CWS Market Review – November 4, 2016

“There are two times in a man’s life when he shouldn’t speculate: when he can afford to and when he can’t.” – Mark Twain

After being stuck in a trading range for three months, the bears have finally gotten bold enough to take the market down a peg. The S&P 500 has now fallen eight days in a row. That’s the longest losing streak since the heart of the Financial Crisis in the fall of 2008. The index has closed lower in ten of the last eleven sessions. The last time we hit nine in a row was in 1980.

Still, the overall decline has been pretty tame—just 2.9% in eight days. In fact, all eight of the one-day drops have been less than 0.7%. It’s just that we’ve been so steady for so long. The S&P 500 snapped a streak of 82 days in a row of closing in the 2100s. Perhaps we’re riding through some pre-election jitters as the polls appear to be tightening.

In this week’s CWS Market Review, we’ll look at the recent GDP report. As I’ve been saying for a few weeks, the economy is growing, but at a mediocre pace. The important fact is that we’re not near a recession. I’ll also discuss this week’s Fed meeting. Later on, we’ll look at the earnings report from Cerner. Plus, I’ll preview next week’s earnings report from Cognizant Technology. We also got a nice 16% dividend increase from Snap-on. But first, let’s take a closer look at where the economy now stands.

The Economy Is Finally Accelerating

Last Friday, the government reported that the U.S. economy grew in real terms by 2.9% during the third quarter. Historically, that’s pretty average, but it’s not so bad compared with the last few years. It was the fifth-best quarter of the last 19 quarters.

The details were pretty good. Exports rose by 10% thanks to, believe it or not, big gains in soybean exports. Business investment needs to improve, but a lot of that weakness was driven by lower oil prices. Consumer spending rose by 2.1% in Q3. That’s not bad, but it’s lower than some recent quarters. Overall, we can say that the economy is accelerating, but that’s coming off tepid growth.

Earlier this week, we learned that personal spending rose by 0.5% in September, the final month of Q3. Personal income rose by 0.4%. Wall Street had been expecting increases of 0.4% for both. The ISM Manufacturing report for October rose to 51.9. The manufacturing sector has now risen for 89 months in a row.

I’m writing this to you on Friday morning, ahead of the big October jobs report. For September, the government said the economy created 156,000 jobs. The consensus on the Street for October is for a gain of 178,000 jobs. That sounds about right to me—maybe a bit too high. As important as the number of jobs is, I also want to see more gains in wages. There’s been some improvement here, but we need to see more. You can be sure Janet Yellen and her friends at the Federal Reserve will be paying close attention to the jobs report (as will some politicians).

Expect a Fed Rate Hike Next Month

The Federal Reserve held another meeting this week. Since we’re so close to the election, I didn’t expect them to make any changes to interest rates. The Fed did indeed decide to do nothing, but traders closely looked for any signs of what will happen next month.

I think it’s pretty clear that the Fed is going to raise rates in December. The fact is that the economy is creating new jobs. Wages are slowly rising, and financial markets are mostly stable. The Fed has been plenty patient. At the start of the year, the Fed anticipated raising rates four times this year. They haven’t done it once.

Of course, the FOMC is a committee, so it’s not always easy to pinpoint exactly where the majority currently lies. I thought it was interesting that the last policy statement had three dissensions. Those folks wanted to raise rates immediately. This week’s statement, however, only had two dissents. Eric Rosengren was the one who switched sides. I’m guessing that’s due to the election, but we can’t say for sure.

In the policy statement, the Fed said, “The Committee judges that the case for an increase in the federal funds rate has continued to strengthen but decided, for the time being, to wait for some further evidence of continued progress toward its objectives.” In recent years, the Fed has done a better job of telegraphing their intentions to Wall Street. Given the language they’re using, plus the recent dissents, I think all the signs point to a December rate hike.

For guessing what the Fed will do, I like to look at the two-year Treasury. At the start of the year, when the Fed looked like it was about to get busy, the two-year was yielding over 1%. But as those plans unraveled, the two-year slowly dropped down to 0.56% by the middle of the year. Now it’s back over 0.80%.

But what comes after that? That’s hard to say, but I suspect the Fed may hold steady for a few months, or possibly one increase. I don’t believe this is the start of a tightening cycle a la 2004-2006, when the Fed raised rates at 17 consecutive meetings.

For investors, low rates are good for stocks. The only danger is when the temptation from fixed income is so strong that it lures money away from stocks. We’re far from that happening. Until that time, investors should be focused on a portfolio of fundamentally superior stocks such as those on our Buy List.

Cerner Drops on Earnings Miss

Third-quarter earnings season is starting to come to a close for our Buy List. We had one earnings report this week, from Cerner (CERN), and we have one more next week, from Cognizant Technology Solutions.

Three months ago, Cerner told us to expect Q3 earnings ranging between 59 and 61 cents per share. On Tuesday, the healthcare IT company reported earnings of 59 cents per share. While that was within the company’s range and up 9% from last year, it was a penny below Wall Street’s consensus.

”While Cerner’s third-quarter results were slightly below our expectations, they were still solid and included the second- highest level of bookings in our history,” said Zane Burke, Cerner President. “Our competitiveness remains strong and has been bolstered by over $2 billion of investments in research and development over the past four years. We believe these investments have strengthened our clinical, revenue cycle and population health solutions and position us for strong growth going forward.”

Quarterly revenue came in at $1.18 billion, which was below Cerner’s guidance of $1.20 billion to $1.28 billion. For Q4, Cerner expects 60 to 62 cents per share and revenue between $1.225 billion and $1.300 billion. Wall Street had been expecting 65 cents per share. Cerner also gave preliminary guidance for next year of $2.50 to $2.70 per share. The Street was at $2.69 per share.

Cerner also said it will offer another set of buyouts for employees who qualify. They had a similar offer last year.

“This should not be viewed as a layoff or a sign that we don’t expect to grow,” Naughton said. “We’ve grown our head count by over 2,000 people this year and expect to grow head count next year as well.”

The shares dropped about 7% after the earnings report. Cerner is one of those companies I’m not terribly worried about if they miss earnings. The company is still fundamentally strong. The business is growing, just slightly less rapidly then they had expected. This week, I’m dropping my Buy Below price on Cerner down to $61 per share.

Earnings Preview for Cognizant Technology Solutions

On Monday, Cognizant Technology Solutions (CTSH) will be our final Buy List stock to report third-quarter earnings. Hanging over this report is the recent news that a Cognizant internal investigation revealed that they may have violated the U.S. Foreign Corrupt Practices Act. Cognizant notified the SEC and DOJ. The same day, the company’s president resigned.

The stock plunged sharply on the news but has since regained some lost ground. There’s no news to add, so I think traders fear the worst. I’m relieved that at least the company reported its own possible violations.

Still, we need to focus on CTSH’s operations. In August, the company had a good earnings report. The IT outsourcer earned 87 cents per share. That was a nickel better than expectations. Quarterly revenue jumped 9.2% to $3.37 billion, which matched consensus. Interestingly, the British pound’s fall post-Brexit knocked off about $40 million in revenue.

Cognizant’s guidance for Q3 was noticeably conservative. Francisco D’Souza, the CEO, said, “While our revised guidance reflects the impact of near-term macroeconomic headwinds, our longer-term outlook and underlying business fundamentals remain strong. We continue to see an expanding market opportunity ahead and are well positioned to capitalize on the digital transformations taking place among enterprises around the world.”

Cognizant sees Q3 coming in between 82 and 85 cents per share, whereas Wall Street had been expecting 86 cents per share. On the plus side, Cognizant reiterated its full-year guidance range of $3.32 to $3.44 per share.

On the revenue side, Cognizant sees Q3 ranging between $3.43 billion and $3.47 billion. Wall Street had been expecting $3.54 billion. The company also changed its full-year guidance range for revenue from $13.65 billion – $14.0 billion to $13.47 billion – $13.60 billion. Wall Street had been expecting $13.75 billion.

I’ll be curious to hear any guidance for next year and any updates regarding the investigation. I’m still quite optimistic about Cognizant.

Before I go, I have a few quick updates on our Buy List stocks. Ford Motor (F) said that its sales fell last month by 11.9%, although the Lincoln brand did well. Ford had a lot of fleet sales last month which tend to go for a lower sales price. The stock now yields 5.3%, based on Thursday’s close.

Shares of Bed Bath & Beyond (BBBY) recently dropped below $40 per share for the first time in six years. Since early 2015, the stock has been cut in half. Bed Bath needs to make changes to keep up. I’m lowering my Buy Below price to $43 per share.

On Thursday, Snap-on (SNA) increased its dividend by 16.4%. The quarterly payout will rise 10 cents, to 71 cents per share. The shares yield 1.86% based on Thursday’s close. The company had an excellent earnings report two weeks ago.

That’s all for now. Next week’s news will be dominated by some sort of electoral event on Tuesday. You may have heard about it. In any event, there will be more earnings reports as well. On Wednesday, the Commerce Department will report on wholesale inventories. Then on Thursday, we’ll get initial jobless claims, plus an update on the Federal budget. 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 November 4th, 2016 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.