CWS Market Review – September 5, 2014

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

We’re now past Labor Day, and the stock market keeps on rolling. There are times when it seems like all the news is bad news for the market; then it suddenly switches, and everything is good for stocks! On Thursday, the S&P 500 got as high as 2,011.17, which is yet another new all-time intra-day record high. But in the course of the day, the bears showed up and pushed the index back below 2,000. Still, the bulls have been the rulers of Wall Street for the past month.

As impressive as this rally has been, we have to bear in mind some important facts—the market’s volume and volatility have been low. Very low. Daily trading is the lightest it’s been in years. And look at the S&P 500’s recent price action. The index has now gone 11 days in a row of closing up or down by less than 0.5%. Seven of those days were less than 0.2%. Dear Lord, that’s barely a blip, and it’s especially small compared with the hyper-volatility of just a few years ago. The hot summer has been the Big Chill for Wall Street.

I’m also pleased to see that many of our Buy List stocks are joining in on the rally. Fiserv ($FISV) continues to push to new highs. Bed Bath & Beyond ($BBBY) finally broke above $65 per share. Even CA Technologies ($CA) has perked up recently.

The big news this week didn’t come out of the U.S. market. Instead, it came from Europe. Mario Draghi, the head of the ECB, said that the central bank will start buying asset-backed securities. In other words, they’re doing QE, too. The ECB also cut interest rates. Just like ours, their rates are on the floor, so they need a little experimenting to go negative. The ECB also cut their GDP forecasts for this year and next year.

My take: Draghi is sending a message: “Please, please, pleeezze bring the euro down!” If that works—and I can’t say it will—that would take a lot of heat off the ECB, and it would help the Eurozone get back on its feet.

I do want to caution investors that the U. S. market may be in store for a rough few weeks. Nothing dire, mind you. But I think some bears will soon be bold enough to launch assaults on some high-profile stocks (even Apple felt the sting this week), and the market as a whole may take a dip. You may have noticed that I’ve kept a leash on many of our Buy Below prices. Please understand that I only mean a few weeks, and nothing protracted. As always, investors should protect themselves by owning a diversified list of our Buy List stocks.

In this issue, I’ll cover some of the recent economic news impacting our portfolios. I also want to focus on the goings-on in the gold market. The Midas Metal has been getting squeezed lately, and I think this will go on for some time. I’ll also highlight a few especially good bargains on our Buy List. But first, let’s take a look at the best ISM report in more than three years.

August ISM Index = 59.0

On Tuesday morning, the ISM Index for August came in at 59.0. That’s a very good number, and it tells us that the manufacturing sector is thriving. Let me explain why the ISM report is so important. It’s a survey of manufacturers, and they’re asked whether business is better or worse compared with last month. What’s interesting is that it doesn’t tell us the overall result, just where we are compared with one month ago. The ISM is also a “diffusion” index, which is a fancy way of saying it measures how broad the changes are.

I like to keep a close eye on the ISM report for several reasons. One is that it’s reported on the first business day of each month. Other reports, like trade or GDP, take weeks or months before we know what’s truly happening. Also, the ISM isn’t subjected to countless revisions. What you see is what you get.

With the ISM, any number above 50 means that the manufacturing sector of the economy is expanding. Below 50 means it’s contracting. The ISM has been 50 or better for 60 of the last 61 months. I’ve spliced the data carefully and found that we usually don’t hit recession territory until the ISM gets down to 45 or so. In other words, we’re well within the safe zone.

The August ISM was at its highest level since March 2011. It came very close to matching the highest ISM in the last ten years (59.2 for February 2011). The ISM has now risen for six of the last seven months. The only downer was a small 0.1 drop in June. The ISM is important because if the manufacturing sector is doing well, it’s likely to spill over into other areas of the economy.

The trouble spot continues to be the labor market. I’m writing to you on Friday morning ahead of the big August jobs report. All of Wall Street will be waiting to see how many jobs were created in August. Nonfarm payrolls have grown by more than 200,000 for the last six months, and August may make it seven. We got a sneak preview of the jobs report when ADP, the private-payroll firm, released its report showing a gain of 204,000 private-sector jobs last month. The weekly initial-unemployment claims have also been well behaved.

I think The Wall Street Journal captured it well when they described the economy’s “solid-if-unremarkable growth.” The economy is indeed growing, but at a subdued pace. The good news is that it can keep this up for several more quarters.

This past week, the Federal Reserve released its Beige Book report. If you want to get a good report on how well the economy is doing, the Beige Book is a good place to start. I’ll warn you, though, it’s fairly wonky. The most recent Beige Book confirmed a lot of what we already know: the economy continues to expand at a slow-to-moderate pace.

On our Buy List, we saw more evidence of this trend in the surprisingly good sales report from Ford Motor. Wall Street had been expecting a sales drop for August. Instead, it was a small increase. Ford had its best August in eight years.

Next week we’ll get more info on how consumers are behaving, but it looks as if the lower gas prices have lured more consumers to open their wallets. Remember the recent strong earnings report from Ross Stores ($ROST) and the higher guidance? In my book, watching business at a deep discounter like Ross is a lot more useful than a roomful of well-regarded government econ reports.

What does this mean for us? The fundamentals of the economy are better than they were a year ago. All the signs point to a moderate expansion. Nothing great, but the arrows are finally pointing in the right direction. I expect to see more strength in consumer-related areas like eBay ($EBAY), McDonald’s ($MCD), Wells Fargo ($WFC) and others.

What Does the Recent Weakness in Gold Mean?

While the stock market has been quietly bullish lately, the gold market’s been in rougher shape. On Wednesday, the yellow metal dropped more than $20 an ounce. On Thursday, gold closed at its lowest level since June 11.

Interestingly, this Saturday will mark the three-year anniversary of gold’s all-time intra-day high of $1,923.70. (Dear Lord, was it really that high?) Needless to say, this has been a rough bear market for the gold bugs. Gold is currently off by more than one-third from its peak price.

Gold closed Thursday at $1,261.70, and I think there’s a chance it could soon test its closing low of $1,187.10 from last December. Here’s the important thing: Gold tends to move in long multi-year trends. Once the trend is in place, it’s darn hard to stop. At least, that’s been the historical behavior.

So why has gold been heading down? I suspect that it’s in anticipation of the Fed’s raising interest rates sometime next year. There’s still some debate as to when that will happen, but I think more investors have reconciled themselves to the fact that it will be an event in calendar year 2015.

Once real interest rates start to rise, gold will come under more and more pressure. I think a lot of gold investors got used to easy times. Gold had an amazing run for more than a decade. That’s over. For right now, I’m staying away from gold.

Three Buy List Stocks That Are Especially Attractive Right Now

I wanted to highlight a few Buy List names that look particularly good right now. I’m surprised by the recent weakness of McDonald’s ($MCD). I realize the company faces a number of hurdles, but I think this price is quite reasonable. The shares recently came very close to breaking below their low from February. The stock currently yields nearly 3.5%, which is quite good in this market. This is also the time of year when MCD traditionally raises its dividend. Since this year’s earnings will probably be about the same as last year’s, the company may forego a dividend increase. But it won’t lower it either. This one may take some time, but MCD is at a bargain price here.

I also like Cognizant Technology Solutions ($CTSH). The shares took a big hit a few weeks ago, and I think the selling pressure has passed. Bear in mind that Cognizant didn’t plunge on lower earnings guidance; the stock fell due to the lower sales guidance. The company was very clear that its earnings forecast for this year ($2.54 per share) was the same. Also, CTSH’s lower sales guidance works out to a lowering of its growth rate from 16.5% to 14%. That’s still quite impressive. I’m keeping my Buy Below at $48 per share, but if you can snag these shares below $46, you got a very good deal.

Shares of Ford Motor ($F) pulled back a bit on Wednesday and Thursday. The automaker reported another good month for sales. Last month was their best August in eight years. Ford’s sales rose 0.4%, while the Street had been expecting a decrease of 1.9%. The Ford Fusion did especially well. Some of Ford’s sales numbers are impacted by consumers’ waiting for the rollout of the aluminum-body trucks late this year. This could be a game changer.

That’s all for now. The big August jobs report will come out later this morning. Next week we’ll get important reports on Consumer Credit and Retail Sales. It will be interesting to see how strong consumers were this summer. I suspect that shopping has been aided by the recent drop in gasoline prices. We’ll also get a clue when Bed Bath & Beyond reports later this 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 September 5th, 2014 at 7:12 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.