CWS Market Review – January 15, 2021

“There is only one boss. The customer. And he can fire everybody in the company from the chairman on down, simply by spending his money somewhere else.” – Sam Walton

For the fourth time in U.S. history, a president was impeached this week. A Senate trial may not happen for a few more weeks, after President Trump has left office. The financial markets, however, took the news in stride, and stock prices are still close to a new all-time high.

In last week’s issue, I cautioned that the December jobs report might not be a good one. I was right: it wasn’t. That, combined with other evidence, strongly suggests that the economy went into a nasty slide toward the close of 2020. President-elect Biden just unveiled plans for a massive stimulus program.

However, the big news coming our way is the fourth-quarter earnings season. From mid-January through early February, hundreds of companies will tell us how business fared during the final three months of 2020. For Wall Street, earnings season is like Judgment Day. Investors will learn who’s been naughty or nice. On our Buy List, 22 of our 25 stocks follow the March/June/September/December reporting period. That means they’ll be reporting soon. As usual, I’ll provide a complete earnings calendar for you as we get closer to earnings season.

In this issue, I have some Buy List updates for you. Some of our stocks are already up nicely this year. Trex, for example, is up close to 10%. That’s nice to see after last year’s big run. Miller Industries, a newbie this year, is already an 8% winner for us. Of course, it’s still early. Later on, I’ll lift some of our Buy Below prices. I’ll also highlight shares of Thermo Fisher Scientific. But first, let’s take a closer look at some recent economic news.

The U.S. Economy Lost 140,000 Jobs Last Month

Earlier this week, multi-gazillionaire and noted bluntsman Elon Musk tweeted rather mysteriously: “Use Signal.” Investors immediately sprang into action. Shares of Signal Advance (SIGL) skyrocketed from 60 cents per share to $3.76 per share. Within a few days, the stock eventually reached $70 per share.

There was one wee problem. Signal Advance had nothing to do with the company Musk was tweeting about. Signal Advance is a tiny biotech stock that used to be known as Biodyne Development Company. Musk wanted people to use Signal, an encrypted-messaging platform that isn’t publicly traded.

Still, the market took the wrong signal, literally, and the wrong Signal soared. With investing, people often talk of the Greater Fool Theory. This means that someone is overpaying but they’re buying in because they think they can unload it an even higher price. Here the theory became reality.

Well after the Signal mix-up was discovered, shares of SIGL were still frantically bouncing around. On Thursday, shares of SIGL closed at $11.50 per share. That was a 36% gain in one day for a stock that has little true value.

My point is that investing isn’t a rational business. Over the long term, sure, it’s pretty good. But in the short term? No way. The market is little more than a poorly-organized mob.

Last Friday, the government released the December jobs report. Wall Street was expecting a loss of 50,000 jobs. Instead, the economy lost 140,000 jobs. The unemployment rate is now 6.7%. The situation is grim. There are currently more than 110 million people who are either out of work or out of the job market entirely.

After digging into the details of the jobs report, we learned that most of the damage fell on the education sector as well as the leisure and hospitality sectors. In a net-net sense, all of the jobs lost last month were held by women. Male employment increased by 16,000.

As I said in last week’s issue, I had been expecting bad news. Several other economic reports hinted that the economy was slowing down late in 2020. On Thursday, the initial-claims report rose to 965,000. That was the highest since August. It’s still about four times higher than the pre-pandemic average.

On January 28, the government will release its initial estimate for Q4 GDP growth. Again, I’m not expecting good news. The New York Fed’s Nowcast currently estimates Q4 GDP growth of 2.2%. I think that’s too high. President-elect Biden unveiled his $1.9 trillion stimulus package.

To fill the lingering holes in the economic recovery, the plan also includes more than $1 trillion in direct aid to struggling families through $2,000 stimulus checks, extended unemployment insurance, rental protections and nutrition assistance. The Biden proposal also allocates $440 billion to small businesses, local communities and transit systems on the brink.

Well, that’s the proposal. What Congress approves may look quite different.

One concern is inflation. The government has already spent lots of money, and it’s looking to spend ever more. So far, there hasn’t been much evidence of inflation. This week’s CPI report showed that headline inflation rose by 0.4% last month. That matched expectations.

The culprit for higher prices wasn’t hard to find. For December, gasoline prices rose by 8.4%, and that accounted for 60% of the rise in December’s CPI. When we look at the “core rate” of inflation, which excludes food and energy prices, then inflation rose by just 0.1%. I tend to be a pragmatist on this issue. There are far too many folks predicting that massive inflation is just around the bend. Eh…maybe. I prefer to look at the data. We’re just not seeing a big increase yet, but it may soon come.

I can’t help noticing that the bond market is reacting, albeit slowly. In August, the 10-year Treasury yield was as low as 0.5%. This week, it got as high as 1.2%. That’s still low, but I’m keeping an eye on it. Inflation may be back with us.

Small Caps Soar

One of the more remarkable events of recent months has been the tremendous rally in small-cap stocks. This comes after nearly a decade of the small-cap Russell 2000 Index’s trailing the overall market, sometimes badly. But not lately. The Russell 2000 ETF (IWM) is up more than 123% from its March low. The relative performance really took off at the end of September. Since then, IWM is up almost 49% while the S&P 500 ETF (SPY) is up “only” 17.5%. That’s a huge gap for that time period.

Here’s a 20-year look at the Russell 2000 ETF divided by the S&P 500 ETF. See how raucous the last year has been.

So what’s driving the little guys? I have a slightly heterodox view on this. I don’t think the Russell 2000 is a good indicator of small-cap performance. Instead, it’s an index that leans heavily towards the cyclical sectors, with some unusual features. Most prominently, the R2000 doesn’t have any of the mega-cap tech stocks. That means that whenever the Apples of the world sour, the R2000, by definition, sees a relative gain.

The Russell 2000 leans towards energy and financial stocks. Those are the ones that have been doing well. This is further evidence of the trend we’ve discussed before. Cyclical and value stocks have been leading the charge, and that may continue. This has been mirrored in the bond market by those yields that we discussed before. What we’re seeing is a large shift from defense to offense. Related to this, consumer staples have been relatively weak, even good ones like Hershey (HSY) and Church & Dwight (CHD).

It’s not so much that cyclicals are getting high valuations. It’s that they’re fed up with trailing for so many years. Not that long ago, Apple was worth more than the entire Russell 2000. That’s not the case anymore. I wasn’t surprised by this rotation, but the quickness with which it occurred did get my attention. I expect this rotation to continue on for at least several more weeks.

Profile of Thermo Fisher Scientific

I promised to go into greater depth on our new stocks. This week, it’s Thermo Fisher Scientific’s (TMO) turn. The best way to think of TMO is to know that they make all the stuff that makes labs run. That means all matter of scientific instruments. The company is also involved with diagnostics consumables and life-sciences reagents.

This is a good business to be in, and a very good business to dominate, because customers buy the initial base of equipment. As that expands and upgrades, TMO gets a steady stream of recurring revenue. I didn’t select it as a Covid stock, but Thermo will certainly be an important player in the fight against the pandemic. In fact, the company recently launched two antibody tests. Wherever research money is spent, Thermo will get its beak wet. It’s simply the arms dealer to the pharma industry.

In many respects, TMO has a business model similar to that of razors and razor blades. Once you get the customer to buy the razor, they’re tied in to buying many more blades. Nearly 80% of TMO’s revenue is recurring. Importantly, the company strives to have the best instruments out there. Thermo spends about $1 billion a year on R&D, and about 40% of TMO’s revenue comes from pharma and biotech.

Last year. TMO offered to buy Qiagen (QGEN) for $11.5 billion. That was a lot of money, but QGEN shareholders shot down the deal. Wisely, TMO walked away. That impressed me.

The stock is currently going for 24 times this year’s earnings estimate. That’s not cheap, but given TMO’s historic valuation, it’s not bad. The company’s ability to grow earnings consistently is truly impressive. Check out the long-term chart below.

The share price is in blue, and it follows the left scale. The red line is EPS, and it follows the right scale. The two lines are scaled at a ratio of 16-to-1.

The next earnings report is due out on February 1. Wall Street is expecting earnings of $6.47 per share. Thermo Fisher Scientific is a buy up to $490 per share. I may adjust that soon, but I want to see earnings first.

Buy List Updates

Our Buy List is up on the year. Thanks to the recent rally, a few of our stocks have jumped above their Buy Below prices. Right now is the quiet before the storm. There’s not much news about our stocks, but that will change soon. This week, I’m raising our Buy Below on Ansys (ANSS) to $390 per share.

I’m also raising AFLAC’s (AFL) to $50 per share. The duck stock is due to report earnings on February 3. The current estimate on Wall Street is operating earnings of $1.05 per share. Since October 30, AFLAC has rallied 38%.

I’m also raising our Buy Below on Intercontinental Exchange (ICE) to $123 per share. This week, ICE said it’s going to sell its Bakkt unit. The division will enter the public markets via a SPAC. That’s a special purpose acquisition company. It’s basically a shell company that’s listed on the exchange. It can buy up a company like Bakkt in order to avoid all the headache of going public.

Bakkt focuses on digital markets. Initially, it made a big splash by having Bitcoin futures. Now it lets people trade all sorts of digital assets. The deal values Bakkt at $2.1 billion.

As I mentioned earlier, Trex (TREX) is up nearly 10% this year after a spectacular 2020. I’m raising our Buy Below on Trex to $98 per share.

Stepan (SCL) got out of the gate very strongly this year. At one point last week, shares of Stepan broke above $131, but they pulled back some this week. I’m lifting our Buy Below on Stepan to $134 per share.

That’s all for now. The stock market will be closed on Monday is honor of Dr. Martin Luther King’s birthday. The civil rights leader would have been 92. On Wednesday, Joe Biden will be inaugurated as our 46th president. On Thursday, we’ll get another jobless-claims report. On Friday, the existing-home sales report is due out. 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 January 15th, 2021 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.