CWS Market Review – January 31, 2014

“Go for a business that any idiot can run—because sooner
or later, any idiot probably is going to run it.” – Peter Lynch

It seems like the stock market’s had a difficult time making up its mind recently. On Wednesday, the S&P 500 closed at an 11-week low, but Thursday was the index’s best day all year. Overall, the earnings news continues to be good, but that’s largely because expectations were so low.

There are several things weighing on the market’s mind. Late last week, Wall Street was spooked by troubles in the emerging markets (I’ll have more on that in a bit). There are also signs that China’s economy is slowing. On top of that, the Federal Reserve this week decided again to taper its bond purchases by $10 billion next month. The Fed declined to make any changes to its language vis-a-vis raising short-term interest rates. I think we can expect interest rates to remain low for a good deal longer.

On Thursday, the government said that the U.S. economy grew, in real terms, by 3.2% in the final three months of 2013. Relative to the past few years, that’s not bad. It’s especially good considering that spending by the federal government was down. But in order to see the stock market continue to rally, and see the unemployment rate continue to fall, we still need to see a lot of improvement in GDP growth.

If the economy could grow at an average rate of, say, 3.5% over the next three years, and if inflation could bump up to 2.5%, then our fiscal situation would be vastly improved. I’m not saying it will happen. I’m just saying it would be a great help for investors. Corporate America has stretched profit margins about as far as they can go, so it’s time to see some top-line growth.

The earnings news for our Buy List continues to be good. Both Ford and Qualcomm released impressive results this week, although we had a lousy report from Moog. Some of our stocks are holding up well despite the market’s fragile mood. Express Scripts, for example, just hit a new 52-week high. In this week’s CWS Market Review, I’ll discuss the issues affecting the emerging markets. I’ll also take a look at our recent earnings report and preview next week’s reports. But first, let’s see why the bond and currency markets have been so worried over the “Fragile Five.”

Don’t Blame the Fed for the Emerging-Markets Mess

The stock market’s been rattled lately, and for once, it’s not due to fears from Europe. Instead, there’s been growing concern about the stability of emerging markets, and more specifically, what’s been call the “Fragile Five” (Brazil, India, Indonesia, Turkey and South Africa). Many talking heads are blaming the Federal Reserve for the recent unpleasantness, but this is one case where the Fed isn’t to blame, although it was the instigator of events.

Let’s take a step back. When the financial crisis hit, the Fed and other central banks lowered interest rates to the floor. Econ 101: Money goes to where it’s treated best, so people started investing heavily in emerging markets where the yields (and risks) were higher.

The problem is that a lot of the emerging economies have some serious structural problems. The inflow of cash bought them time, but they haven’t done much to change their ways. Now that the Fed is winding down Quantitative Easing, investors realize that near-0% interest won’t last much longer. Naturally, that will dry up the capital flow to the emerging markets. This problem is compounded by the fact that the governments in the emerging markets loaded up on dollar-dominated U.S. Treasury debt. As a perverse result, they’re doubly sensitive to moves in U.S. interest rates.

People knew this day would eventually come; they just didn’t know when. “When” is apparently now. The governments in the emerging markets are somewhat like a person who builds a balsa-wood house in a tornado zone. When the house goes to smash, they blame the poor foresight on the builder’s part, not the tornado.

The situation in Argentina is especially screwed up—although when I use the phrase “screwed up” in conjunction with our friends on the Rio Plata, it’s like saying there’s “trouble” in the Middle East. The president of Argentina promised not to devalue the currency, but reality intervened. Of course this was after the government spent a pile of cash trying to defend the indefensible peso. In the last three years, Argentina’s currency reserves have been cut in half, and no one really knows what the inflation rate or dollar-peso exchange rate truly is.

I don’t want to pick on Argentina. Turkey is in bad shape as well. The Turkish central bank just jacked up interest rates by 4.75%, and the lira still fell. (Forex traders are an ornery lot.) Brazil doesn’t look so hot, either. The one saving grace for a lot of EMs was their monster customer in China. But when we got sluggish economic reports from China, that really spooked EM investors.

It’s gotten so desperate that even the poor battered yen has done well (see my AFLAC discussion later). I’ll give you another easy rule: If your country exports a lot of commodities (especially to China), then your currency probably got whacked. Places like Turkey, Argentina and Venezuela are running very low on their forex reserves. Broadly speaking, I think currency devaluations can be the best of several bad options, but they don’t work all by themselves. You need reform, too, and that can be politically unpopular.

Several years ago, Bill Gross of PIMCO made a daring investment when he loaded up on Brazilian bonds. That was a shrewd move, and it turned out to be a big winner. So it was a bit jarring when Gross recently said that Brazil is no longer attractive.

I don’t know where all these recent EM developments are headed, but we’re going to soon find out who’s been responsible and who hasn’t. Mexico, for example, will probably pull through just fine. Poland as well. But I’m not so sure about others. Until then, we can expect a little more volatility in our markets and a lot more in the emerging markets. Now let’s run through some of our recent Buy List earnings reports.

Moog Is a Buy up to $66 per Share

Last Friday, we got our first earnings dud of this earnings season. Moog ($MOG-A), the maker of flight control systems, reported fiscal first-quarter earnings of 88 cents per share, which was one penny below estimates.

But the troubling part was that Moog lowered its full-year guidance. The company now sees earnings for this fiscal year (ending in September) of $3.65 per share. That’s down from its earlier range of $3.95 to $4.10 per share. The market was not at all pleased, but remember that guidance is still above the $3.50 per share that Moog made last year.

The lower guidance has three causes. First, Moog plans to spend 15 cents per share more on R&D for its aircraft business. Secondly, they also see their business-system conversion costing 10 cents per share more than originally expected. Finally, Moog projects revenue for this year to fall by 2%, which will knock 10 cents per share off the bottom line.

John Scannell, Moog’s CEO, addressed their slow start: “Our commercial-aircraft business is strong, but our defense and industrial markets are weaker than planned. Despite the difficult market conditions, we continue to invest in programs which will deliver long-term benefits. Although we have revised our fiscal ’14 outlook downward somewhat, it is still a step up from fiscal ’13.”

The shares got banged up last Friday, and the stock continued to drift lower this week. In fact, shares of Moog came very close to dipping below $60 on Thursday. While this news is disappointing, it doesn’t change my fundamental opinion of the company. Moog is a well-run outfit that’s facing a tough environment. We’re in this game for the long-term. I’m lowering my Buy Below to $66 per share.

More Impressive Earnings from Ford Motor

On Tuesday, we got another good earnings report from Ford Motor ($F). For Q4, the automaker earned a cool $3.04 billion, or 31 cents per share, which beat Wall Street’s consensus by three cents per share.

This is a huge year for Ford, as they’re introducing several new vehicles. The basic story remains intact. Ford’s doing a great business in North America, but Europe is struggling, although the Old World is beginning to show signs of improvement. The success story in North America continues to be the F-Series trucks. They’ve been the top-selling vehicle in the U.S. for the last 32 years in a row.

In Europe, Ford lost $1.61 billion last year. They expect more losses this year, but a profit by 2015. Slowly, things are getting better. Ford lost $571 million in Europe last quarter, which is bad, but it’s better than the $732 million they lost in Q4 2012. Also, Ford had a small loss from Latin America and a small profit from Asia, but those are still pretty minor parts of their overall business.

Ford reiterated that profits will fall a bit this year ($8 billion to $7 billion pre-tax), but that’s because the company has very ambitious plans to roll out new models. Ford is introducing 23 new vehicles, of which 16 are in North America. Overall, these were good results. Ford remains a buy up to $17 per share. The stock is especially attractive below $15.30 per share.

Qualcomm Beats Earnings by Eight Cents per Share

After the closing bell on Wednesday, Qualcomm ($QCOM) reported fiscal Q1 earnings of $1.26 per share. That topped Wall Street’s forecast by eight cents per share. Going into this earnings report, a lot of people on Wall Street were expecting weak smartphone sales to hurt earnings. Qualcomm’s shares had dropped four straight days prior to the earnings report.

Fortunately, the earnings report helped calm some nerves, and QCOM rallied 3% on Thursday. I often say that our new buys appear to be damaged merchandise. Investors assume that something is wrong, and in Qualcomm’s case they jump to the conclusion that Apple and Samsung are their only customers. That’s just not so.

The best news is that Qualcomm raised its full-year forecast. For this fiscal year, which ends in September, Qualcomm now sees earnings ranging between $5 and $5.20 per share. The previous range had been $4.95 to $5.15 per share. They also reiterated their full-year-sales range of $26 billion to $27.5 billion, which is an increase of 5% to 11%. The big gains are coming from emerging markets.

For the current quarter, Qualcomm expects earnings to range between $1.15 and $1.25 per share. That’s a bit weaker than expected. Wall Street had been expecting $1.26 per share. Qualcomm sees revenues coming in between $6.1 billion and $6.7 billion. The consensus was for $6.72 billion.

Qualcomm had said they expected a slow start this fiscal year. On the plus side, they were able to improve profit margins in their chips business due to cutting costs. For Qualcomm, their big opportunity is the arrival of LTE in China. However, the Chinese government is currently investigating Qualcomm to see if they’ve broken any anti-monopoly laws. Overall, this was a good quarter for Qualcomm. The company is sitting on $31.6 billion in cash. I’m keeping our Buy Below at $79 per share.

CR Bard Earns $1.42 for Q4

After the closing bell on Thursday, CR Bard ($BCR) reported fourth-quarter earnings of $1.42 per share. That was three cents more than estimates. This is becoming a nice habit for them. You may recall that three months ago, Bard beat earnings by 10 cents per share, and the stock gapped up 7% the next day.

For all of 2013, Bard earned $5.78 per share. Bard’s board also authorized a $500 million buyback program. As usual, I’d rather have that as a dividend, but at least it’s something. The company has increased its dividend every year since 1972, and I think we can expect another increase this spring. I’m keeping my Buy Below on Bard at $142 per share.

Three Buy List Earnings Reports Next Week

Earnings season rolls on. We have three more Buy List earnings reports coming next week.

On Tuesday, AFLAC ($AFL), the supplemental insurance company, is due to report their fourth-quarter earnings. Three months ago, AFLAC told us to expect operating earnings to range between $1.38 and $1.43 per share. They also gave us full-year guidance for 2014, but a lot of that depends on what the Japanese yen does since so much of their business comes from Japan.

If the yen stays between 95 and 100 to the dollar, then AFLAC sees 2014 earnings as ranging between $6.28 and $6.52 per share. The yen is currently about 103 to the dollar. In 2012 and 2013, the yen fell sharply as a result of the government’s weak-yen policy but it’s been creeping up a bit lately. Either way, AFLAC is still going for about 10 times this year’s earnings. AFLAC is an excellent company.

Cognizant Technology Solutions ($CTSH) had a great run during the last half of 2013 (see below), and I think it will continue into 2014. The company will report its fourth quarter results on Wednesday, February 5. For the third quarter, CTSH beat estimates by three cents per share. They also raised their full-year 2013 guidance from $4.32 to $4.37 per share, which translates to Q4 earnings of $1.10 to $1.15 per share. Jefferies raised their price target on CTSH to $112 per share, and Barclay’s raised theirs to $120. For now, our Buy Below is at $104.

Fiserv ($FISV) is also due to report on Wednesday. Wall Street expects earnings of 81 cents per share, which is a nice increase over the 70 cents per share they made one year before. (Remember that FISV split 2 for 1 in December.) The company has been doing very well lately; free cash flow rose 21% for the first nine months of 2013. I think Wall Street’s guidance for 2014 might be a little too high.

Before I go, I also want to lower the Buy Below on our retailers. Bed Bath & Beyond ($BBBY) is a buy up to $71 per share, and Ross Stores ($ROST) is a buy up to $74 per share.

That’s all for now. Next week, we’ll get more Buy List earnings reports. There will also be some important economic reports. The ISM Index comes out on Monday. The ADP jobs report is on Wednesday. On Thursday, we’ll have a look at productivity and trade. Then on Friday is the important January jobs report. The last jobs report was pretty weak, so it will be interesting to see if that was a blip or the beginning of a trend. 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 January 31st, 2014 at 7:11 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.