CWS Market Review – August 15, 2014

“Carpe diem. Seize the day, boys. Make your lives extraordinary.”
– Dead Poets Society

The stock market’s July swoon sure didn’t last long. From closing high to closing low (July 24 to August 7), the S&P 500 lost a grand total of 3.94%. That small bit of turbulence unnerved a lot of folks who should have known better. But since there’s been so little volatility of late, that minor dustup seemed larger than it truly was.

Last week, the Russian military called off some exercises near the Ukrainian border. I can’t say those exercises specifically caused the market’s tumble, but ever since they ended, the stock market has rallied. The S&P 500 has advanced in four of the last five sessions, and we’re not too far from another new high. Since August 7, the S&P 500 has gained 2.39%. Another sign that tensions have chilled out is that small-cap stocks have led the bounce-back rally, and the VIX is back down again.

Now that second-quarter earnings season is past us, this is a good time to run through all 20 stocks on our Buy List and review their prospects for the rest of the year. I’ll also take a look at the recent bond market rally. Long-term yields have been dropping, and I think the time has finally come for bonds to take a rest. We’ll also preview two Buy List earnings reports for next week. But first, let’s look at the stretched market for bonds.

It’s Time for Bonds to Sit Down

As well as the stock market’s done lately, the bond market has been a rock star this year. The yield on the 10-year Treasury closed at 2.40% on Thursday. That’s a 14-month low. If you had told me on New Year’s Day that the 10-year would go for 2.40% by August, I would have thought you were out of your mind. The yield has dropped more than 60 basis points since the start of the year.

It’s interesting how few people saw this big bond rally coming. Jeffrey Gundlach, the bond kingpin, was one of the few who got it right. There seems to be an insatiable appetite for all things bond. This week, the Treasury auctioned off some 30-year bonds, and yields were the lowest in more than a year.

Why the demand for fixed-income? I think this represents misplaced concerns about stock prices. Given where we are in the economy, it’s safe to say that the bond rally has run too far. The idea that investors are willing to lock in their capital for 10 years to get a measly 2.4% seems a bit crazy to me. That’s almost exactly what the stock market has gained in the last five years.

Several of our blue-chip Buy List stocks yield more than the 10-year, such as Wells Fargo ($WFC), Ford ($F) and Microsoft ($MSFT). Not only do they yield more, but they’re also thriving businesses. As much as I love bonds, they just sit there.

You can really see the absurdity of the bond market by looking at the TIPs—the inflation-protected bonds. The 10-year TIP currently yields 0.2%. That’s down from 0.8% late last year. I understand why investors are nervous about stocks, but I don’t see why anyone would invest in a bond that barely beats inflation for the next 10 years. In 2012 and 2013, the 10-year TIPs turned negative, but the fear was more understandable, given the dramatic events in Europe. The 10-year Spanish bond now yields less than American bonds. In Germany, the 10-year bond dropped below 1%. The 1% Club is very exclusive; the only other members are Japan and Switzerland.

Thanks to improved economic numbers, we can expect long-term yields to drift higher as the year goes on. By this time next year, the Federal Reserve may have already started raising interest rates. Now let’s take a look at our Buy List.

Rundown of the Buy List

I was puzzled by the market’s negative reaction to AFLAC’s ($AFL) Q2 earnings report. I thought the earnings were fine. After all, they beat expectations by seven cents per share, but the shares fell as low as $58.50, and two weeks ago, I said the stock was an especially cheap buy below $60. The good news is that AFLAC ticked up above $60 per share on Thursday. AFLAC remains a good buy up to $66 per share.

Bed Bath & Beyond ($BBBY) continues to recover, but unevenly. BBBY broke above $64 per share in late July. That’s nearly $10 more than its July low. Investors clearly overreacted to BBBY’s bad news. Remember that this is one of our off-cycle stocks, so they’ll report their Q2 earnings in about six weeks. They see Q2 earnings ranging between $1.08 and $1.16 per share. That’s not bad. Bed Bath & Beyond remains a good buy up to $65 per share.

Last week, I mentioned that CA Technologies ($CA) was in danger of being knocked off next year’s Buy List. I’m free to change my mind before then, but I need to see more signs of improvement from CA. The part I really like is the generous yield. Going by Thursday’s close, CA yields 3.52%, but I’m not crazy about them. CA Technologies is a moderate buy up to $31 per share.

Cognizant Technology ($CTSH) seemed to be our only bomb from last earnings season. Now that I’ve looked at the numbers, I’m not worried about CTSH at all. I apologize if you were caught in the sell-off, but the company is still doing well. If you don’t own CTSH, this is a good time to start a position, especially if you can get it below $45 per share. Cognizant Technology remains a good buy up to $48 per share.

CR Bard ($BCR) is one of those quiet stocks that you tend to forget about because they’re so quiet. That’s unfair, because this is a solid company. Bard beat earnings last month and raised their full-year guidance. They now expect $8.25 to $8.35 per share for the full year. I held off on changing our Buy Below on Bard, but I think this is a good time for an increase. I’m raising our Buy Below on CR Bard to $160 per share.

I also mentioned DirecTV ($DTV) last week as a possible deletion from next year’s Buy List. The difference is that I love DTV. It’s the AT&T deal that makes them less attractive as an investment. Their business continues to do well. I’ll let you know as we hear more about the AT&T deal. My decision will come down to how close the shares are to $95 by year’s end. There’s no point in holding on to a stock for a few more percent. Until then, DTV is a buy up to $95 per share.

eBay ($EBAY) got knocked around for most of the spring. I’m pleased to see the shares are making their way back. They beat earnings by a penny per share last month, and the stock has continued to rally. eBay sees full-year earnings ranging between $2.95 and $3.00 per share. I’m going to keep a tight Buy Below for eBay at $55 per share.

Express Scripts ($ESRX) was our surprise star from last earnings season. The shares jumped 7.15% over two days. The pharmacy-benefits manager now expects full-year earnings of $4.84 to $4.92 per share. I also like that ESRX has a fairly clean balance sheet. I’m going to keep our Buy Below at $74 per share for now, but I may raise it soon.

After the market’s July slide, I was curious which Buy List stock would be the first to make a new high. I remember thinking that picking Fiserv ($FISV) would be “too easy.” The stock rarely disappoints. On Thursday, Fiserv got as high as $62.47 per share, which is only 63 cents below the high from three weeks ago. This week, I’m raising our Buy Below on Fiserv to $66 per share.

You should never fall in love with a stock, but I have to admit that I have a serious crush on Ford Motor ($F). The stock had a strange sell-off that brought it below $17 for a few days. Don’t let that scare you. Things are going very well for Ford. I think we can expect another run at $18 per share. Ford currently yields 2.87%. Ford Motor is a buy up to $19 per share.

IBM ($IBM) was the stock that everyone loved to hate. I think that’s softened a bit, but Big Blue has many problems ahead. Fortunately, the shares are pretty cheap here. I don’t know if they’ll hit their highly touted earnings target of $20 per share for next year. I’m assuming they will. The company has been spending enormous amounts of money buying back their own shares—$3.7 billion in Q2! I don’t think this is the wisest strategy. I’d rather see that money go back to shareholders. IBM is a buy up to $197 per share.

McDonald’s ($MCD) is another stock that I listed last week as a candidate to stay home next year. I want to see signs from management that they get how serious the problems are. I don’t consider MCD to be a speculative play since the dividend is quite solid at 3.46%. McDonald’s is a buy up to $101 per share.

Medtronic ($MDT) is due to report on Tuesday, August 19. Wall Street currently expects earnings of 92 cents per share. My numbers say that’s about right. The medical-device maker is currently working through its big deal with Covidien. This is another stock that may not be back next year. Again, it’s not because I don’t like Medtronic, but the new company will be quite different. They see full-year earnings ranging between $4.00 and $4.10 for this year. Medtronic is a buy up to $67 per share.

Satya Nadella, Microsoft’s ($MSFT) new CEO, is still enjoying his honeymoon on Wall Street. Investors clearly love Steve Ballmer’s replacement. The irony is that much of the company’s recent success is due to Ballmer as much as to Nadella. If you recall, the stock fell in the after-hours market after the last earnings report came out. Then, once folks had a second to actually read what the company had to say, investors realized they had a good quarter. I think MSFT will make a run at their 52-week high soon. It’s our second-best performer this year. Microsoft continues to be a solid buy up to $48 per share.

Moog ($MOG-A) is the final company I listed last week as a potential candidate to be culled from the Buy List. I didn’t like their recent guidance. I’m keeping a tight Buy Below at $71 per share.

Oracle’s ($ORCL) last two earnings reports were not particularly inspiring. But the more I look at the company, the more impressed I am. Thanks to the sell-off, I think Oracle is an especially good bargain here. Oracle will report fiscal Q1 earnings in mid-September. In June, they gave guidance of 62 to 66 cents per share. They should be able to get that easily. Oracle is a very good buy below $40. My Buy Below is at $44 per share.

Qualcomm ($QCOM) got wrecked after its last earnings report, but here’s the hitch—the earnings were outstanding. Qualcomm also raised their full-year guidance, but investors were worried about their legal conflict with China. Unfortunately, there’s not much QCOM can do. I think they may wind up paying a hefty fine which may be the easiest route. Qualcomm remains a buy up to $79 per share.

Shares of Ross Stores ($ROST) have not done well this year, but that’s mostly due to the lousy environment for retail, not their performance. This week’s poor retail report also hurt the deep discounter. Ross is due to report fiscal Q2 earnings next Thursday, August 21. The company expects earnings between $1.05 and $1.09 per share. They also gave full-year guidance of $4.09 to $4.21 per share. If Ross can land in the upper end of that forecast, then the current share price is quite good. But I want to see next week’s results before I can say I’m more confident. Ross Stores is a buy up to $71 per share.

Stryker ($SYK) is one of those steady stocks that rarely surprises us. However, they surprised last month when they lowered guidance. Stryker lowered the top end of their full-year forecast by 10 cents per share. The shares pulled back from $86 at the beginning of July to $81 recently. Nevertheless, this isn’t one I worry about. Stryker remains a good buy up to $87 per share.

Wells Fargo ($WFC) is simply the best-run big bank in the country. Wells is having a good year for us (+11%). The bank isn’t quite the bargain it used to be, but I hope to see another dividend increase soon. For now, earnings growth has slowed down, but Wells is also a much safer stock than it used to be. Wells Fargo remains a buy up to $54 per share.

That’s all for now. Next week should be another slow week. There’s not a lot of economic news or earnings reports due, so traders may be especially sensitive to headline risk. On Tuesday, the Labor Department reports on consumer inflation. The recent up trend has been very modest, and it may have peaked. On Wednesday, the Fed releases the minutes from its most recent meeting. I think it’s clear what path they’re on. 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 August 15th, 2014 at 7:05 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.