CWS Market Review – July 11, 2014

“Never buy at the bottom, and always sell too soon.” – Jesse Livermore

Friends, allow me to introduce you to Cynk Technologies ($CYNK). This is a stock which has soared from 10 cents on June 21 to nearly $22 yesterday.

I should warn you that Cynk has a few minor operating problems. For example, the company has no assets revenues, and only one executive. Or perhaps, only one employee. In fact, we’re not exactly sure if the company exists. Also, they’re based in Belize.

Outside that, things are going swimmingly. You gotta admit—that’s some rally. Cynk has a paper value of $6 billion. The stock has rallied more in the last three weeks than Apple has since their IPO 34 years ago.

Beyond my mocking, there’s an important lesson here. Those of us who force rationalism and sobriety on the market are engaged in a constant war, and we’re not always winning. The suckers are out there. Who knows how garbage like Cynk gets going? Once people start buying it, the irrational exuberance mentality builds on itself. Soon people bid it up simply because they think the stock will go up, which in turn causes more people to buy…which in turn causes the stock to go up.

Remember, there are lots of finance professors today who tell us how efficient the market is, who say that the market is rational and that it’s impossible for an investor to beat the market over the long haul. Please. The market is made of humans, and it has all our virtues and vices. The rally in Cynk Technologies is a perfect example.

In this week’s CWS Market Review, we’ll talk about the big news in the minutes from the Federal Reserve’s last meeting. It looks like the Fed’s QE program will end earlier than we thought. We’ll also look at the big buyback announcement from Bed, Bath & Beyond. Later on, we’ll run down some of our Buy List stocks as they get ready for earnings season. But first, what exactly are the Fed’s plans for the rest of this year?

QE to End during Q4

On Wednesday afternoon, the Federal Reserve released the minutes from their June 17-18 meeting. Even though the policy statement from that meeting was largely what everyone expected, the minutes, which are released three weeks later, contained a surprise. The Fed members plan on ending their bond buying program in October.

Let’s take a step back. The original bond-buying program (Quantitative Easing or QE) had the Fed buying $85 billion worth of bonds each month. That was $45 billion in Treasuries and $40 billion in mortgage-backed securities. At each meeting since December, the Fed has tapered the program by $10 billion.

Projecting forward, I had assumed that would leave the final $5 billion to be tapered at the December meeting. Apparently not. The Fed minutes indicated that they’re looking for a $15 billion taper in October.

The timing here is important because, as I mentioned in last week’s issue, Janet Yellen has said that the Fed will start raising interest rates “something on the order of six months” after QE is over and done with. Some on Wall Street have referred to this as the Fed’s TT strategy, meaning they want a clear separation between tapering and tightening. I think that’s right. We can probably look forward to the Fed´s increasing short-term interest rates sometime next spring, about two months earlier than I expected.

I was baffled by the Fed’s move. On Twitter, I wondered, “Why the heck wasn’t this in the last FOMC policy statement?” Binyamin Appelbaum, the New York Times reporter who covers the Fed, responded, “Really good question.” If they had been considering these steps, this should have been mentioned. Or Janet Yellen could have mentioned it in her post-meeting press conference.

I often tease the bond market, but its reaction was surprisingly tame. The yield on the 10-year Treasury is back down to 2.55%. The interesting part of the yield to watch is the one- and two-year Treasuries. The yield for the one-year has basically stayed the same, right around 0.10%. But the yield on the two-year has slowly crept higher. The yield recently broke 0.5%, and the three-year yield hit 1%. Both cases are near three-year highs. What does this mean? It tells us that the market doesn’t expect any rate increases soon. But in about a year, rates will move higher. Until then, the Fed is on the side of investors.

The stock market has now gone 58 trading days in a row without rising or falling by more than 1%. That streak looked like it was going to come to an end on Thursday morning, as the stock market opened lower. Shares of Portugal’s Banco Espirito Santo plunged as investors were concerned about the bank’s viability. This triggered a sell-off in some European markets. Fortunately, the stock market founds its legs, and the S&P 500 closed lower by 0.41%.

I do have some concerns about what’s been driving the rally. Companies have opened up their wallets and bought back tons of shares. Lately, that money river has started to dwindle. Let’s consider some facts: In MarketWatch, Mark Hulbert noted that in June, buybacks fell to an 18-month low. That’s worrisome because there’s been a semi-strong relationship between buybacks and share prices. According to David Santschi, the CEO of TrimTabs, the correlation coefficient between buybacks and stock prices is 0.61.

The few shares outstanding have helped boost earnings-per-share, although nominal profit growth hasn’t been that great. In fact, sales growth has been downright tepid. Hulbert writes, “Over the past five years, for example, per-share sales growth for S&P 500 companies has been an annualized 2.4%, lagging far behind the 20% annualized earnings-per-share growth rate.”

That’s why this earnings season is so important. The growing evidence we have suggests that the economy did much better in Q2 than in Q1. Earnings reports can confirm that. It will also let us know if more consumers are heading out to stores and buying stuff. Janet Yellen and her friends at the Fed have done everything they can to lead consumers to water. Now we have to see if they’ve taken a drink.

Bed Bath & Beyond Announces $2 Billion Buyback

Speaking of stock buybacks, Bed Bath & Beyond ($BBBY) decided to make a news splash on Monday when they announced a massive $2 billion share-repurchase program.

This makes a lot of sense if you think your company’s shares are underpriced. I’m not a big fan of share buybacks. I’d rather see that money go to shareholders as dividends. But I have to give credit to BBBY because they’ve actively worked to reduce their share count. Too many buyback programs simply mask executive compensation.

BBBY’s existing buyback program was down to $681 million on May 31. This new program will be wrapped up by the end of FY 2016, which is about 18 months from now. Since 2004, the home-furnishing store has bought back $6.6 billion worth of its stock. It’s painful for me to consider how many companies have wasted billions of dollars in profits buying back inflated shares.

BBBY got a nice bump on Monday, and the shares nearly pierced $60 this week. The company still needs to deliver on its guidance for this year, but this buyback program is a strong vote of confidence from management. Bed Bath & Beyond remains a good buy up to $61 per share.

Three Buy List Earnings Reports Next Week

I’m writing this newsletter early on Friday. Later this morning, Wells Fargo ($WFC) is due to report their Q2 earnings. That will be our first Buy List stock to report this season. The bank has increased its earnings for the last 17 quarters in a row, and Wells has topped expectations for the last 10 quarters in a row. That streak may be in jeopardy this time around. Wall Street expects Wells to report $1.01 per share, along with a slight revenue decline.

A few years ago, Wells Fargo went into mortgages in a big way, but backed off considerably last year and this year. They’re now the leading bank in the country, and their earnings report will be an important sign of how well the industry is faring. Keep up with the blog for details on their earnings report.

For most of Wall Street, earnings season will heat up next week. As of now, I know of three Buy List stocks that are due to report next week: eBay on July 16, and Stryker and IBM on July 17. (There could be other earnings reports but some companies aren’t very good at communicating their plans.)

Three months ago, eBay ($EBAY) said it expected Q2 earnings of 67 to 69 cents per share. Wall Street had been expecting 70 cents per share. Even though it was a small disappointment, the stock has not fared well. The shares have slid from nearly $60 in March to $48 recently. I think that’s a big overreaction.

I also want to see what they have to say about their full-year guidance. In April, the online showroom reiterated guidance of $2.95 to $3.00 per share. That’s up from $2.71 last year. The stock closed the day on Thursday at $50.33, which is a bargain.

Stryker ($SYK) is one of those companies that regularly churn out steady earnings increases. In 2012, they made $4.07 per share, and last year, they made $4.30 per share. For this year, Stryker has given guidance of $4.75 to $4.90 per share. Wall Street expects Q1 earnings of $1.09 per share. I think there’s an outside chance that Stryker will go for a big merger, or possibly be bought out. That seems to be the direction of the industry. Stryker remains a good buy up to $87 per share.

IBM ($IBM) has been a disappointment this year. Big Blue has frustrated investors, and the shares lagged during much of the second quarter. The last earnings report wasn’t very good. Since the beginning of July, however, the stock has perked up. For next week’s earnings report, Wall Street expects $4.29 per share for Q2.

One interesting angle is that IBM said it expects earnings of “at least” $18 per share for the entire year. Wall Street doesn’t buy it, but IBM hasn’t backed down. The Street’s consensus is at $17.87. More than earnings, IBM’s problem is topline growth. If their guidance is right, then IBM is going for just 10.5 times this year’s earnings. IBM is a buy up to $197 per share.

A few more quick notes. Satya Nadella, the CEO of Microsoft ($MSFT), sent a company-wide e-mail yesterday. In it, he laid out his vision for the company. Although the e-mail wasn’t long on specifics, I like the way he’s taken over things there. MSFT will report earnings on July 22.

Also, Ford Motor ($F) said they expect to turn a profit in Europe next year. That’s very good news. The automaker has been bleeding money in the Old World, but we know they’ve been working to turn things around. Ford got as high as $17.45 on Tuesday. I expect to hear more good results later this month.

I also want to lower my Buy Below price on Ross Stores ($ROST) to $71 per share. I like Ross, but I want my Buy Below to reflect the stock’s disappointing spring.

That’s all for now. Earnings season will start to heat up next week. Within a few days, we’ll get a sense of how strongly earnings are coming in. We’ll also get a few key economic reports. The Industrial Production report comes out on Wednesday, along with the Fed’s Beige Book. Housing starts and building permits are due out on Thursday. 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 July 11th, 2014 at 7:06 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.