CWS Market Review – September 20, 2019

“Things are never clear until it’s too late.” – Peter Lynch

On Wednesday, the Federal Reserve voted to cut interest rates. The new target range for the Federal funds rate is 1.75% to 2.00%. This is the Fed’s second rate cut in the last seven weeks. As recently as December, the Fed had been raising interest rates.

President Trump wasn’t pleased with the move, as he wanted a larger cut. The president tweeted, “Jay Powell and the Federal Reserve Fail Again. No ‘guts,’ no sense, no vision! A terrible communicator!”

Despite the president’s criticism, the stock market has calmed down considerably. In six of the last ten trading sessions, the S&P 500 has closed up or down by less than 0.1%. The index is close to another new all-time high.

In this week’s issue, we’ll take a closer look at the Fed’s move and what it means for us. Our Buy List continues to thrive, and we touched another new high this week. Later on, I’ll preview next week’s earnings report from FactSet. We also had one of our stocks spin out an IPO. But first, let’s look at the Fed’s rate cut.

The Fed Cuts – What’s Next?

This week’s rate cut was widely expected. On Wall Street, whenever an expected thing happens, observers are quick to dismiss it as old news. However, we should bear in mind that the Fed was raising rates not that long ago. The last increase came in December. In fact, according to the Fed’s own projections, the central bank planned to continue hiking rates all year.

The story of this year is how that view of the economy fell apart. Thanks to weakness in China, there were fears of an economic slowdown in the United States. Those fears were compounded by a growing trade war between the U.S. and China.

The most visible aspect of the new world view was felt in the bond market. About this time one year ago, the yield on the 10-year Treasury got to 3.2%. Soon after, yields crashed. A few weeks ago, it dropped under 1.5%.

That caused the Federal Reserve to take notice. I’ll give you an example. As a very general rule of thumb, the yield on the two-year Treasury leads where the Fed puts interest rates. Not always, but the measure has a decent track record. In November, the two-year yield was more than 70 basis points above the Fed. Then came the recession fears, and by June, the two-year was 60 basis points below the Fed. That put a lot of pressure on the Fed to act.

At his post-meeting press conference, Fed Chairman Jay Powell said:

Since the middle of last year, the global growth outlook has weakened, notably in Europe and China. Additionally, a number of geopolitical risks, including Brexit, remain unresolved. Trade-policy tensions have waxed and waned, and elevated uncertainty is weighing on U.S. investment and exports. Our business contacts around the country have been telling us that uncertainty about trade policy has discouraged them from investing in their businesses.

Powell also reiterated that he sees this week’s action as a mid-cycle adjustment rather than the start of a long series of rate cuts prior to a recession. This is key. Historically, it’s very unusual for the Fed to be cutting rates when unemployment is below 4%. The current Fed funds target rate is basically in line with inflation, meaning the real rate is near 0%.

What does this mean for us? For the most part, lower rates are very good for the stock market. Lower rates tend to boost the market’s valuation. Of course, it also helps with borrowing costs. I think we’ll see continued improvement in the housing market.

The S&P 500 is back over 3,000. Last Thursday, the index came very close to another new high. I wouldn’t be surprised to see us hit a peak any day now. Our Buy List just recently hit a new high. We’re now up 23.8% on the year.

Will the Fed continue to cut? Eh, I’m not so sure. I think there’s a good chance the Fed will take a pause. Maybe one more cut before the end of the year. The fact is that the economy is still doing well. I’m not saying the economy is ripping higher, but the recession fears were clearly overblown.

For example, this week we learned that housing starts are at a 12-year high. Monday’s industrial production was also quite good. The IP reports have been pretty weak this year. Over the weekend, the price of oil spiked after an attack on Saudi oil-production facilities. It’s still early, but the impact appears to be muted. There’s a lot of incentive to get production back to normal.

I thought it was interesting that there were three dissensions in this week’s Fed statement. Dissenting votes are rare but not unheard of. Two Fed members voted for no change to interest rates, while a third wanted to see a 50-basis-point cut.

In this meeting, the Fed also updated its economic projections. If the median vote gets its way, that means the Fed won’t be touching rates for the rest of this year and all of 2020. I can’t say how long that view will last, but that’s why I took notice of the dissenting votes. At some point, the dissenters could become a majority.

Last week, we saw a major rotation from growth to value. This got a lot of attention, but I think the story was a little different than what was commonly discussed. I believe it was more of a shift from defensive stocks to cyclical stocks. Of course, there’s a lot of overlap between those categories, but the defensive-to-cyclical was, in my view, the dominant theme.

In essence, this was the stock market violently pushing back against the view that the economy is getting weak. It’s not. If the market is right, then the Fed may back off on rates. We’ll learn a lot more in a few weeks when the third-quarter earnings season gets going.

According to the latest figures, Wall Street expects the S&P 500 to report earnings of $40.98 per share for Q3 (that’s the index-adjusted number). That figure has come down about 7.5% since the start of the year. It’s typical for earnings estimates to be pared back as earnings season approaches.

But if Wall Street’s estimate is correct, then it would be about 1% below the earnings results for last year’s Q3 and the first quarter of negative earnings growth in three years. Bear in mind that after being pared down, earnings usually beat expectations by about 3% to 5%. It’s a $30 trillion game of “lower the bar to the point where you can easily step over it and declare yourself the winner.”

All told, earnings growth for the year is expected to be up by 6.6%. We’re still a long way from a bubble. The S&P 500 is currently going for 16.6 times the earnings estimate for 2020. Speaking of earnings, let’s take a look at our Buy List earnings report for next week.

Preview of FactSet’s Earnings

FactSet (FDS) is scheduled to report its fiscal Q4 earnings before the market opens on September 26. Their fiscal year ends on August 31. FDS has been a big winner for us this year. In May, FactSet raised its dividend by 12.5%. The quarterly payout increased from 64 to 72 cents per share.

For Q3, FactSet had a blow-out earnings report. The company earned $2.62 per share, which topped estimates by 26 cents per share. The result was a 20% increase over the same quarter from last year. Organic revenue grew 7.3% to $366.3 million. FactSet’s operating margin increased to 34%.

The key stat for FDS is Annual Subscription Value, or ASV. Last quarter, that rose to $1.45 billion. The organic growth rate, which excludes the effects of acquisitions, dispositions, and foreign currency, was 5.6%. The Board of Directors approved a $210 million increase to the existing share-repurchase program.

In June, FactSet updated its guidance for 2019. The company expects revenue between $1.42 and $1.44 billion, and operating margin between 32.5% and 33.0%. FactSet sees its earnings per share ranging between $9.80 and $9.90. That’s an increase to the previous guidance of $9.50 to $9.65 per share.

Since FactSet has earned $7.39 per share for the first three quarters, that implies an earnings range for Q4 of $2.41 to $2.51 per share. The consensus on Wall Street is for earnings of $2.47 per share. In June, shares of FDS briefly broke above $300, but the stock has since pulled back. Another strong earnings report could push FDS back above $300.

We’re in the slow period for Buy List earnings reports. The next Buy List earnings report will be RPM International (RPM) on October 2. After that, we’ll have to wait until the Q3 earnings season starts in mid-October.

Buy List Updates

On Wednesday, Danaher (DHR) had an initial public offering for Envista (NVST), Danaher’s dental business. This is not a spin-off; it’s an IPO. Danaher still holds a large stake in the company.

Envista priced at $22 per share. Danaher sold 26.8 million shares at that price. The shares opened at $25.65 per share and got as high as $28.92. Danaher still owns around 83% of the voting power in Envista. Danaher remains a buy up to $150 per share.

I also want to raise the Buy Below prices for two of our Buy List stocks. Globe Life (GL), the new name for Torchmark, has been quietly gaining steam lately. The shares are up about 10% in the last month.

In July, GL beat earnings by two cents. The company projects net operating income per share will be between $6.67 and $6.77. I’m raising our Buy Below to $100 per share.

Raytheon (RTN) had an interesting week. One day it was upgraded by an analyst at JP Morgan, and the next day it was downgraded by an analyst at Sanford Bernstein. Shareholders of RTN will, at some point, get 2.3348 shares of the new combined company with United Technologies (UTX). The combined company, however, will not include the spinoffs of Otis and Carrier.

Shares of RTN have been rallying lately, possibly due to increased international tensions. This week, I’m raising our Buy Below on Raytheon to $210 per share.

That’s all for now. There’s not much in the way of economic news next week. On Tuesday, the consumer confidence report comes out. Then on Thursday, we’ll get another revision to the Q2 GDP report. The initial report showed real annualized growth of 2.1% in the second quarter. Last month, that was revised down to 2.0%. On Friday, we’ll get data on personal income and spending in addition to the durable-goods report. 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 September 20th, 2019 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.