CWS Market Review – April 19, 2013

“Labour was the first price, the original purchase—money that was
paid for all things. It was not by gold or by silver, but by labour, that
all wealth of the world was originally purchased.” – Adam Smith

This was an ugly week for Wall Street. In the last four days, more than $1 trillion was erased from global stock markets. On Monday, the S&P 500 had its single-worst one-day loss in five months. Fortunately, we regained some lost ground on Tuesday, but Wednesday was the second-worst plunge in five months. Then on Thursday, the index closed below its 50-day moving average for the first time this year. That’s usually a bad omen for stocks.

The Worst Gold Plunge in 30 Years

But as rough as things were for stocks, gold’s been doing far worse. On last Friday and Monday, gold had its worst sell-off in three decades. In two days, the price for the yellow metal dropped more than 13% or $200 per ounce. Au was acting like Pb balloon.

What’s behind gold’s pain? That’s easy. Traders are worried that deflation is picking up and I think they’re right. This week’s CPI report showed that consumer inflation fell 0.2% in March. Leading the downward charge were energy costs; the price of gasoline fell 4.4% last month. Emerging deflation means that real interest rates are climbing and that’s bad news for commodities. All this worry about inflation has been hot air. Just look at the market. Inflation-averse investors like to buy TIPs; these are inflation-protected bonds, but this week’s TIPs auction had its worst bid-to-cover ratio in five years.

Retail sales got clipped earlier this year thanks to the end of the payroll tax holiday. That’s clearly holding some consumers back, but make no mistake, the larger story is falling commodity prices. While cyclical stocks have been trailing the market badly over the last month, I don’t believe that’s due to expected lower growth. This week’s report on industrial production was pretty good. Instead, I believe the market is taking on a more defensive posture. We heard a lot of talk about a Great Rotation out of bonds and into stocks. It appears that the rotation is simply out of commodities.

The S&P 500 hit a near-term peak in 2010 on April 23rd. In 2011, it came on April 29th, and last year, it came on April 2nd. I’m sensing a pattern here. In other words, spring sell-offs have been regular occurrences in the greatest bull market in decades.

In this week’s CWS Market Review, I want to focus on our upcoming earnings reports. Next week is going to be a busy week for our Buy List, with five earnings reports due. While Q1 earnings season is still young, the numbers for the overall market are promising. Of the 85 companies in the S&P 500, 75% have beaten earnings estimates and 51% have beaten sales estimates. Before we get to our upcoming reports, let’s look at some recent results from our Buy List starting with the strong earnings report from Microsoft.

Microsoft Is a Buy up to $32 per Share

After the closing bell on Thursday, Microsoft ($MSFT) reported quarterly earnings of 72 cents per share which was four cents better than Wall Street’s estimate. For the same quarter one year ago, the company made 60 cents per share. I’ve been bewildered by the slew of negative comments about Microsoft. Just a few days ago, Goldman lowered MSFT to “Sell.” Yes, the company does have problems, but don’t let that fool you. The overall firm is very profitable.

For the first three months of the year, MSFT’s fiscal third quarter, their net profits grew 19% to $6.06 billion. While the company is feeling the squeeze from struggling PC sales and weak reception for Windows 8, Microsoft is doing well with its corporate software and Xbox biz. They’ve also done a commendable job of keeping their costs in check. In fact, cost control was probably the main driver of the earnings beat. Looking at the top line, revenue rose 18% to $20.5 billion which matched what the Street was expecting.

It’s true that Bing is spewing red ink but let’s add some context. Last quarter, Microsoft’s online division lost $282 million, but the entire company made a profit of more than 20 times that. For now, I’m raising my Buy Below to $32 per share. Microsoft continues to be a solid bargain. The shares currently yield 3.2% and I think we’re going to see a nice dividend increase this September.

Big Earnings from our Big Bank Stocks

Just after I sent last week’s CWS Market Review, our two big banks reported earnings. For the first quarter, JPMorgan Chase ($JPM) earned $1.59 per share which was 20 cents better than estimates. Net profits rose 33% to $6.53 billion. Revenues, however, were “only” $25.8 billion which was $100 million below estimates. The earnings benefited by $1.15 billion thanks to lower loss provisions.

Bloomberg quoted analyst Charles Peabody as saying the reserve releases plus a tax-benefit and a one-time accounting adjustment helped JPM’s bottom line by 26 cents per share. Without those, the bank would have missed earnings. While the mortgage business is soaring, the profits from mortgages aren’t because rates are so low. Thanks to the negative reaction from some traders, the shares pulled back below $47. I’m not worried about JPM at all. The bank remains a good buy up to $52 per share.

Wells Fargo ($WFC) reported earnings 92 cents per share for the first quarter which topped analysts’ expectations by four cents per share. Net income jumped 22% to $5.17 billion which is a record for the bank. WFC’s revenues dropped 1.2% for the quarter but like Microsoft, they’ve been able to cut costs to please analysts.

Profits at Wells’ community banking division rose 25% to $2.92 billion. Profits in wholesale banking rose 9.5% to $2.05 billion. In their wealth and brokerage unit, profits were up 14% to $337 million. Unlike JPM, the last group is a small portion of their overall business. Wells recently got approval from the Fed to raise their dividend to 30 cents per share. Thanks to the improved financial conditions of JPM and WFC, both banks are borrowing costs have dropped and they’re wisely raising tons of cash from investors. Wells Fargo is an excellent buy up to $40 per share.

Next Week Buy List Earnings Reports

Next week is going to be a busy week for our Buy List. Five of our stocks are due to report results next week including three on Tuesday. Let’s run down the reports.

On Monday, CR Bard ($BCR) is scheduled to report Q1 earnings. Previously, the company warned us that 2013 would be a rough one but that growth would pick up next year. Wall Street currently expects earnings of $1.43 per share which is a big drop from the $1.61 per share Bard made for last year’s Q1. I’m not yet confident to say that Bard’s business will rebound strongly, but if it does then the shares are quite inexpensive at the moment. I want to see the details of the earnings report before I can make a stronger case for Bard. The shares are a buy up to $102 per share.

On Tuesday, AFLAC, Ford and Stryker are due to report. The story for AFLAC ($AFL) is straightforward: Business is going well but the weak yen is gobbling up profits. In October, one dollar fetched 78 yen. That same dollar today gets 98 yen. AFLAC has said that if the yen averages 100 for the year, operating earnings per share will range between $5.99 and $6.19 per share. The stock closed Thursday at $48.90. AFLAC is a good buy up to $54.

Ford ($F) has had remarkable success lately, and I’m particularly impressed with the company’s growth in China. The weak link, however, is Europe, and that’s not all Ford’s fault. Thanks to the euro, the continent’s economy is a mess. Ford is working hard to restructure their European operations but it will take a while to see results. Wall Street expects earnings of 39 cents per share but I think Ford is our best candidate for a big earnings beat. Ford continues to be a very good buy up to $15 per share.

Stryker ($SYK) had been the hottest stock on our Buy List. Only this week have shares showed any sign of cooling off. The stock closed Thursday just below $64 per share. I’m not so worried about Stryker’s earnings report. The company usually comes within a penny or two of Wall Street’s consensus. This time around, analysts expect earnings of $1.01 per share. The company didn’t give guidance for Q1 but said to expect earnings between $4.25 and $4.40 for the entire year. Frankly, I think they’re low-balling but it’s still early in the year. Stryker remains a good buy up to $66 per share.

Moog ($MOG-A) is one of those dull stocks that I like a lot. The company is due to report earnings on Friday, April 26th. The last earnings report was a dud and the company lowered the upper-end of its full-year guidance by 10 cents per share. Still, Moog should turn in good results. The company expects fiscal year results to range between $3.50 and $3.60 per share. Moog earned $3.33 per share last year. The stock remains a solid buy up to $50 per share.

That’s all for now. Next week is a huge week for earnings. We’re also going to get our first look at the government’s report on GDP growth for Q1. I suspect that the GDP reports for this year will be better than most folks expect. 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 April 19th, 2013 at 8:08 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.