CWS Market Review – August 29, 2014

“The market can do anything.” – Jesse Livermore

It finally happened! Shortly after the opening bell on Monday morning, the S&P 500 broke 2,000 for the first time in history. Of course, breaking through some arbitrary number doesn’t mean anything for the stock market’s future, but it’s a good time to reflect on how amazing this rally has been. To give you some perspective on what 2,000 means, consider that each point in the index is worth about $8.8 billion.

Less than three years ago, the S&P 500 stood at 1,100. We’re now closing in on double that number. Measuring from the big low in March 2009, the index has tripled in a little less than five and a half years. Add in dividends and we’re up more than 230%! That’s more than 24%, annualized. It took just 94 days to go from 1,900 to 2,000. The index got as high as 2,005 on Tuesday before settling back to 1,996.74 by the close of trading on Thursday.

Without question, this has been one of the greatest bull markets in history. It’s also been one of the most hated. From the day it started, people have predicted its imminent demise. Of course, the current bull market came about after a long and painful bear market. But this shouldn’t be too surprising since bull markets have a habit of starting with a low. Even adjusting for inflation, the S&P 500 is still below its high from March 2000. That’s why I always keep in mind the wise words of Mr. Livermore: “the market can do anything.” Not only can it…it probably has.

In this week’s CWS Market Review, we’re going to take a look at some of the recent economic news. Slowly, things are improving. This week, the government revised higher its estimate of Q2 GDP growth. Next Friday is the big jobs report for August, and we could extend our streak of adding 200,000-plus jobs to seven months in a row. Let’s hope these good numbers continue.

Of course, hope is not an investment strategy. Around here, we focus on cold, hard facts. The good news is that our Buy List has been rallying with the overall market. Fiserv just hit a new all-time high. Ross Stores continues to float higher after its strong earnings report; the shares just broke out to a nine-month high. Microsoft is nearing a 14-year high. Heck, even Bed Bath & Beyond is moving up. In fact, I’m raising BBBY’s Buy Below this week. I didn’t see that coming a few weeks ago. But first, let’s look at the latest news on the economy.

Q2 GDP Revised Higher

I always try to be careful when discussing the broad economy because at CWS Market Review, we’re primarily focused on the business end of things: profit, loss, debt and margins. We can lose sight of the fact that there’s still a lot of weakness in the economy, especially in the labor market. There are also many people with homes that are underwater, even years after the crisis. So when I point to signs of improvement, I don’t want to feel that I’m gliding over the distressed areas.

On Monday, the Census Bureau reported that new-home sales declined for the third month in a row. I should add context here by saying that sales are up more than 12% compared with one year ago. Look at any numbers from housing: you’re struck by how much things fell apart during the recession. Even though sales are up, they’re still running at the rate we saw during the lows in previous recessions. Economic recoveries are typically led by housing, but there was so much over-building before the crash that it’s taken us years to burn off the excess inventory. Only recently have new-home sales started to pick up.

Now let’s look at the price side. On Tuesday, the Case-Shiller Index said that home prices, as measured by the 20-City Index, rose by 8.1% in the 12 months ending in June. Once again, we’re better than where we were, but still below the crazy bubble peak. The 20-City Index is still more than 17% below its high, but it’s more than 24% above its crisis low. To borrow from Stealers Wheel, we’re stuck in the middle with you. Home prices are still rising, but the pace of increases appears to be slowing down.

On Tuesday, the Commerce Department said that durable goods soared 22.6% in July. That’s the biggest percentage increase on record. However, it was driven by a surge in orders for new aircraft. I like to keep an eye on orders for durable goods because these are the kinds of things companies wait to pay for when they think times are going to be good. During a recession, companies usually put off their plans to buy big-ticket items.

Digging into the durable-goods report, once we exclude aircraft, durable-goods orders dropped by 0.8% in July. But the number for June was revised upward to 3%. Compared with a year ago, orders are up 6.6%. Like housing, the trend looks good, but there’s been a summer slowdown.

On the technical side of the report, orders for non-defense capital goods, excluding aircraft (there’s a mouthful), fell 0.5% in July. But the June figure was revised up to 5.4%. The year-over-year increase is 8.3%. The message from these stats is that companies are out there buying things. They only do that if they see more revenue coming to cover the costs. This should also hint that more hiring will follow later this year.

We’ve seen a bunch of folks on Wall Street raise their forecasts for Q3 GDP. As many of you know, I’m not exactly a big fan of these forecasts, but it gives us a sense of what the institutions are thinking. Morgan Stanley just raised their estimates for Q3 GDP from 3% to 3.5%.

This Tuesday, we’ll get the ISM Index for August. These reports have a pretty good track record of lining up with recessions and expansions. The last few reports have been quite good. In July, the ISM hit 57.1, which is its highest point since April 2011. Any reading above 50 means that the economy is expanding. The ISM has dropped below 50 just once in the last five years.

Last month, Wall Street was shocked when the government’s initial report for Q2 GDP came in at 4%. That was well above what most people were expecting. On Thursday, it was time for the government to revise that report, and obviously people thought it would be revised down an inch or two. Not at all. It was revised higher, to 4.2%.

Breaking into the details, I noticed that gross domestic income rose by 4.7% last quarter. That’s the biggest increase in more than two years. I like to look at this metric because it better reflects the financial health of consumers.

Now that August is coming to a close, we’re already two-thirds of the way through Q3. In mid-September, earnings season will begin again. According to figures from Standard & Poor, Wall Street expects Q3 earnings for the S&P 500 of $30.11. Remember, that’s the index-adjusted figure (one point is $8.8 billion). This would be the highest quarterly total ever, and it would be the first time the S&P 500 has earned more than $30 in a single quarter.

For context, we earned $57 for the whole year in 2009. Wall Street’s estimate for Q3 earnings have been falling over the past few months. At the start of the year, the Street had been expecting Q3 earnings of $30.89. The falling estimates are actually much more modest than the big earnings cuts we saw in previous quarters. In fact, the estimates for Q4 have actually been increasing by a small bit. The Street now sees earnings of $32.39 for Q4. That’s up $0.22 since the start of the year.

The results are almost all in for Q2, and it looks like the S&P 500 earned $29.45. That’s up 11.7% over last year’s Q2. (Note that the earnings numbers from S&P sometimes differ from those of other media outlets.)

The S&P 500 is currently on track to earn $119.27 per share this year, give or take. That’s an increase of 11.2% over last year. Through Thursday, the S&P 500 is up 8% for the year. That roughly translates to a 12% rate for the entire year. In other words, stocks and earnings have been rising at about the same rate. That’s why I’ve ignored all this silly talk about another stock bubble. The market is going for 16.7 times this year’s estimate earnings. That’s in the dead center of historic valuations. Now let’s look at some of the news impacting our Buy List stocks.

The AT&T/DirecTV Merger Is Moving Along

We finally got some news on the big AT&T ($T) merger deal with DirecTV ($DTV). The New York Post reported this week that AT&T is working closely with the government on what it needs to do to win approval for its deal for DTV. I’m assuming this means they’ll have to ditch some assets to appease anti-trust regulators. The article didn’t have many details, which probably means negotiations are still going on. But this news was enough for UBS to raise its price target from $82 to $95 per share.

The merger deal is for $95 per share for DTV. Once we get past the “will it happen” question, the next hurdle is “when.” Shares of DTV are currently about 10% below the $95 deal price. That probably means that the market sees some risk in the deal falling through. The news this week is good for DirecTV. AT&T has too much at stake to let this deal fall through. DirecTV remains a buy up to $95 per share.

Three New Buy Below Prices

Trading hasn’t merely been low lately, it’s been absurdly low. Stock prices simply don’t move around very much each day. Perhaps that will change once all the Wall Street Poobahs get back from their beach cribs.

Despite the low volume and volatility, I want to raise my Buy Below prices on a few of our Buy List stocks. Two weeks ago, I raised my Buy Below on Fiserv ($FISV) from $64 to $66 per share, and it’s already threatening to climb above that. FISV recently rallied 10 times in 12 days. This week, I’m raising my Buy Below on Fiserv to $68 per share.

One of the rules of the Buy List is that our stocks are locked and sealed for the entire year. No matter how badly we want to, we can’t make any changes until the end of the year. This rule has probably helped us far more than it’s hurt us. When Bed Bath & Beyond ($BBBY) plunged this year, I’m sure a lot of nervous investors bailed out.

Ever since BBBY reached its low in late June, the stock has rallied impressively. Two months ago, I lowered my Buy Below to $61 per share. Later on, I raised it to $65 per share. The stock got as high as $64.70 on Wednesday, which is a four-month high. Fiscal Q2 earnings are due on September 23. The company said they expect earnings to range between $1.08 and $1.16 per share. I’m raising our Buy Below to $70 per share.

Express Scripts ($ESRX) is another good example of why we stay with high-quality stocks even when the market doesn’t. The shares had been having a rough year. But last month, the pharmacy-benefits manager beat earnings by a penny per share. ESRX also narrowed their full-year guidance to a range between $4.84 and $4.92 per share. The stock gapped up after earnings and continued to rally for most of August. I’m raising my Buy Below on Express Scripts to $79 per share. This is a solid stock.

The Elfenbein Theory

I wanted to draw your attention to a long post I did earlier this week on the blog site. I discussed my view for how different parts of the market behave.

I encourage you to read the entire piece, but the basic idea is that there are two important “dimensions” of the stock market. The first is between Cyclical and Defensive stocks. The other is between Value and Growth stocks. The first dimension is correlated with long-term interest rates, while the latter is correlated with short-term rates.

The idea that different sectors do well at different points in the economic cycle isn’t new. But by adding a larger framework to this cycle, I hope to give investors a better idea for what drives equity returns. You can read the post here.

That’s all for now. The stock market will be closed on Monday for Labor Day. In the U.S., the Labor Day weekend traditionally marks the end of summer, and trading volume typically picks up in September. We’ll get the ISM report on Tuesday. July Factory Orders are on Wednesday. Friday will be the big jobs report for August. Nonfarm Payrolls have topped 200,000 for the last six months in a row. Let’s see if we can make it seven. 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 August 29th, 2014 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.