CWS Market Review – December 6, 2013

“Don’t gamble; take all your savings and buy some good stock and hold
it till it goes up, then sell it. If it don’t go up, don’t buy it.” – Will Rogers

We’re back! I hope everyone had a wonderful Thanksgiving.

Before I start, I have an announcement. I’m going to unveil the 2014 Buy List in the CWS Market Review for December 20, 2013, two weeks from today. Subscribers to CWS Market Review will be the first to see our new list. As always, I’m only changing five stocks. We keep our turnover low around here. I release the names early to prove to doubters that I don’t “game” the market. I also want to show investors that you don’t have to be a frenetic trader to do well on Wall Street. I’m excited for next year’s Buy List, and I think it will be our eighth year in a row of beating the Street.

Now let’s take a look at the stock market. Actually, stocks are doing something they haven’t done in a while—they’re going down! Thursday was the fifth down day in a row for the S&P 500. Unless there’s a big rally on Friday, this will snap the S&P 500’s eight-week winning streak. That’s the longest weekly winning streak in nearly a decade.

So is it time to panic? Well, no. We shouldn’t blow things out of proportion. Measuring from last Wednesday’s close to yesterday’s close, the S&P 500 has lost of grand total of 1.23%. That’s peanuts, a piddling $200 billion. Bear in mind that the market has made a cool $14 trillion since the low. Yet some observers are acting as if the bursting of the bubble, which they’ve predicted every day for five years, is finally at hand.

But the interesting action isn’t what’s happening in the stock market. No, it’s what’s happening with our easily-provoked friends in the bond pits. The long end of the yield curve is creeping its way higher. The yield on the 30-year Treasury just reached its highest point in more than two years, and the culprit is…(are you ready for this)…promising economic news!

In this week’s CWS Market Review, I’ll talk about what this means for investors and why good news for the economy isn’t such rosy news for our portfolios. I’ll also focus on some of our recent Buy List news. Ross Stores, for example, has been getting beaten up lately. (Spoiler alert: I still like it.) We also got a nice 15% dividend hike from Stryker. I love it when that happens. But first, let’s see if the stock market can withstand this recent assault of good economic news.

Good News Frightens the Markets

Earlier this year, the bond market freaked out when Ben Bernanke hinted that the easy-money party would be coming to an end. The yield on the three-year Treasury spiked from 0.3% in May to nearly 1% after Labor Day. Ben was clearly shocked by the market’s reaction to his comments, and he’s been careful to walk back, or “clarify,” those remarks. Either way, the Fed hasn’t come near tapering since. But now Bernanke is nearly out the door, and Janet Yellen will soon be taking over. The latest conventional wisdom is that tapering will be coming this March. We’ll see about that.

But the bond market has been in a sour mood again. On Thursday, the yield on the 30-year Treasury closed at 3.92% which is its highest yield since August 1, 2011. But here’s the key point: The recent sell-off in the bond market is quite different from what we saw this summer. Back then, it was the middle part of the yield curve that saw the biggest rise in rates. This reflected the belief that short-term interest rates were going to rise sooner than folks had expected.

This time, the rise in rates has largely been at the long end of the curve. In fact, the middle part of the curve hasn’t moved very much at all. The three-year is hovering just over 0.6% which is well below its peak from September.

This is an important change in the market’s attitude, and I think it’s because the current bond market downturn is due to a belief in stronger economic growth rather than an imminent rise in interest rates. Here’s the weird part. Lower bond prices may be specifically due to a belief that the Fed will hold down rates for a while more. In other words, the Fed is working to steepen the yield curve.

So what’s all this good economic news, then? Let’s review. On Monday, the November ISM Manufacturing Index came in at 57.3. That’s the highest level since April 2011. Any reading above 50 indicates that the manufacturing sector is expanding. This was the 50th time in the last 52 months that the ISM has come in above 50. Let me be clear: That isn’t gangbusters, but it’s not bad.

On Wednesday, the Federal Reserve released its “beige book” report, which is a survey of the U.S. economy by region. On balance, the report was encouraging, and business activity seems to be picking up, although there are still pockets of weakness.

Also on Wednesday, ADP, the private payroll firm, said that 215,000 jobs were created last month. That was 30,000 more than analysts were expecting. Then on Thursday, the number of Americans filing first-time jobless claims fell to 298,000 which is the second-lowest number since early 2007. This report tends to bounce around a lot, so it’s better to look at the trend which has been heading in the right direction. It also appears that any side effects of the government shutdown have passed.

But the really big economic report is Friday’s jobs report for November. I’m writing this to you early on Friday morning before the report comes out, so you may already know the results. But if the non-farm payroll report tops 200,000, it will be more confirmation that the economy is ramping up.

We got more good news on Thursday when the government revised its Q3 GDP report significantly higher. The initial report came in at 2.8%, but now the number crunchers say the economy grew by 3.6% last quarter. Over the last 30 quarters, that’s the economy’s fifth-strongest quarter. But one downside to the GDP revisions is that a good portion of that economic activity was restocking shelves, and not so much people buying stuff off those shelves. However, this was the third quarter in a row that economic growth has accelerated.

These encouraging economic reports aren’t much of a surprise to us. I’ve recently discussed how the rally has been led by cyclical stocks, and that’s usually a precursor of good economic news. By cyclical, I mean industries that are heavily tied to the economic cycle. When things get tight, folks keep buying toothpaste, but new houses? Not so much. Last Wednesday, the relative strength of the Morgan Stanley Cyclical Index reached its highest point since July 2011. For the last 16 months in particular, cyclical stocks, consumer discretionaries especially, have been grabbing the lion’s share of the market’s gains.

I’ve often noted that the current rally is the most-hated rally in Wall Street’s history. OK, perhaps that’s a bit of an overstatement. Still, I suspect that a major reason for this hatred isn’t that the bears haven’t seen drops; it’s that they have. Consider that during the current rally, which began in March 2009, we’ve seen separate drops of 5.6%, 5.8%, 6.4%, 7.1%, 7.7%, 8.1%, 9.9%, 16.0% and 19.4%. Every single one has led to a new high. Every single one.

What’s also interesting is the breadth of this market. The top 10 point contributors in the S&P 500 have accounted for 18% of this year’s gain. In 1999, that number was 65%. The tech bubble was created by a very small number of stocks. That’s not what’s happening now. Nor have we run out of room. Since World War II, the S&P 500 has gained 20% or more 18 times. The following year’s gain has averaged 10%.

Here’s my take: No, I’m not going to predict a crash. That’s a pointless endeavor. I do, however, caution investors not to expect the kinds of easy gains we’ve seen this year to continue. The simple fact is those higher bond yields I talked about are more attractive to investors, and that’s stiffer competition for stocks; that’s what’s driving the “good news is bad news” dynamic. And yes, there’s still the issue of the Fed’s endlessly-discussed taper, but that’s probably a few months off at the earliest. I think that explains the recent downturn in gold. The yellow metal is closing in on a three-year low, and this will be its first yearly loss since 2000.

For now, a lot of healthcare names look very good here, and much of the tech sector has been left out of the rally. I continue to like Oracle ($ORCL) below $36. The company has another earnings report later this month. Ford ($F) is also cheap here. Don’t let the drop below $17 scare you. The automaker had another strong month for sales. Truck sales are at a nine-year high.

Both Cognizant Technology Solutions ($CTSH) and DirecTV ($DTV) are good buys at these levels. Cognizant said this week it plans to hire 10,000 workers in the U.S. over the next three years. Weak companies don’t say things like that. (By the way, here’s a good profile of Cognizant’s CEO Frank D’Souza.)

Stryker Raises Dividend 15.1%

I love how Stryker ($SYK) consistently churns out profits and dividend increases. On Wednesday, the orthopedic company announced that they’re raising their quarterly dividend by 15.1%. The payout rises from 26.5 cents to 30.5 cents per share.

Kevin Lobo, the CEO, said, “Given our strong balance sheet and cash flow generation, we continue to expand our dividend, which has grown 26% on a compound annual basis since 2008.” Stryker’s dividend has doubled in just four years. Based on Thursday’s closing price, SYK now yields 1.67%. The new dividend is payable on January 31 to shareholders of record on December 31. Stryker remains a very sound buy up to $76 per share.

Microsoft Touches 13-Year High

While other stocks were having a tough time this week, Microsoft ($MSFT) continues to edge higher. Shares of the software giant reached a 13-year high on Wednesday. The company also did something interesting. Even though Microsoft is sitting on a ton of cash, they tapped the bond market for $3.25 billion, plus another 3.5 billion in euros.

The reason is that much of MSFT’s cash is sitting outside the U.S., and they’d have to pay taxes on it if they brought it home. Also, the company has been increasing its dividend and has committed to buy back a large number of shares.

For the five-year bond, Microsoft was able to borrow money at just 1.625%, which is less than the stock’s dividend yield of 2.94%. Essentially, the company is making an easy profit by borrowing money. Microsoft is one of the few companies with a AAA credit rating. Microsoft is a 42% winner for us this year. MSFT remains a good buy up to $40 per share.

Ross Stores Is a Buy up to $79 per Share

Two weeks ago, Ross Stores ($ROST) surprised Wall Street (and me) with a dour outlook for their fourth quarter. The discount retailer said they see Q4 earnings ranging between 97 cents and $1.01 per share. The Street had been expecting $1.09 per share. For Q3, Ross beat their own forecast, but traders focused on the forecast and punished the shares.

Prior to the earnings report, ROST had come close to breaking $82 per share. Immediately after the report, it dropped below $74. The stock seemed to recover some, but it took a turn for the worse this week after Ross was downgraded by Credit Suisse. They lowered Ross to Neutral from Outperform, and their price target is $75.

I apologize for the shaky movement, but I want to assure you that I’m still a fan of Ross. Even the best stocks get knocked around from time to time. In fact, Ross was hit even harder earlier this year. After a lousy sales report in March, ROST plunged 7.5%, but it recovered and soared to a new high. The fact is that Ross is having a great year, and it continues to be a good buy up to $79 per share.

That’s all for now. Next week, we’ll get important reports on the Federal budget and retail sales. Also, remember that Fiserv will be splitting its stock 2-for-1 on December 17th, so don’t be shocked by the lower share price. Also, Oracle is due to report earnings after the market close on December 18th. And most importantly, the new Buy List will be coming your way in two weeks! 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 December 6th, 2013 at 7:09 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.