CWS Market Review – July 4, 2014

“We hold these truths to be self-evident, that all men are created equal.”

I hope everyone is having a wonderful Fourth of July weekend. The stock market is closed today in honor of Independence Day, but we had an eventful—albeit shortened—trading week.

The big news was Thursday’s excellent jobs report. The economy added 288,000 jobs last month. That was far more than expected, and it marked the first time the U.S. economy has added more than 200,000 for five straight months since the Tech Bubble (check out the chart below). The unemployment rate dropped to 6.1%, which is its lowest level since September 2008, the same month that Lehman Brothers went kablooey.

The good economic news helped power the stock market to more new highs. On Thursday, the Dow Jones Industrial Average topped 17,000 for the first time. The index needed only 227 days to rise from 16,000 to 17,000. For some context, the Dow first broke 1,700 on February 21, 1986, so we’re up 10-fold in a little over 28 years. The S&P 500 also broke into record territory. The index finished the week at 1,985.44 for its 25th all-time closing high this year.

In this week’s CWS Market Review, we’ll take a closer look at the jobs report and focus on what it means for us and our portfolios. I’ll also run down how our Buy List did during the first half of the year. I also want to discuss a few of our Buy List stocks. Second-quarter earnings season begins in a few days, and I expect to see good results from our stocks. Wells Fargo ($WFC) will be our first Buy List stock to report next Friday. I’ll have more on that in a bit. But first, after a long winter, the U.S. jobs market is finally showing some strength.

The U.S. Economy Created 288,000 Jobs Last Month

Since the market is closed today, Jobs Day fell on a Thursday this month. Jobs Day, of course, is very important on Wall Street. Investors around the world stop what they’re doing to see what the government has to say. The monthly jobs report is probably the best month-to-month barometer of how well the economy is doing. It’s also the report that the Fed watches most closely. We know that Fed policy is largely determined by the jobs market, or at least where they think the jobs market is going.

Yesterday, the Department of Labor said that the U.S. economy created 288,000 net new jobs last month. That’s a very impressive number. Economists were expecting an increase of 215,000. (I was much closer with my guess.) On top of that, the jobs gains for April and May were revised higher.

In the last five months, the U.S. economy has created 1.241 million jobs. I was also pleased to see that the jobs-to-population ratio finally topped 59%. The ratio had been stuck between 58% and 59% for a staggering 57 months in a row. The story had been that any gains in the employment rate were caused by folks leaving the job market. That’s still a factor, but make no mistake, there’s real hiring going on as well.

The unemployment rate fell to 6.1%, which is its lowest level in more than five years. In March, the Federal Reserve released its economic projections for 2014. The central bank saw unemployment between 6.1% and 6.3% by the end of this year. Well, things have been running ahead of schedule. Last month, the Fed revised its year-end range to 6.0% to 6.1%. The economy looks to beat that soon. The year’s only halfway done, and we’re already at 6.1%. After years of consistently overestimating the economy, the Fed has apparently underestimated the strength of the jobs market.

This week, we also had another good ISM report. For June, the ISM Manufacturing Index came in at 55.3, which was 0.1 below May’s report. The manufacturing sector came very close to increasing its growth rate for five months in a row. On Wednesday, the factory-orders report for May was sluggish (-0.5%); however if you exclude military hardware, then orders rose by 0.2%.

Of course, the ultimate judge of the economy is the notoriously ornery bond market. However, to be fair, the bond market has been well behaved. We all know how the bond market can act like World Cup soccer players—writhing around in spurious agony when they’ve been lightly grazed by another player. The strong jobs report pushed the yield on the 10-year Treasury up to 2.65%, which is still quite modest. After all, the yield is 28 basis points lower than where it started the year.

Watching the bond market is important because that, combined with the Fed’s plans, is the key to the stock market. With the economy running ahead of the Fed’s projections, I think Janet Yellen could alter her plans. I still think the Fed will taper QE at each meeting this year. That way, it will be completely wrapped up by January 1st. Previously, Chairwoman Yellen said to expect the first rate increase “something on the order of six months” after QE is done. That would be about one year from today. Now I think that date will be pushed up to the first quarter of 2015. As I’ve mentioned before, there are now signs that inflation is starting to heat up.

Here’s my take: As long as the yield curve is wide, meaning the difference between long-term and short-term interest rates is big, that’s good news for stocks. But that’s not going to last forever. Long-time readers know that I’m a fan of Dr. Twotenspread, one of the greatest economic forecasters of all time. The spread between the ten- and two-year Treasuries has been far more accurate than a lot of higher-paid folks on Wall Street (see the chart above). On Thursday, the two-year yield got to 0.52% for the first time since last September, and it’s very close to making a three-year high. But the spread between the two and ten is still a very bullish 213 basis points.

The bottom line is that this is a very good environment for stocks. Valuations have climbed, but they’re not excessive. Earnings are growing, and we’ll see more evidence of that once Q2 earnings season starts. We should also remember that stock prices have chilled out in a major way. Volatility is the lowest it’s been in years. The S&P 500 has now gone 34 days in a row without a gain or loss of more than 0.8%.

Buy List First-Half Review

This past Monday was the final trading day of the first half of 2014, and I wanted to update you on the Buy List’s performance. The good news is that we’re in the black. The bad news is that we’re trailing the market, but not by much.

Through Monday, our Buy List was up 1.99% for the year, while the S&P 500 was up 6.05%. If we include dividends, then the Buy List gained 2.70% through Monday, compared with 7.14% for the S&P 500.

At the end of the first quarter, our Buy List was ahead of the S&P 500. But during Q2, we had a small loss (-0.09%), while the market rallied 4.69%. Part of the reason is our big losers like Bed Bath & Beyond and Ross Stores. All by itself, our BBBY position knocked 1.6% off our YTD gain. Another weakness is that we don’t have any energy stocks, and that sector has heated up since March.

For the first half, our biggest winner was DirecTV (+23.1%), followed by Wells Fargo (15.8%) and Stryker (12.2%). Our biggest loser was, not surprisingly, Bed Bath & Beyond (-28.5%), followed by CA Technologies (-14.6%) and Ross Stores (-11.7%).

As I’ve mentioned many times, our Buy List has beaten the market for the last seven years in a row. Even though we’re trailing the market now, I have no plans to depart from our proven strategy. We’re not even close to being out of it, and I’m confident we can catch the S&P 500 before the year is up. Now let’s look at some recent news affecting our stocks.

Buy List Updates

Wells Fargo ($WFC) will start earnings season for us next week. The bank is due to report Q2 earnings on July 11, before the opening bell. The stock just made another new 52-week high yesterday. Wall Street expects quarterly earnings of $1.01, which WFC should be able to top. The shares have done well for us this year, but Wells is far from fully priced. The bank is currently going for less than 13 times this year’s earnings estimate. Plus, it yields more than 2.6%. For now, I’m going to keep our Buy Below somewhat tight. Wells Fargo remains a very good buy up to $54 per share.

Oddly enough, Bed Bath & Beyond ($BBBY) showed some life on Thursday as the shares gained 2.7%. There’s been some talk of a potential buyout, but it seems to be only rumors for now. For now, I’m keeping our Buy Below at $61 per share.

On Thursday, shares of Ford ($F) closed at $17.32, which is its highest closing price since October. On Tuesday, the auto maker reported a monthly sales decline, but that’s due to some technical factors as Ford retools its production facilities. Overall, sales fell by 5.8%, but that was less than expected. The good news is that Fusion sales were up 14%. Ford is due to report Q2 earnings on July 24. Wall Street currently expects earnings of 38 cents per share. Ford remains a solid buy up to $18 per share.

That’s all for now. Next week will probably be fairly quiet. Most of the Wall Street big shots are chilling at the Hamptons. Alcoa will kick off earnings season on Tuesday. Our own Wells Fargo is due to report on Friday morning. On Wednesday, the Fed will release the minutes of its last meeting. Traders will scour the minutes for any hint of tight money, but I doubt they’ll find it. 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 4th, 2014 at 7:07 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.