CWS Market Review – December 14, 2018

“Investment success does not require glamour stocks or bull markets.” – John Neff

Before I get to today’s issue, I want to announce that I will unveil the 2019 Buy List in an email to you on Christmas Day. As usual, there will be five new stocks and five deletions. The Buy List will remain at 25 stocks.

The new Buy List will go into effect on January 2, the first day of trading in the new year. All 25 stocks will start the year equally weighted, and I won’t make any changes for the next 12 months. I’ll have another email for you on January 1 which will summarize the 2018 Buy List and have the details for the 2019 Buy List. Stay tuned!

Now let’s review some of the market’s action this week—and what a week it was. At one point on Monday, the Dow was down over 500 points; by the closing bell, the index finished in the green. Then on Tuesday, the Dow was up over 360 points before it closed in the red. Perhaps, the Dow is getting into the Christmas spirit with its red-green motif. Stranger things have happened.

Or more likely, the market is frazzled and undecided as we move into the closing days of 2018. On Thursday, the Russell 2000, which is a popular measure of small-cap stocks, closed at a 15-month low; it’s now close to being in a bear market. This is part of the larger trend of riskier and more economically sensitive stocks falling out of favor. Recently, the S&P 500 sector indexes for Financials, Industrials and Energy all reached fresh 52-week lows.

In this week’s issue, we’ll break down what’s going on. I’ll also preview next week’s big Federal Reserve meeting. It looks like the Fed is going to raise interest rates again. I’ll also preview next week’s earnings report from FactSet. This will be our last Buy List earnings report this year. But first, let’s see what the Fed has in store for us next week and into 2019.

There’s a Good Chance the Fed Will Raise Rates Next Week

Last Friday, the government reported that the U.S. economy created 155,000 net new jobs last month. For November, the unemployment rate was 3.7%. I like to look at all the decimals, and I found out that last month we had the lowest unemployment rate since December 1969 (see below). In fact, if we exclude the wars in Korea and Vietnam, then we had the lowest peacetime unemployment rate in 70 years.

That wasn’t the only good news. We also had some encouraging news on wages. Over the last 12 months, wages are up 3.1%. Sure, that’s not too far ahead of inflation, but it’s the best growth rate we’ve seen in some time.

Then on Wednesday, the government released the latest CPI report. For November, inflation rose by just 0.019%. That’s the smallest increase since March. Obviously, falling energy prices played a big role. Last month, gasoline prices fell 4.2%. Over the last year, CPI is up 2.532%.

November is a good example of why we also want to look at “core” inflation which excludes food and energy. Last month, core inflation rose by 0.209%, and in the last year, it’s up 2.242%. In other words, the improving labor market is not leading to higher inflation. At least, not yet.

That leads us to next week’s Federal Reserve meeting. In my opinion, the Fed has been overly concerned with the threat of higher inflation. So far, I just don’t see evidence that inflation is upon us. I should explain that central banks are, by their nature, very fearful of inflation. Given the history of central banking, that’s understandable.

The Federal Reserve meets again next week, and it looks like they’ll raise interest rates again. This would be the fourth rate hike this year and the ninth of this cycle. I should caution that unlike previous rate hikes, Wall Street is not 100% convinced a rate hike is coming. According to the most recent futures prices, traders place the odds of a rate increase next week at 80%. So it’s widely expected but not in the bag.

Also with this meeting, the Fed will update its economic projections for the coming few years. Going by the most recent projections, the Fed sees itself raising interest rates three times next year. I don’t think that’s going to happen.

Just look at the evidence. The dollar is doing well, the pound recently dropped to a 20-month low, and commodity prices are down. Inflation is well behaved and the housing market is jittery. I’m not sure if the Fed realizes it now, but their plans for 2019 are too much. At some point, the Fed will be forced to admit that we don’t need higher interest rates. The 10-year Treasury slipped to 2.85% earlier this week. That’s down 39 basis points since early November. I noticed that in the Seattle housing market, sales are down 20% from a year ago, while inventory is up 135%. (Of course, this is just one metro area.)

Here’s what’s happening. The stock market is getting nervous about economic growth for next year. That’s caused the spike in volatility that we’ve seen recently. The market is worried that higher rates are already damaging the economy, On Monday of this week, the S&P 500 got as low as 2,583.23. That’s the lowest intra-day mark since April 4.

Not only are we seeing that concern play out in the broad stock market, and at the long end of the bond market, but we’re seeing it in particular areas of the stock market. It’s exactly those high-risk and economically cyclical areas that are getting rolled. As I mentioned earlier, we saw new 52-week lows this week for the Energy, Financial and Industrial sectors. The areas doing the best (or falling the least) are those defensive areas like Utilities and Consumer Staples.

Here’s a good chart showing S&P 500 Consumer Staples (black) along with Materials (red) and Energy (blue). Notice how the divergence has steadily grown wider.

It shouldn’t be much of a surprise that Church & Dwight (CHD) is our top-performing stock this year, with a gain of nearly 38%. Hormel Foods (HRL) is our second-best, with a gain of 25%. In other words, baking soda and Spam are the big winners this year. OK, they’re a lot more than that, but the key point is that these are businesses not impacted much by a recession.

Compare that with Wabtec (WAB), a stock I like. Shares of WAB are down 35% from their high, and the stock has closed lower for the last eight days in a row. This is an important lesson for investors. Wabtec hasn’t done anything wrong in the last four months except be a freight services company when that’s not what the market likes. All stocks, good and bad, hit bad parts of the cycle. Lately defensive names are in, and cyclical names are out. That trend may last until the Federal Reserve decides to face reality and chill out on interest rates. Now let’s take a look at our final Buy List earnings report for this year.

Earnings Preview for FactSet

FactSet (FDS) is due to report its fiscal Q1 earnings on Tuesday, December 20 before the opening bell. The company helps Wall Street professionals crunch all the numbers they need to make investment decisions. It’s a very profitable business. We have an 18% gain in FDS so far this year.

Three months ago, FactSet reported earnings of $2.20 per share for its fiscal Q4. That was one penny below Wall Street’s consensus. That morning, traders punished the stock. At one point, FDS was down more than 6%. However, by the end of the day, the stock closed down 1.9%.

For all of last year, FactSet’s organic revenues rose 5.6% to $1.35 billion, while their key metric, Annual Subscription Value or ASV, rose 5.7% to $1.39 billion. Earnings increased 16.7% to $8.53 per share. Previously, the company said its guidance range was $8.37 to $8.62 per share, so things seemed to work according to plan.

Now let’s look at guidance for fiscal 2019 (ending next August). FactSet expects earnings to range between $9.45 and $9.65 per share. That’s not a bad increase over last year. Wall Street had been expecting $9.61 per share. FactSet sees organic ASV rising by $75 million to $90 million in 2019, and they see operating margins between 31.5% and 32.5%. That’s pretty good. For Q1, the consensus on Wall Street is for earnings of $2.29 per share.

Shares of FDS have pulled back over the last few days, but I’m not particularly concerned. The stock had a very strong rally during much of August. FactSet remains a buy up to $242 per share.

Buy List Updates

On Thursday, Japan Post announced that it will buy a $2.6 billion stake in AFLAC (AFL). It’s not a merger, and no part of AFLAC will become part of Japan Post. AFLAC currently derives about two-thirds of its business from Japan.

This has been a big year for Japanese companies investing in foreign stocks. On Thursday, shares of the duck stock gapped up $2.85, or 6.64%, to close at $45.75 per share (see above). AFLAC remains a good buy up to $47 per share.

This week, I want to lower my Buy Below prices on two of our Buy List stocks. I’m dropping the Buy Below for Alliance Data Systems (ADS) to $193 per share. I’m also lowering the Buy Below on Continental Building Products to (CBPX) $28 per share.

I also wanted to point out that shares of Torchmark (TMK) have been very weak lately. The stock closed Thursday at $78.02 per share. That’s the lowest close all year. I think the shares are a good value here.

That’s all for now. The big news next week will probably be the Federal Reserve meeting. The Fed meets on Tuesday and Wednesday. The policy statement will come out Wednesday afternoon at 2 p.m. ET, along with the new economic projections. Also on Tuesday, we’ll get the report on housing starts. On Friday, we’ll get the latest revision on Q3 GDP. The last report showed that the economy grew by 3.5% on Q3. 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 on December 14th, 2018 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.