CWS Market Review – June 7, 2013

“The expectation of an event creates a much deeper impression
on the exchange than the event itself.” – Jose de la Vega, 1688

After countless predictions of its imminent demise, this year’s bull market is finally starting to show some cracks. On Thursday, the S&P 500 not only fell below its 50-day moving average, but also fell below 1,600 for the first time in a month. Fortunately, a strong afternoon push-back rally brought us back over 1,622, but traders are clearly getting nervous. The Volatility Index ($VIX) jumped 40% in just 12 trading days.

In this week’s CWS Market Review, we’ll take a closer look at what’s going on. I also want to preview some of our upcoming Buy List earnings reports. The turmoil in the broader market has actually been good for our Buy List which has outpaced the S&P 500 for nine of the last ten days, and we’re once again beating the index for the year. This would be our seventh year in a row of beating the market. Before I get to our portfolio, let’s look at what’s been causing the market so much grief lately.

Don’t Expect the Bond Selloff to Continue

What’s been unusual about 2013, at least until now, is that the stock market hasn’t had any major reversals. That’s not how previous years have played out. Despite the historic bull market, the S&P 500 had major drops in 2010, 2011 and 2012. Now we have a modest one: Measuring from the intra-day peak on May 22nd to Thursday’s low, the S&P 500 lost 5.27%. That’s the biggest break all year.

Here’s what’s happening. Since May 2nd, long-term interest rates have gapped up significantly. But what’s interesting is that shorter-term rates (inside of one year) haven’t moved much at all. The yield curve is essentially flat out to one year. If anything, short rates have edged slightly downward in the past three months.

One reason for the higher long-term rates is that the economy seems to be improving. The housing market, for example, is much better, and consumer confidence is on the upswing. With the improved economy, traders believe that Ben Bernanke and his pals at the Fed will ratchet down their bond-buying spree. “Taper” is the new buzzword on the Street.

I have to explain that moves in the bond market often foreshadow moves in the stock market. Usually, it’s by a few months, but sometimes it’s only a matter of weeks. Think of the two markets, stocks and bonds, as being in constant competition with each other for investors’ dollars. In just a few days, the yield on the 30-year Treasury has climbed from 2.8% to 3.3%, so that’s tempting to some folks who are getting a measly 2% yield out of the S&P 500.

Simultaneously, we’ve seen a gigantic boom in the Japanese stock market as the yen has plummeted against the dollar. The authorities in Japan are determined to boost their economy by getting some inflation going. I can’t judge if this will work, but their stock market responded. From November 13th to May 22nd, the Japanese Nikkei soared 80%. That’s an astounding gain. Since then, however, the Nikkei has given back 17%. The extreme volatility of the Japanese market seems to be causing some unease in the U.S. market.

After getting crushed by the dollar for several months, the Japanese yen finally struck back in a big way on Thursday. I suspect that this is traders anticipating a weak jobs report on Friday and therefore more aid from the Fed. The stronger yen is good news for AFLAC ($AFL), but I’ll stress that I like AFLAC because of its business and low valuation, not as a backdoor play on the yen. AFLAC remains a good buy up to $57 per share.

Despite the downturn in the bond market, I don’t believe it will last very long. While the economy is better, it’s still far from strong, and all the talk of the Fed’s tapering is premature. Frankly, I don’t see the Fed taking its foot off the pedal for the rest of this year. Expect to see bond yields go back down, although not to the mega-lows from last summer. In fact, bond yields have already dropped since their peak last Friday. I think the 10-year yield will soon drop below 2% again.

My advice to investors is to ignore any short-term market fluctuations. The next big event for us will be Q2 earnings season. We’ve now passed the first-quarter earnings season, and there are only three weeks left in the second quarter. If the analysts are right, we’re going to see even better earnings growth for Q2. Now let’s take a look at three of our off-cycle stocks that are due to report soon.

Oracle Is a Buy up to $38 per Share

Most of the Buy List stocks are on the March-June-September-December reporting cycle, but we have three stocks—Oracle, Bed Bath & Beyond and FactSet Research—that follow the February-May-August-November cycle. As a result, they’ll be reporting earnings later this month.

Oracle ($ORCL) wrapped up its fiscal year at the end of May, and the company is due to report its fiscal fourth-quarter earnings on June 20th. Frankly, the Q3 earnings report was a dud, and Oracle doesn’t do that very often. It seemed like half the analysts on Wall Street slashed their ratings on Oracle.

But the times when investors start to doubt Oracle are when the company’s at its best. To be fair, their results were weighed down by weakness in Europe. Oracle has said they expect Q4 earnings to range between 85 and 91 cents per share. Look for a big earnings beat here. Yes, their hardware business is not in a happy place, but I’m expecting software-license growth of 10%. Last week, I raised my Buy Below price to $38 per share. Oracle remains a very solid buy.

Buy Bed Bath & Beyond up to $73

Last month, I was excited to see Bed Bath & Beyond ($BBBY) crack $70 per share. That was a very nice turnaround for us, especially considering BBBY had been bouncing around the $55 mark earlier this year.

But over the past few weeks, BBBY has mostly flat-lined. On Wednesday, the stock got a nice bump from an upgrade by an analyst at Nomura. Aram Rubinson raised BBBY to “buy” from “neutral,” and lifted his price target to $82 from $72 per share. I detest the idea of price targets, but if he’s right, that’s a very nice rally from here.

Bed Bath & Beyond will report earnings again on June 26th. On the April conference call, the company told us to expect Q1 earnings to range between 88 and 94 cents per share. I expect the results to be at the high end of that range. I’m also expecting full-year earnings of $5 per share. Bed Bath & Beyond remains an excellent buy up to $73 per share.

FactSet Is a Very Good Buy Below $108

Last month, FactSet Research Systems ($FDS) boosted its quarterly dividend by 13% to 35 cents per share. I was pleased to see that, but FDS pays a very small amount of its profit out as dividends. On June 18th, the company will report earnings for the fiscal third quarter. FactSet has already said that earnings should be between $1.14 and $1.16 per share. Since that’s such a narrow range, I’ll take that as a strong hint they know what the results are.

I’m a little concerned that cost-cutting on Wall Street may take some growth off FDS, but they seem to be managing this well. Bear in mind that FactSet has increased its earnings for the last 16 years in a row. Not many companies can make that claim. FactSet is an excellent buy up to $108 per share.

Before I go, I have a few other comments. I expect to see a dividend increase soon from CR Bard ($BCR) and Medtronic ($MDT). The latter has raised its dividend every year for the last 35 years in a row. I also want to highlight that Microsoft ($MSFT) broke out to another five-year high this week. But don’t chase it. MSFT is a good buy up to $35 per share.

That’s all for now. Next week will be a slow news week for economic reports. On Thursday, we’ll get the report on retail sales. This is a good gauge for consumer strength. The most important report will come on Friday when the Federal Reserve releases its report on Industrial Production for May. The IP report for April was pretty weak, so it will be interesting to see if there was a rebound last month. 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 7th, 2013 at 7:43 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.