CWS Market Review – July 3, 2015

“Investors must keep in mind that there’s a difference between a good company and a good stock. After all, you can buy a good car but pay too much for it.” – Loren Fox

In last week’s CWS Market Review, I told you how calm and relaxed the market had become. It seemed like the market was taking it easy this summer. We hadn’t had a 2% drop all year.

Well, I guess I jinxed the market. Sure enough, on Monday, the S&P 500 not only dropped more than 2%, but the index had its worst daily fall in 17 months. Once again, investors were spooked by the unending mess in Greece. There’s a big yes-or-no national referendum scheduled for Sunday.

Once again, I’ll assure you not to worry about Greece. The simple version is that Wall Street doesn’t have much to focus on right now, so it’s giving outsized attention to Greece. Cullen Roche added some much-needed context by noting that Greece was defaulting on $1.6 billion. That’s equivalent to 30 hours’ worth of revenue for Walmart’s (WMT). The good news is that second-quarter earnings season starts next week, and we’ll finally have much more important news to digest.

In this week’s CWS Market Review, we’ll take a look at the upcoming earnings season and what it means for the market. I’ll also cover the latest news on the PayPal spinoff from eBay (EBAY). On July 20, PayPal will join our Buy List as a stand-alone company. I’ll also have the latest on Cognizant Technology (CTSH). The shares dropped on Thursday, but I don’t think it’s anything to worry about. Now let’s look at how well our Buy List did during the first half of 2015.

At the Halfway Marker, Our Buy List Is Beating the Market

I often tell investors not to stress out over short-term moves in the stock market. Viewed minute by minute, the market has a mind of its own. Investors need to understand that stocks fluctuate. Sometimes they go up for no good reason, and sometimes they go down for no good reason. To quote Hyman Roth, “this is the business we’ve chosen.” Only by taking the long view can you really take the measure of how well you’re doing.

On Tuesday, Wall Street closed the books on the first half of the year. In those six months, the S&P 500 gained a mere 0.20%. That’s the market’s worst first half since 2010. I’m please to report that our Buy List continues to outpace the rest of the market. The 20 stocks on our set-and-forget portfolio gained 3.02% for the first half of the year. Remember, that’s with making ZERO trades all year. (A mutual fund company would probably advertise our numbers as beating the market by 15 to 1.)

Once we include dividends, our Buy List gained 3.59% for the first half of the year. With dividends, the S&P 500 gained 1.22%. Roughly speaking, our Buy List yields about 1.1% annually, while the S&P 500 yields about 2%. (I can’t give an exact figure, since our dividends are probably growing faster than the rest of the market.)

Last year, our Buy List lost to the market (11.80% to 13.69%). That broke our streak of beating the S&P 500 for seven years in a row. I started the Buy List to show ordinary investors that with patience and a little discipline, you can consistently beat Wall Street over the long haul. So far, we’re on our way towards beating the market yet again. Patience and discipline are still the keys. Now let’s look at the upcoming earnings season.

Q2 Earnings Season Begins Next Week

On Wednesday, July 8, Alcoa (AA) will officially kick off Q2 earnings season when it reports. Over the next five weeks, 16 of our 20 Buy List stocks will report sales and earnings for the second three months of the year. A few will also update their guidance for the rest of the year. The first Buy List stock to report will be Wells Fargo (WFC) which is scheduled to report on Tuesday, July 14. I’ll preview more of our earnings reports in upcoming issues.

You’ll notice that many of our stocks offer sales and earnings guidance. Bear in mind that companies aren’t required to do this. It’s generally a sign of a better-run company that it tells investors what their goals are for the future.

Wall Street currently expects the S&P 500 to earn $28.42 per share for Q2. (That’s the index-adjusted number. Every one point in the S&P 500 is worth about $8.83 billion.) As with most quarters, analysts have been paring back their estimates. At the start of the year, Wall Street had expected Q2 earnings of $32.36 per share. But as investors realized the full scope of the damage caused by the surging dollar, Wall Street lowered its estimates. The continued impact of the dollar is one of the open questions for this earnings season. Wall Street had overestimated the damage done during Q1.

If Wall Street’s estimate for Q2 is accurate, then this will be the third quarter in a row of declining earnings. As this “earnings recession” began, there was a lot of fear that it would turn into a broader economic recession. Now that we have more data, it appears to be a minor blip within a favorable climate of rising sales and earnings. In fact, earnings are projected to increase slightly in Q3, and for Q4, Wall Street expects earnings growth of more than 17%.

I should also mention that dividends continue to grow very nicely. The S&P 500 saw dividend growth of nearly 10% during Q2. That means that despite many pronouncements of a stock-market bubble, dividends have actually been growing faster than stock prices, and the market’s dividend yield is rising, not falling.

We got more mildly positive news on Thursday, when the government said that the economy created 223,000 net new jobs in June. That was a bit below consensus, but basically it was what the market had been expecting, although the numbers for April and May were revised lower. The unemployment rate dipped to 5.3%, which is the lowest since April 2008. Part of the reason for the lower jobless rate is that more people are leaving the job market. The workforce participation is now at a 38-year low, but some of that is due to demographics (all those retiring Baby Boomers).

The bad news was that average hourly earnings were unchanged. Frankly, wage growth has been weak. What this means is that there’s less pressure on the Fed to raise rates soon. Bill Dudley, the Grand Poobah of the New York Fed, recently said the Fed could increase rates in September. Call me a doubter. The futures market currently thinks there’s a 50-50 chance the Fed will raise interest rates at their December meeting. That sounds about right.

The important takeaway from this jobs report is that there’s a lot of “slack” in the labor market. In previous recoveries, economists had assumed that inflation would start creeping up once unemployment hit 5.5% or so. That’s just not true anymore. In fact, I wouldn’t be surprised if the tipping point is now below 5%. That’s the thing about financial crises—the old rules no longer apply. The U.S. economy is nowhere close to full capacity. That’s good news for stock investors.

There was also mildly good news with the ISM Manufacturing report. The index came in at 53.8. That’s the second monthly increase in a row. It’s also the 30th month in a row that the ISM report topped 50, which indicates an expanding manufacturing sector. The Commerce Department also said that construction spending rose 0.8% in May. It’s now at a 6-1/2-year high. I hate to sound like a careless optimist, but I think Q2 GDP will be one of the best reports in years.

eBay to Spinoff PayPal On July 20

Mark your calendars for Monday, July 20. That’s when eBay (EBAY) will finally spin off PayPal. Technically, the shares will be “distributed” on Friday, July 17, but they won’t start trading until the following Monday.

If you’re an eBay shareholder, you’ll automatically get one share of PayPal for each share of eBay you own as of the close of business on July 8. The ticker symbol for PayPal will be PYPL.

Now there’s the issue of how much PayPal is worth. That’s a toughie. I won’t make a prediction on that, but most market watchers think PayPal will start trading around $35 per share. That would mean that eBay’s stock, without PayPal, will drop to around $26 per share. Remember, you’re not losing anything. You’re gaining a new stock.

To help make the adjustment smoother, “when-issued” shares of PayPal and eBay sans PayPal will start trading on Monday July 6. When-issued shares are for deals that have been announced but haven’t yet been consummated. They’re useful for gauging the market’s interest in the deal. But don’t worry about the when-issued shares. I just wanted you to be aware of what’s going on when you see them. You won’t get your PayPal shares for a few more days.

Overall, I think this is a very good deal for shareholders. I also think there’s a good chance that PayPal will be snapped up quickly by a large finance or tech company. I’m looking at you, Amazon (AMZN)!

Until then, PayPal will join our Buy List as the 21st stock. Just like the others, it’s locked and sealed for the rest of the year. I won’t have a Buy Below on PayPal until the deal is complete. I’ll also provide all the details on how we’ll account for the spinoff on our track record. eBay will report Q2 earnings, its last as a combined unit, on Thursday, July 16. Look for a good report.

Before I go, I want to highlight a few of our Buy List stocks that look especially attractive at the moment. I like Cognizant Technology (CTSH), especially below $62 per share. The shares got nicked on Thursday after Centene said it was buying Health Net, which is a partner with Cognizant. That deal would cost Cognizant $100 million in revenue, but the company was quick to reiterate its full-year guidance for earnings of at least $2.93 per share.

Microsoft (MSFT) also looks quite good if you can get it below $45 per share. The shares yield 2.8%, and I expect another dividend increase later this year.

Signature Bank (SBNY) looks good below $147 per share. Here’s a recent profile of the bank by Alyssa Oursler.

Wabtec (WAB) has pulled back recently, and I think it’s a solid value here. WAB is especially attractive below $95 per share. The company recently raised its dividend by 33%.

That’s all for now. The stock market is closed on Friday, July 3, so investors can enjoy a three-day holiday weekend. Expect some drama next week. I didn’t talk much about Greece in this issue, but the big referendum is scheduled for Monday. It’s a lot of sound and fury and doesn’t signify all that much. Still, traders will look for any excuse to buy or sell. The big news will be the start of earnings season on Wednesday. Also on Wednesday, the Fed will release the minutes of its last meeting. That may contain clues as to what the central bankers are thinking. 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 July 3rd, 2015 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.