CWS Market Review – April 10, 2015

“Far more money has been lost by investors’ preparing for corrections, or trying to anticipate corrections, than has been lost in the corrections themselves.” – Peter Lynch

First-quarter earnings season is here, and this is a tricky time for the markets. Not just here, but globally. Thanks to the massive bond-buying of Mario Draghi and the ECB, bond yields in Europe have gotten comically low. This week, the Swiss were the first to have a negative yield for their 10-year bond. Think about that! Investors are paying the government to borrow their money for the next ten years.

Now there’s a rush of non-Europeans to float debt that’s denominated in euros. Heck, why not? Mexico just sold 1.5 billion euros’ worth of bonds for a yield of 4.2%. The bonds mature in the year 2115. That’s right—these are 100-year bonds!

You don’t need an econ Ph.D. to see what’s going on. If somebody’s willing to buy everything, then someone else will be more than happy to sell it to them. Some folks wonder if Draghi will be able to find enough bonds to buy. Just as our stock market celebrated QE, so too are the European stock markets toasting Draghi. The key European stock index, the Stoxx Europe 600 Index, is up already up 19% this year, and it finally breached its high from 15 years ago (see chart above). There are few things stocks love more than easy money.

In this week’s CWS Market Review, we’ll take a closer look at what’s driving the market and what it means for us. I’ll also cover the recent earnings report from Bed Bath & Beyond (BBBY). The results were decent, but their guidance was on the weak side. I’ll also preview next week’s earnings report from Wells Fargo (WFC). Wells continues to be one of my favorite banking stocks. Last month, the bank passed the Fed’s latest stress test with flying colors. I’ll also share with you some Buy List stocks that look particularly attractive right now. But first, let’s try to make some sense out of the craziness found on a certain street in lower Manhattan.

Don’t Get Caught up in the Earnings-Expectations Game

The S&P 500 has risen four of the last five days, but it’s been in a narrow trading range. The index has closed between 2,040 and 2,120 for the last 46 days in a row. But now earnings season is upon us, and we’ll soon see the profit and loss numbers. But I want to caution investors not to get too caught up in the earnings-expectations game. It’s not such a big deal if a high-quality stock misses earnings by a penny or two. What we want to see are general trends of sound business. That’s far more important than trying to outguess some analyst.

Until now, the strong dollar has mostly been a financial phenomenon. I certainly saw it at work when I was in the Philippines, but most Americans haven’t seen the macro effects outside their local gas pump. That’s starting to change, and we’re going to see more evidence of the strong dollar this earnings season. A currency rally is like the financial equivalent of placing a magnet near a compass. It can throw off all your readings.

The latest numbers say that Wall Street expects Q1 earnings from the S&P 500 of $26.74. That’s the index-adjusted figure (each point in the S&P 500 is worth about $8.85 billion). That’s down 16.9%, or $5.44, from the middle of last year, and a lot of that is due to the strong dollar.

Bank of America Merrill Lynch estimates that every 10% increase in the dollar knocks $3 to $4 off of the S&P 500’s earnings. According to BAML, half the drop-off in earnings is due to the fall in oil prices, while another 20% is due to the dollar (see chart of the dollar index below). BAML says that without these factors, they would expect earnings to grow by 10% this year. Instead, they expect earnings to decline.

This raises an important point about valuations. If these factors are temporary, then it makes sense for the market to look past the drop in earnings. (And it’s expected to be a modest drop). That means that price/earnings ratios ought to rise. I’ve heard a lot of careless fretting about this. Instead of being the sign of an overheated market, the higher valuations are a natural response to a transient earnings glitch. Analysts currently expect earnings this year of $118.37 for the S&P 500. That’s an increase of 4.73% over last year’s total.

Wall Street was shocked by the March jobs report, which was about half what analysts were expecting. Part of that is certainly the dollar, but I’m not yet convinced it’s a major problem. In fact, the initial jobless claims are still quite good. Last week’s initial jobless report was tied for the fourth-lowest in the last 41 years. On Thursday, initial jobless claims were reported to be 281,000. This number tends to be volatile, so economists prefer to focus on the four-week average, which is now at its lowest level since 2000.

Also, the dollar appears to be stabilizing. The yen has settled around 120 to the dollar, and that could be helping AFLAC (AFL) which just touched a fresh 52-week high. Even the Russian ruble is slowly climbing back after getting obliterated last year. On Tuesday, West Texas Crude reached its highest close of the year ($53.25 per barrel). I doubt oil is headed higher, but the freefall we saw during Q4 is mostly likely over.

Now we have to worry about the Federal Reserve. I continue to believe that the Fed is sounding more hawkish than necessary. I doubt they need to raise interest rates until Q4, or maybe even next year. On Wednesday, the Fed released the minutes of their March meeting. This was a key one because the Fed ditched the all-important word “patience” from their policy statement. But the tone of the Fed’s minutes shows that the members doubt a June rate hike is needed. William Dudley, the head of the New York Fed, said, “It’d be reasonable to think that the timing of the Fed’s first rate hike might be a little further off in time.” Kind of an understatement there, Bill.

My hope is that the Fed doesn’t hike rates for a few more months, but I know not to base my investments on what I think the Fed ought to do. The important fact is that interest rates are low and will likely remain so for some time. That’s good for stocks, and it’s especially good for dividend-paying stocks. Now let’s take a look at some of the bargains on our Buy List, which includes some dividend-rich shares.

Current Buy List Bargains

There are a few Buy List stocks that look particularly good right now. Let me stress that I consider any Buy List stock that’s below its Buy Below price to be a good buy. Our Buy Below prices are not price targets, so don’t bother trying to find out which is the furthest below its Buy Below, because that doesn’t mean anything.

One Buy List stock that is a good value at the moment is Microsoft (MSFT). The stock has been very weak this year; it’s the worst-performing Buy List position. Wall Street did not like the company’s last earnings report at all. However, most of those issues were items not under Microsoft’s control, like currency-related or geopolitical problems. Analysts have been slashing their earnings forecasts. The company is expected to report quarterly earnings of 51 cents per share, which is down from 68 cents last year. The shares currently yield 3%, which is 1% more than a 10-year Treasury. Microsoft is a solid buy.

Ford (F) is another stock that looks good thanks to its dividend. Going by Thursday’s close, Ford yields 3.76%. The upcoming earnings report will be an important one. Ford is expected to show an earnings increase over last year’s Q1. Hopefully this will break a five-quarter streak of flat or declining earnings. Analysts currently expect Ford to earn $1.59 per share this year, which means the company is going for about 10 times earnings. My Buy Below on Ford is $17 per share, but if you are able to get it below $16, then that’s a very good deal.

Lastly, Cognizant Technology Solutions (CTSH) looks very good here despite its strong rally this year. This is a non-dividend payer. The next earnings report is due out on May 4. CTSH could be a big winner for us this year. As always, don’t chase after good stocks, and make sure you’re well diversified. Now let’s look at this week’s earnings report from Bed Bath & Beyond.

Bed Bath & Beyond Earned $1.80 Per Share

After the closing bell on Wednesday, Bed Bath & Beyond (BBBY) reported fiscal Q4 earnings of $1.80 per share. That’s a good result, and it was largely expected. The company had already given us a range for Q4 of $1.78 to $1.83 per share. Net sales rose by 4.2%, and the key retailing metric, comparable-store sales, rose by 3.7%. The company had modeled 4% to 5%, which they would have made if not for issues like the weather and currency fluctuations.

For the whole year, the home-furnishings retailer earned $5.07 per share. That’s a healthy increase over the $4.79 they made in fiscal 2013. Net sales rose 3.3% for year. I have to mention that BBBY’s per-share results have been greatly helped by the company’s buyback program. They’ve been buying back their own stock at a furious rate. Last quarter, the company bought back 11.8 million shares. That’s huge. It’s about 6.5% of all the outstanding shares. The current repurchase program can buy another 12 million at the current price.

Some people are strangely bothered by buyback-aided results. They think it’s somehow fudging the numbers. I disagree. These are indeed concrete gains for shareholders. I’m more bothered by companies that buy back shares while at the same time issuing millions of shares to senior executives. BBBY doesn’t do that, and the actual share count has dropped significantly over the last decade.

They key point for investors is that BBBY generates tons of cash flow. I didn’t mind when that money was used to buy a cheap stock. Remember that BBBY was at $55 last summer. But now, I’d rather not see the company so eager to buy a stock that’s not so cheap (yet hardly overpriced).

Now let’s turn to the weak spot, which was guidance. For Q1, which is already halfway over, the company sees earnings ranging between 90 and 95 cents per share. That’s kinda blah. In last week’s CWS Market Review, I told you I had been expecting 95 cents to $1 per share. They see comp-store sales rising between 2% and 3% for the quarter and the entire fiscal year. For full-year earnings, BBBY expects flat to mid-single digits. Let’s say that means 0% to 5%, so that implies an EPS range of $5.07 to $5.32. Wall Street had been expecting $5.43 per share.

I was pleased to hear the company address its web presence, which has been a weak spot. Frankly, they’ve been behind the curve on this, and they’re working to close the gap. Overall, this was a decent quarter for Bed Bath & Beyond. It was a nice increase over last year. I’m not pleased with the guidance, but this is still a well-run outfit. The shares dropped more than 5.4% on Thursday to close at $73.46 per share. Bed Bath & Beyond remains a solid buy up to $77 per share.

Wells Fargo Is a Buy up to $57 Per Share

Earnings reports for our Buy List will start to come in the week after next, but there’s one early bird, which is Wells Fargo (WFC). The big bank is due to report Q1 earnings before the market opens on Tuesday, April 14. Wells Fargo did very well for us last year, and this year started off well, but the shares have slipped a bit in the past two weeks.

The recent news has been good for Wells. Last month, the Federal Reserve said that it has no objection to their capital plan. That means the bank is allowed to raise its dividend by 7.1%, from 35 cents to 37.5 cents per share. Not all banks got the green light from the Fed, but as I’ve repeatedly said, Wells Fargo is the best-run big bank in America. Warren Buffett agrees; he owns about 9% of the stock.

Unlike other banks, Wells is more focused on lending rather than trading, and that’s been good for it. Last year, Wells’s return on equity was 13.7%. That compares well with JPM, which had an ROE of 9.8%.The downside is this is a rough environment for banking. The mortgage market is pretty weak. The S&P Bank Index has been lagging the market for more than a year.

Here’s the earnings-per-share for WFC’s last seven earnings reports: $0.98, $0.99, $1, $1.05, $1.01, $1.02, $1.02. Pretty consistent. The company has delivered 18-straight quarters of year-over-year profit growth, but that streak may be in jeopardy. The outlook for domestic consumers is improving, but that might not be enough to offset weakness in the mortgage market. Wall Street expects Q1 earnings of 98 cents per share. I expect $1. Wells Fargo continues to be an excellent stock for conservative investors. The new dividend gives the stocks a yield of 2.77%. Wells Fargo is a buy up to $57 per share.

Buy List Updates

Shares of Express Scripts (ESRX) continue to climb higher. On Thursday, the stock broke out to a new 52-week high. Walgreens (WBA), which has been very strong this year, said they’re interested in more deals. ESRX rose nearly 5% on Thursday to close at $88.47. For now, I’m keeping my Buy Below at $89 per share. Stay tuned for Q1 earnings on April 28.

On Wednesday, shares of Fiserv (FISV) closed at $80.30, which was an all-time high. This was a $14 stock in 2008. Earnings are due out later this month.

On Tuesday, Ball Corp. (BLL) said they got another request from the FTC for info about their deal to buy Rexam. The government wants to make sure the deal doesn’t violate any anti-trust laws. This is standard stuff. There’s nothing to worry about.

The big event for eBay (EBAY) this year will be spinning off PayPal. This is what Carl Icahn pushed hard for, and he was exactly right. I think there’s a very good chance that PayPal will be quickly bought out by Google or Apple, or somebody big. On Thursday, eBay disclosed the agreement they’ve reached with PayPal. The good news is that PayPal will continue to be a revenue source for them. eBay said they’ll aim to have 80% of their gross sales go through PayPal for the next five years. We still don’t know when the deal will happen, but it should be before the end of this year.

That’s all for now. Earnings season ramps up next week; several high-profile companies are due to report. We’ll also get several important economic reports. On Tuesday, the Census Bureau reports on retail sales. Industrial production is on Wednesday. IP fell for December and January and rose modestly in February. We need to see improvement here. Also on Wednesday is the Fed’s Beige Book report. Then on Friday is the CPI report. The Federal Reserve expects to see inflation rise back above 1%. 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 April 10th, 2015 at 7:08 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.