CWS Market Review – June 19, 2015

“I can calculate the motion of heavenly bodies, but not the madness of people.”
– Isaac Newton

On Thursday, the Nasdaq Composite touched its highest point ever. Yesterday, the index hit an intra-day peak of 5,143.32. That finally eclipsed the high of 5,132.52 reached on March 10, 2000, more than 15 years ago. The Nasdaq had already broken its record for closing highs, but the intra-day peak held out until yesterday.

It’s not just the Nasdaq. On Thursday, the small-cap Russell 2000 closed at an all-time high. The S&P 500, which is a broader index than both the Russell or Nasdaq, closed at 2,121.24, which is less than 0.5% from its all-time closing high reached four weeks ago.

What’s the reason for the rally’s latest surge? For that, we can thank Janet Yellen and her friends at the Federal Reserve. This week, the Fed decided against raising interests, at least for now. The Fed made it clear that interest rates will be going higher soon, and probably before the end of the year. But now Wall Street is starting to think the Fed may raise rates once or twice, and then stop.

Our Buy List continues do well (+5.39% YTD) but we had a weak earnings report from Oracle (ORCL). The culprit was, again, the strong U.S. dollar. Shares of Oracle lost nearly 5% on Thursday. I’ll have full details in a bit. Later on, I’ll discuss the latest act of the ongoing Greek drama. It seems that both sides are incapable of serious negotiations unless it’s the final minute. I’ll also bring us up to speed on the latest news from our Buy List. But first, let’s look at what the Federal Reserve had to say this week.

Will the Fed Do a One-and-Done?

On Wednesday, the Federal Reserve wrapped up its two-day meeting in Washington. For now, the Fed decided against raising interest rates but strongly hinted that a rate hike isn’t far off. As part of this meeting, Fed members updated their economic projections. These are the famous “blue dots” from the graphs in this report.

The key detail from these forecasts is that 15 of the 17 FOMC members said they see a rate increase coming before the end of this year. Since the year is nearly half over, that’s not too far away.

The Fed’s policy statement said that the economy is growing moderately and that job growth is picking up. They also noted that the housing market is getting better, while household spending is “moderate.”

The crucial point for the Fed is that inflation is still low, but they said they expect inflation to rise towards their 2% target. The Fed hasn’t done a very good job of hitting that target. The central bank’s preferred measure of inflation is the personal-consumption expenditures price index, and that’s come in below 2% for 36 straight-months.

On Thursday, the government released the Consumer Price Index report for May. That showed the highest monthly inflation rate in more than two years. Don’t worry, inflation’s still low, but it may be trending upward. Don’t forget that a few months ago, we had three months of deflation, which was largely due to plunging oil prices. That episode has passed.

Personally, I like to look at the “core rate” of inflation, which excludes food and energy prices. So far this year, core inflation is growing at 2.37% annualized. It’s still early to say that inflation is definitely in an uptrend, but the early evidence suggests that the Fed may finally reach its 2% target. Naturally, that would boost the argument for raising interest rates sooner rather than later.

The Fed has four meetings left this year. Here’s what the futures market currently thinks. For the July meeting, the futures say “no way”—there’s a 0% chance of a rate hike. I have to agree. For September, that rises to 16.8%. For the October meeting, the chances rise to 34.4%. So, possible, but not probable. But for December, the chances rise to 57.1%. The futures market actually thinks there’s a 20% chance there could be two rate hikes by December.

But here’s something to consider: What if the Fed raises rates only once and pauses? Or maybe once, pauses, then again, and another pause? The last rate-hike cycle consisted of 17 rate hikes at 17 consecutive meetings. Just because they did it that way before doesn’t mean they’ll do it again.

To my mind, what really bolsters the case for the one-and-done scenario is what Janet Yellen said during her post-meeting press conference. The Fed Chairwoman said, “Let me emphasize that the importance of the initial increase should not be overstated. The stance of monetary policy will likely remain highly accommodative for quite some time after the initial increase in the federal funds rate in order to support continued progress towards our objectives of maximum employment and 2% inflation.”

I think that’s what’s causing the market’s latest rally. This means that real interest rates, meaning inflation-adjusted rates, will probably remain negative for 18 more months. Maybe even longer. That’s good news for stocks. I’m still in the bullish camp until interest rates provide significant competition for stocks. On our Buy List, some of the best bargains include Qualcomm (QCOM), Hormel Foods (HRL), Wells Fargo (WFC) and Stryker (SYK).

The Consequences of Greece Exiting the Euro

I haven’t written much about Greece and its ruinous finances lately since I don’t believe it has a major impact on our portfolios. The issue, however, has dominated a lot of the financial media, so I wanted to say a few words (and calm some nerves).

The short version is that Greece has a major debt payment coming due to the IMF. Greece’s creditors, the IMF and other euro countries, have demanded that Greece make some reforms to its public finances. The Greek government is screaming that this is blackmail, and they’ve resisted every step of the way. The EU has hinted that this time they’ve been pushed too far and that they’re willing to let Greece default and exit the euro.

Negotiations fell though this week, and leaders are planning a summit for Monday to give it another shot. But time is running out. The loans are due at the end of the month. There’s been a lot of finger-pointing as both sides blame each other for the impasse. Alexis Tsipras, Greece’s prime minister, won the election by his vocal opposition to the terms of the bailout. His recent chumminess with Vladimir Putin hasn’t helped.

Would it be such a disaster if Greece leaves the euro? The IMF said that a default would be manageable for Europe, but the impact on the U.S. economy would be minimal. Greece simply isn’t a major trading partner for the United States. A Greek default would barely register on our markets and in our economy. Greek savers are already pulling their money out of banks. The authorities may have to step in and limit withdrawals. The ECB said they’re not sure if Greek banks can open on Monday. Shares in the National Bank of Greece (NBG) have fallen to $1 per share. In 2007, they were going for $700.

But the real fear isn’t Greece—it’s who comes next. If Greece leaves the euro, then it establishes a precedent. Soon, countries like Spain, Italy or Portugal could follow. The fear before was that an exit from the euro would disrupt the intertwined banking system. That’s not the case now. Rather, it’s a political fear that an anti-establishment party in one of the euro countries would lead a revolt against its creditors.

I think any fears of this happening are very premature. Greece is a very different case from the rest of Europe. (If you have time, I’d recommend Michael Lewis’s devastating look at the Greek economy.) As bad as Greece is, the rest of Europe wants to keep them in. A deal will probably be reached at the last possible moment. There’s little chance of any contagion spreading across the continent.

Oracle Drops on Earnings Disappointment

After the closing bell on Wednesday, Oracle (ORCL) reported fiscal Q4 earnings of 78 cents per share. That’s not good. It was nine cents below Wall Street’s estimate. The results were even below the company’s own guidance. Oracle had told us to expect earnings to range between 90 and 96 cents per share. Quarterly revenues came in at $10.71 billion, which was below the Street’s forecast of $10.92 billion.

So what was the problem? Oracle said that their business was “significantly impacted” by the strong U.S. dollar. They said the same thing three months ago. Revenues fell 5% compared with last year, but Oracle said that adjusted for forex, revenues would have risen by 3%.

Looking at the numbers, I agree that currency was a factor, but that’s not all. Oracle is facing real headwinds with their business. In fact, it’s impacting all tech. For Q4, software sales fell 6% to $8.4 billion. I was expecting more. One bright spot is that Oracle’s cloud revenue rose 28%, but that’s still a small part of their overall business.

I’m disappointed with this earnings report, but I’m not about to bail on Oracle. The company still has lots of strength. For the fiscal year, Oracle earned $2.77 per share. Their free cash flow was an astounding $12.9 billion. Net of debt, the company is sitting on $12 billion in cash.

For fiscal Q1, Oracle sees earnings coming in between 56 and 59 cents per share. Wall Street had been expecting 61 cents per share. The share dropped sharply on Thursday. At one point, Oracle got as low at $40.97 per share, but it rallied back to close at $42.74. Oracle is not a pricey stock, but they need to give investors something to cheer about. This week, I’m lowering my Buy Below on Oracle to $45 per share.

Buy List Updates

On Thursday, three of our stocks hit new 52-week highs; Fiserv (FISV), Snap-on (SNA) and Wells Fargo (WFC). Also, Stryker (SYK) is closing in on its 52-week high. Here’s some more news on our Buy List stocks.

Bed Bath & Beyond (BBBY) is due to report fiscal Q1 earnings on Wednesday, June 24. I previewed the earnings report in last week’s CWS Market Review. I said that I’ve gotten a little frustrated with BBBY. I don’t like to see them spend so much on share buybacks. It’s a solid company, but I want to see better numbers. They gave us an earnings range of 90 to 95 cents per share. I’m also curious to see what their guidance is for the current quarter.

Ross Stores (ROST) split 2-for-1 last Friday, so I hope you didn’t panic about the lower share price. The deep discounter continues to perform well. Ross got dinged after the last earnings report, even though it looked fine to me. Traders were expecting better guidance. On Thursday, Ross closed above $50 for the first time since the earnings report. Ross Stores is a good buy up to $52 per share.

Signature Bank (SBNY) announced this week that former Congressman Barney Frank is joining their board of directors. I got a few emails telling me that this move spells certain doom for the bank. (Even the Wall Street Journal got in the act “Barney Frank—Yes, THAT Barney Frank—Joins a Bank Board.”)

Sorry, but I’m not going to bite. For one, Congressman Frank has lots of experience that can serve Signature well. Don’t forget that the financial-reform law is called Dodd-Frank. Congressman Frank also chaired the House Banking Committee. It’s nice to have someone like that on your team. I’ve seen too many investors get hurt when they use their politics as the basis for their portfolios. Signature is a buy up to $150 per share.

That’s all for now. Next week is the final full week of Q2. We’re also going to get some key economic reports. The durable-goods report comes out on Tuesday. On Wednesday, the government will release its second revision to Q1 GDP. The last report said that the economy contracted by 0.7% during Q1. Then on Thursday, the government reports on personal income and spending for May. 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 June 19th, 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.