CWS Market Review – December 5, 2014

“I rest perplexed with a thousand cares.” – Henry VI, Pt 1

So does the stock market. Share prices continue to march higher, yet in very measured steps. On Wednesday, the S&P 500 closed at yet another all-time high, although we gave some of that back on Thursday. Still, the indexes are holding on to solid year-to-date gains. The S&P 500 is up more than 12% this year.

On Monday, the S&P 500 had its worst drop in six weeks. Of course, I have to laugh at this because the worst drop in six weeks is a measly -0.68%. Historically, that ain’t nothing. It’s especially small compared with the hyper-volatility of a few years ago. The fact is, the equity markets have chilled out in a major way.

The recent drama hasn’t been in stocks but in the commodity pits. The price of oil has been sliding since the spring (see above). Then, last Friday, the bottom fell out. Oil plunged 10% in one day. Bear in mind that this drop came after black gold had fallen by 27% in five months. Prices at the pump are the lowest they’ve been in four years!

Just about every major commodity has been feeling the pain. In this week’s CWS Market Review, we’ll take a closer look at what the commodities bear means for us. I’ll also run down some of the latest news for our Buy List stocks. Stryker ($SYK), one of our healthcare stalwarts, just gave us a nice 13% dividend increase. Express Scripts ($ESRX) just snapped a streak of 12-straight daily rallies. Before we get to that, though, let’s take a look at the slide in oil and the still-kicking Strong Dollar Trade.

The Global Fallout of the Rising Dollar

Earlier this year, I started telling you about the Strong Dollar Trade. I argued that this was emerging as a dominant investing theme and that it was impacting the economy and financial markets in different ways. All investors need to understand the effects of the rising greenback.

Put simply, the Strong Dollar Trade refers to the efforts of policymakers in Europe and Asia to weaken their currencies. Those economies are in rough shape, so they hope to spark a recovery by bringing down their currencies. That means the U.S. dollar appreciates. In turn, a rising dollar puts the squeeze on commodities like gold, silver and oil. This hurts energy stocks, but on the other hand, cheaper gasoline frees up money for consumers to shop more, and that’s good for retail stocks.

The Strong Dollar Trade is still on, but the ripple effects have spread further out. The most startling consequence is the effect on the Russian economy. Vladimir Putin’s soft autocracy has been aided by a long-term rise in energy prices. To the average Russian, his bluster delivered peace and prosperity. Then he annexed Crimea and began his ongoing shadow war in Ukraine. Now energy prices are no longer rising. The U.S. and our allies have responded with sanctions against Russia, and they’ve started to hurt. Even worse than any sanctions we’ve imposed against Russia is the collapsing price of oil. The Russian government estimates that the impact of cheap oil is more than twice that of the sanctions.

As a result of all this, the Russian currency, the ruble, has been getting crushed on the forex market. In July, a ruble was worth 2.9 cents. Today it’s down to 1.8 cents. In 2008, the ruble was going for 4.3 cents. The decline has been stunning. President Putin has responded by taking full responsibility. No, I’m kidding. He’s blamed “speculators.” Since July, the Russia ETF ($RSX) is down by 30%. (But stay away! Down isn’t the same thing as cheap.)

It’s important to keep in mind that Russia has an extraction-based economy. Their adventurism in the 1970s was funded by a bull market in gold and oil (ending in a hostile takeover of Afghanistan). The long commodity slide of the 1980s probably helped speed up the dissolution of the Soviet Union. The Russian economy is in much better shape than it was during the 1998 financial crisis, when the Russians devalued the ruble and defaulted on their debt. Russia isn’t as heavily indebted; plus they have foreign currency reserves standing by to defend the ruble—though for how long is another matter. Their economy is slowing down, and inflation is on the rise. I don’t see things getting better soon.

The outlook for oil continues to be bleak. What happened last week was fascinating as OPEC got together in Vienna. With oil dropping, some observers though OPEC would respond by cutting back on production. They didn’t, and that led to the oil crash last Friday.

Why did OPEC balk? There are a lot of theories. Some say the Saudis want to hurt the Russians, and possibly the Iranians. I can see that. Others think it’s a swipe at the U.S. shale market. The Shale Revolution has upended the world energy market, since we’re no longer so dependent on foreign oil.

The problem is that Saudi Arabia has a very low breakeven point ($5 to $6 per barrel), while American shale’s is fairly high. Perhaps the Saudis want to bring oil down low enough to make shale uneconomical. In any case, many major energy stocks are well off their highs. Apache ($APA) is down 39%; Haliburton ($HAL) is off by 45%. Airlines, which are major energy consumers, have been some of the strongest stocks around. The Airline Index is up 35% since mid-October.

Another wrinkle is that a lot of energy companies are over-represented in the junk-bond market. That was the way they could get funding to extract shale. As a result, the spread between junk-bond yields and higher-grade debt has widened. It’s still somewhat tame, but it’s interesting to see the connections in financial markets. We had a real-estate bust, and we had little idea of exactly who was exposed. I’m reminded of the little towns in Norway that were nearly ruined after they invested in complex instruments tied to the American mortgage market. Sometimes finance is like a giant game of dominos where you don’t know which domino is next to which—that is, until they fall.

There’s concern that a worsening market for low-grade debt could hurt the stock market since so much of the bull market has been funded by debt-fueled share buybacks. I doubt that will be a major factor, but undoubtedly, it will impact marginal borrowers.

Another impact of cheaper oil is that it helps the consumer sector. Prices at the pump are the lowest they’ve been since 2010. For many Americans, any savings there goes right into more shopping. Just look at Walmart ($WMT). The stock jumped 20% in six weeks. Nike ($NKE) seems to rise every day. On our Buy List, Ross Stores ($ROST) and Bed Bath & Beyond ($BBBY) have rebounded nicely (I’ll have more on them in the next section). Consumer staples have been leading the market since the summer. While consumer-discretionary stocks have been weak most of the year, they’ve picked up strongly in the last month. The recovery is beginning to filter down to the level of consumers.

The stronger dollar also acts to hold down inflation. There’s been absolutely no evidence of inflation, so that may give the Federal Reserve more breathing room to help the economy. If inflation is still holding between 1.5% and 2.0%, there will be little demand to raise rates. As a result, the 30-year yield is back under 3%, while mortgage rates are at their lowest levels in 18 months. That will certainly help housing. Mid-curve yields haven’t budged, so the spread between the 5-year and 30-year Treasuries has narrowed to 135 basis points. The spread hasn’t been that narrow since the bull market began.

For now, we should continue to focus on high-quality stocks like the ones on our Buy List. Earnings season doesn’t start for several more weeks, but we want to watch out for more signs of happy consumers. This could be a very good holiday season for businesses. Now let’s take a look at some recent news affecting our stocks.

Buy List Updates

Through Thursday, our Buy List is up 9.97% for the year, trailing the S&P 500’s YTD gain of 12.10% (that doesn’t include dividends). We’ve beaten the market for the last seven years, and sadly, it looks like that streak will come to and end.

While I’m disappointed, I have absolutely no plans to alter our long-term high-quality strategy. It may lose to the market here and there, but it works. Actually, most of our underperformance came earlier this year, during the spring. The good news is that we’ve been doing very well this quarter. Since September 30, our Buy List is up 8.00% compared with 5.05% for the S&P 500. Yes, we’re losing to the market YTD, but not by much (a deficit of about 2.1%), and we’re still making a solid profit. I’ll have the complete stats on our Buy List at the end of year. Now let’s look at some recent news impacting our stocks.

Express Scripts ($ESRX) has been on fire lately. The pharmacy-benefits manager tends to be quiet, but don’t let that fool you: they’re quite profitable. The stock closed higher on 12-straight trading sessions from November 17 to December 3. The shares are now up more than 22% from their October low.

So what’s the catalyst for the surge? Beats me. The only new story is that Warren Buffett recently started a position in ESRX. That’s certainly comforting. This was his only new position during Q3. In earning news, ESRX met expectations for Q3, and their guidance for Q4 was also within expectations. Personally, I’m fine with meeting expectations. It’s more important to me that a company hits the marks they state publicly rather than consistently low-balling us. ESRX is a classic slow-and-steady stock. This week, I’m raising our Buy Below on Express Scripts to $87 per share.

In the CWS Market Review from November 14, I told you to expect a dividend increase soon from Stryker ($SYK). I said I expected the quarterly payout to rise from 31.5 cents per share to 33 or 34 cents per share. I was close. This week, Stryker announced they’re raising their quarterly dividend to 34.5 cents per share. That’s a 13% increase. Given the new dividend, SYK now yields 1.46%.

Six months ago, after Medtronic ($MDT) announced their tax-inversion deal with Covidien, I said to keep an eye on Stryker and Smith & Nephew ($SNN). Sure enough, SYK is now said to be considering a tax inversion with SNN. I think a deal could come soon. It makes a lot of sense. I’m raising our Buy Below on Stryker to $98 per share.

As always, let me remind you: don’t chase after good stocks. Be patient and wait for good prices. Warren Buffett described investing as being like a batter standing at the plate who can wait for an endless number of pitches before swinging at a nice fat one coming down the middle. Keep that in mind.

CR Bard ($BCR) keeps on charging! It’s now our third-best performer this year. Shares of BCR are up nearly 29% this year. I’m raising the Buy Below to $175 per share, which is fairly tight. I’m expecting another good earnings report next month.

I also want to raise the Buy Below of our big bank, Wells Fargo ($WFC). I think Wells will raise its dividend again this spring. The stock is good for conservative investors. It tends not to move around so much. Wells is going for less than 13 times next year’s estimate. That’s a good deal. I’m bumping up my Buy Below on Wells to $57 per share.

Last month, for the first time in nearly 15 years, shares of Microsoft ($MSFT) pierced $50 per share. The stock reached its all-time high of $59.97 on December 30, 1999. We’re actually not that far from topping that. MSFT been a great stock for us this year. For now, I’m keeping our Buy Below at $50 per share.

Our two retailers, Bed Bath & Beyond ($BBBY) and Ross Stores ($ROST), have been performing quite well lately. The drop in oil prices certainly helps shoppers. I also think investors expect a strong holiday season for retail (we’ll get an important report on retail sales next week). This week, I’m raising my Buy Below on BBBY to $74 per share, and on Ross Stores to $93 per share. Both are excellent stocks.

One quick note: Even though BBBY’s fiscal third quarter ended last week, the company won’t report earnings until January 8. Our other Buy List stock on the November reporting cycle is Oracle ($ORCL). They’ll report earnings on December 17. That’s the only Buy List earnings report we’ll have this month.

I also wanted to touch on Ford Motor ($F). The stock recently traded over $16 per share for the first time since September. This year has been a rough one for Ford, but the payoff isn’t far away. Don’t expect much from the Q4 earnings report next month, but the fiscal Q1 report this spring will reflect Ford’s new business strategy. A lot of investors aren’t believers. Ford currently trades at less than 10 times next year’s earnings. I think Ford has made a lot of smart moves. Ford Motor remains a buy up to $17 per share.

That’s all for now. The big jobs report will be later this morning. We’ve had a nice run of good jobs reports, and I expect the trend to continue. The weak spot has been wage growth, so hopefully we’ll see better news there. Next week, we’ll get important reports on retail sales. It will be interesting to see how strong the consumer is heading into the holiday season. Also, don’t forget that I’ll unveil the 2015 Buy List in two weeks. 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 December 5th, 2014 at 7:09 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.