CWS Market Review – June 28, 2013

“There is only one boss. The customer. And he can fire everybody in the company from the chairman on down, simply by spending his money somewhere else.”
– Sam Walton

After last week’s temper tantrum from the stock, bond and gold markets, officials at the Federal Reserve spent much of this past week trying to calm everyone down. The good news is that it’s worked. Or at least, it has thus far.

But the Fed is merely trying to save itself from yet another Fed-induced problem. They’re CYA-ing in a big way. While the FOMC’s policy statement was pretty much as expected, the after-meeting presser by Ben Bernanke was surprisingly hawkish. The markets responded quickly. At its recent low, the Dow was 991 points below its May high, and the yield on the 10-year Treasury got as high as 2.66%. That’s a full 1% increase in less than two months. Check out the down-and-up of the S&P 500 over the last few days:

So what’s going on?

In this week’s CWS Market Review, I’ll take a closer look at the market’s latest hissy fit. I also want to highlight the good earnings report from Bed, Bath & Beyond ($BBBY). It’s hard to believe BBBY was going for $57 just four months ago. It’s at $70 today. Our Buy List continues to hold up very well, and stocks like Wells Fargo ($WFC) have broken out to new highs. But first, let’s look at the latest song and dance from the Federal Reserve.

Bernanke’s Just a Guy Thinking about the Future and Stuff

At his June 18th press conference, Ben Bernanke said:

If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear.

The financial markets interpreted this to mean that QE would start to taper later this year (probably starting in September) and would end by this time next year. The back story is the belief that the Fed’s policies are the main reason why the bull market has been so strong. In my opinion, Bernanke and Friends have clearly helped, but it doesn’t follow that once the Fed pulls back—or takes its foot off the gas, in Bernanke’s analogy—the market will suddenly collapse.

Traders are capable of anything, but even I was surprised by their skittishness. Considering how many macho people there are in finance, the market as a whole can be one big fraidy cat. In four trading days (last Wednesday to Monday), the S&P 500 lost 5%. I think the folks inside the Fed were genuinely shocked by the market’s strong reaction.

This week, one Fed official after another stressed that no plans are set in stone, and the Fed will alter policy as needed. If you want to hang with the popular kids, the term for this is “data dependent.” In fact, this week’s GDP report was pretty weak, and it most likely will give ammo to folks who think QE needs to go on awhile longer.

Binyamin Appelbaum, the New York Times reporter, got it exactly right when he tweeted, “‏The Fed’s new message seems to be that Bernanke was just a guy who happened to be thinking out loud about the future and stuff.” Scary, but that’s how they’re acting. The minutes from this past meeting are due out on July 10th, and I think a lot of folks are very curious to hear what was said. But for now, the good news for investors is the Fed realizes how damaging their words can be.

What’s the Fallout?

The Fed did indeed calm the market down. The three-day rally on Tuesday, Wednesday and Thursday caused the S&P 500 to gain more than 2.5%. The Dow once again jumped to over 15,000. Perhaps the most dramatic impact was seeing the Volatility Index ($VIX) drop from nearly 22 on Monday to less than 17 by the end of the day on Thursday.

What investors need to understand is that the Fed is watching the economy, and they’re not about to shut off the spigots while the flow is still needed. The lower rates have greatly helped the interest-rate-sensitive areas of the market. I’ve spoken of this before as the magic equation: any place where consumer spending intersects with finance has been a winner. Examples of this include credit-card companies like Mastercard ($MA) and American Express ($AXP). The homebuilding stocks have also done very well. On our Buy List, the magic equation can be seen in stocks like Ford ($F) and JPMorgan Chase ($JPM).

Since the Fed has its hand in interest rates, it can obviously help those rate-sensitive areas. The question is whether the economy is strong enough that it can go along without the Fed’s help. The big clue for this will be second-quarter earnings season, which begins soon. Almost without anyone’s noticing, Q1 earnings growth was positive, and that didn’t happen in either Q3 or Q4 of last year. In other words, earnings growth is reaccelerating, meaning the rate of growth is itself increasing. We want to see that continue in Q2. Wall Street expects to see earnings growth ramp up pretty quickly in Q3 and Q4. If that does indeed happen, a lot of the Fed’s worries will go away.

I suspect that the S&P 500 will stay at or below its 50-day moving average for a while longer (the 50-DMA is currently at 1,620.42). Our Buy List has held out very well over the last two months, and it will continue to lead the market as investors seek out high-quality names. Please pay close attention to my Buy Below prices on our Buy List.

The key area to watch won’t be the stock market but rather the bond market and its close cousin, the gold market. In fact, gold has been getting crushed lately. On Thursday, the Midas metal dropped below $1,200 per ounce for the first time in nearly three years. The drop in gold is really a rise in short-term real interest rates, meaning the rates after inflation. I think gold is acting as an early warning signal, and within a few months, the interest-rate-sensitive areas will start to lag the market. We’re already seeing signs of this with the Homebuilding Sector ($XHB), thanks to higher mortgage rates. The commodity stocks have also been very poor performers. The Energy Sector ETF ($XLE) and the Materials Sector ETF ($XLB) have badly lagged the market.

A major trend for next year may be consumer staples stocks, but we’re far too early to see that kind of rotation. For now, investors should continue to focus on high-quality names. One stock on our Buy List that looks particularly attractive at the moment is Cognizant Technology Solutions ($CTSH). The shares got beat up in April, but now the dust has settled. CTSH is a very good buy up to $70 per share.

Bed Bath & Beyond Is a Buy up to $73 per Share

After the market closed on Wednesday, Bed Bath & Beyond ($BBBY) reported fiscal Q1 earnings of 93 cents per share. That hit Wall Street’s forecast square on the nose. On the conference call back in April, the home furnisher told us to expect Q1 earnings between 88 and 94 cents per share. I said in last week’s issue that I was expecting them to come in near the high end of that range, and that proved to be the case.

Let’s look at the numbers. BBBY earned 89 cents per share for last year’s Q1. For this year, quarterly sales rose 17.8%, to $2.612 billion. But the most important metric for retailers is comparable-store sales, and that rose a healthy 3.4% last quarter.

With a company like BBBY, I’m not too concerned about their missing or beating expectations by a few pennies per share. That’s no big deal. What’s important to me is that the general trend is upward.

If you remember, the shares got pummeled last year (a few times actually). But here’s the thing: yes, the company had some minor short-term issues, but this is a very well-run outfit, and they’ve worked to correct that. The stock dropped to $57 earlier this year, and in the February 15 issue, I said BBBY had become a very good buy.

For Q2, Bed Bath & Beyond sees earnings ranging between $1.11 and $1.16 per share. Wall Street had been expecting $1.15 per share, so this was in range. For the entire year, BBBY sees earnings between $4.84 and $5.01 per share (they made $4.56 per share last year). That number for the low end is way too low. Wall Street had been expecting $5.01 per share. I had said I was expecting $5 per share.

As you’ve probably heard me say many times before, I’m not a big fan of share buybacks. However, BBBY does it in a way that actually reduces share count, so I’ll give them credit for that. Their balance sheet is rock solid, with no debt and lots of cash. We have a nice 25% YTD profit in this stock. BBBY is an excellent buy up to $73 per share.

Moog Is a Buy up to $55 per Share

Before I go, I’m raising the Buy Below price on Moog ($MOG-A) to $55 per share. The stock has been holding strong lately, above $50 per share. The company had a good earnings report for Q1, and the CEO said business should improve for the second half of the year. Moog is a solid buy.

There’s also one small item about DirecTV ($DTV). The satellite-TV operator overstated the number of subscribers it has in Brazil. This appears to be an honest mistake. The stock dropped sharply at the open on Thursday, but rallied back as the day wore on. DTC continues to be a good buy up to $67 per share.

That’s all for now. Next week will be a rather unusual week in that the stock market will close early on Wednesday, July 3rd and will be closed all day on July 4th. There will only be three full trading days over a nine-day stretch. Despite the limited exchange hours, the ISM report will come out on Monday. The ADP report comes out on Wednesday, and finally the big jobs report is due out on Friday, July 5th. Traders will definitely be monitoring the progress of the labor market. 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 June 28th, 2013 at 6:48 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.

Tickers: bbby, CTSH, MOG-A