This rally is remarkably broad-based. It seems like everyone’s going up. Normally, 55% of stocks trade above their 200-day moving average. Today that number is 81%.

I’m not much for picking market tops, but I think more caution from investors is warranted. My feeling is that as long as the S&P 500 stays above its 50-day moving average (currently about 1,590), I think the bears will be held at bay.

Until then, our Buy List continues to be an oasis for conservative investors. In the last month, our Buy List has gained 6.60% to the S&P 500’s 4.54% (that doesn’t include dividends). We’re still a bit behind the market for the year (15.73% to 14.16%), but I’m confident we’re on our way towards beating the market for the seventh year in a row.

In this week’s CWS Market Review, we’ll take a closer look at what’s been driving the rally and see whether it will continue. We’ve had lots of good news from the Buy List recently including a dividend increase from JPMorgan Chase ($JPM). In March, I reassured you there was nothing wrong with FactSet Research Systems ($FDS) after it plunged, and the stock has now rallied to a new year-to-date high. The best news, however, was a very good earnings report from Medtronic ($MDT). At one point on Tuesday, MDT gapped up 8% to a five-year high. Before I get to that, let’s talk about the great Garbage Rally of 2013.

Welcome to the Garbage Rally

On Wednesday, the stock market briefly got a case of jitters after the Federal Reserve released the minutes from its last meeting. The media and traders jumped on this rather unwieldy sentence: “A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting, if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome.”

I’ll be blunt—this ain’t gonna happen. Not next month and probably not this year. Listen to me: The Fed is going to keep on buying bonds to support the economy. Traders are obsessed with the idea that the Fed is about to announce a policy change. Indeed, it will be a big deal when it comes, but we’re not there yet. Remember that the last two inflation reports showed that consumer prices are falling, which means that real interests are rising. Ben Bernanke made it clear in his testimony on Wednesday that policy accommodation will continue “in the medium term and beyond.”

All investors need to understand that an important outcome of the Fed’s policy is that it’s shifting investors (shoving them, really) into riskier assets. We’re starting to see that play out quite dramatically. For example, stocks are doing better than bonds. At the start of the year, the dividend yield for the S&P 500 was 48 basis points higher than the 10-year Treasury. Today, they’re about the same. Even within stocks, the riskier ones are leading. The small-cap Russell 2000 broke above 1,000 this week for the first time ever. The index is up more than 27% since mid-November.

A recent study found that companies with the worst balance sheets—what I unfairly like to call “Garbage Stocks”—have done the best this year. Bloomberg recently noted that companies in the S&P 500 with speculative grades rose by an average of 24% this year, while stocks with investment grades rose by 18%. Please don’t think I’m advocating that we depart from our tried-and-true strategy of investing in top-quality stocks. No, I simply want to show you what’s been happening underneath the surface of this rally.

Plus, it’s not so much that garbage stocks are popular. Instead, they’ve been left behind for so long that it’s time they played catch up. Importantly, the Fed’s low-rate policy makes carrying lots of debt less burdensome. Since November 15th, financially weak stocks are up an average of 38%, while the broader market is up 23%. When you alter the playing field, the game changes. Junk bond offerings, for example, are on pace for another record year this year, while the massive yield spread for junk has narrowed.

In the mean time, investors who are focused on the long term should continue to hold the stocks on our Buy List. Now let’s get to the recent news on our stocks.

Buy Medtronic up to $57

On Tuesday, we got an outstanding earnings report from Medtronic ($MDT). The medical device company reported fiscal Q4 earnings of $1.10 per share which was seven cents more than what Wall Street had been expecting. The stock gapped up nearly 8% on Tuesday before giving back some of its gains.

Frankly, the strong earnings report was a shock to me as well. I knew business at Medtronic was going well, but this report was better than even I was expecting. Digging into the numbers, the big surprise was that sales of pacemakers and defibrillators rose. Pretty much everyone was expecting more declines. Sales of defibrillators rose by 1.5%, and pacemakers were up by 2.6%. Company-wide, revenues rose by 3.8% last quarter. Medtronic’s CEO, Omar Ishrak, said that for the first time in four-and-a-half years, sales of defibrillators and spinal products rose in the U.S. in the same quarter.

Now let’s recall some history. Last May, Medtronic forecast earnings for this year to range between $3.62 and $3.70 per share. In January, they raised the low end of their estimate by four cents per share. As it turned out, Medtronic made $3.75 per share for the year. That’s up from $3.46 per share in 2012.

For fiscal 2014, Medtronic projects earnings between $3.80 and $3.85 per share. Wall Street had been expecting $3.84 per share. Earlier this week, MDT got to a five-year high. Sometime next month, I expect Medtronic to raise their dividend by one penny to 27 cents per share. This would be the 36th consecutive annual dividend increase. I’m raising my Buy Below on Medtronic to $57 per share.

Ross Stores Earns $1.08 per Share

We also had a good earnings report from Ross Stores ($ROST). Note that both Ross and Medtronic are on a January-April-July-October reporting cycle. For their first quarter, Ross earned $1.07 per share which is up 15% from a year ago. This wasn’t much of a surprise since the deep discounter had already told us that earnings would come in between $1.07 and $1.08 per share. Q1 Sales rose 8% to $2.54 billion, and comparable-store sales were up by 3%.

The CEO said, “We are pleased with the slightly better-than-expected sales and earnings we delivered in the first quarter, especially considering this growth was achieved on top of strong prior-year gains. These results continued to be driven by our ongoing ability to offer terrific bargains to today’s value-oriented consumers.”

For Q2, Ross sees earnings between 89 and 93 cents per share. Wall Street had been expecting 91 cents per share. Ross earned 81 cents per share for last year’s Q2. For the whole year, Ross projects earnings between $3.70 and $3.81 per share. Wall Street was a little higher, at $3.88 per share.

Ross is now a 20.3% winner on the year for us. I’m very happy with how this company is performing, and I’m keeping my Buy Below price on Ross Stores at $70 per share.

JPMorgan and FactSet Raise Their Dividends

Jamie Dimon, the head honcho at JPMorgan Chase ($JPM), won a big victory this week when shareholders shot down a motion to split up the jobs of CEO and chairman. Dimon holds both. I wish the vote had gone the other way. As much as I admire JPM, Jamie Dimon is a walking headline risk for shareholders.

The good news is that the bank said it’s raising its quarterly dividend from 30 cents to 38 cents per share. That’s a pretty hefty increase. Going by the new dividend and Thursday’s closing price, JPM yields 2.85%. I’m raising my Buy Below on JPMorgan Chase to $56 per share.

In March, FactSet Research Systems ($FDS) reported impressive fiscal Q2 earnings, and for their Q3 (ending in May), they projected earnings between $1.14 and $1.16 per share. That’s a pretty optimistic forecast, but what’s strange is that the stock plunged 10% after the earnings report.

Fortunately, I’ve long given up on the idea of making sense of short-term market tics. In the CWS Market Review from March 22nd, I said that I wasn’t at all worried about FactSet and that it “remains a very good buy.” I’m glad we stuck to our guns. The stock made back everything it lost.

Last week, FactSet said that it’s raising its quarterly dividend by 13% to 35 cents per share. The stock recently broke out to a new high for the year. FDS is now up more than 13% from its post-earnings report low. This week, I’m raising my Buy Below price on FactSet to $108 per share. This is a solid stock.

Updates on Microsoft, Ford and NICK

Before I go, I have a few more updates. Microsoft ($MSFT) has performed incredibly well for us this year. It’s actually the best performer of the year for us. Who saw that coming? The software giant just unveiled its new Xbox One. I’m keeping my Buy Below at $35 per share.

Last Friday, Ford Motor ($F) finally pierced my $15 Buy Below price. On Wednesday, Ford got as high as $15.32. The company recently announced that it’s expanding its North American production to meet the summer demand. I’m raising my Buy Below on Ford to $16 per share.

Shares of Nicholas Financial ($NICK) have dropped back a bit after the last earnings report. Now that enough time has passed, it’s safe to say that nothing ever came of the buyout offer. That’s OK. I’d rather see management hold out for the best possible deal. I’m keeping my Buy Below at $16, but if you’re able to add shares of NICK below $13.70, you’re getting a very good deal. That’s a yield of 3.5%, and I think there’s a good chance that NICK will raise its dividend this summer.

That’s all for now. The stock market will be closed on Monday for Memorial Day. Next week we’ll get the important Case-Shiller report on home prices, plus a revision to the Q1 GDP report. The government’s initial estimate said that the economy grew by 2.5% for the first three months of the year, which was less than what economists were expecting. It will be interesting to see if that number will be revised higher. 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

Posted by Eddy Elfenbein on May 24th, 2013 at 7:03 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.