CWS Market Review – October 12, 2018

“I think the Fed is making a mistake. It’s so tight, I think the Fed has gone crazy.”
– President Donald Trump

In last week’s CWS Market Review, I told you that the bears would strike again—and they did. On Wednesday, the Dow Jones Industrial Average shed 831 points for its worst loss in eight months. The market then followed that up with a further drop of 546 points on Thursday. That’s a staggering loss of 1,377 points in just 48 hours.

Suddenly, Wall Street is nervous. In the last six days, the Volatility Index is up 160%. The first thing I should tell you is don’t panic. While all this sounds bad, from a historical perspective, this week’s loss isn’t that unusual. In fact, this isn’t even our worst two-day drop of this year. The one from February still has this one beaten.

I am, however, cautious, and in this issue, I want to explain why. On Thursday, the S&P 500 closed below its 200-day moving average (see the green line in the above chart). This is a quick-and-dirty gauge of the stock market’s momentum. Historically, stocks have done better when they’re above their 200-DMA rather than below it. The S&P 500 had not closed below its 200-DMA in more than two months. In fact, if we go back further to March 2016, the S&P 500 has closed every day but two above its 200-DMA.

In this week’s CWS Market Review, we’ll discuss what has the market so spooked. Fortunately, our Buy List has done much better than the market this week (meaning, less badly). We’re also starting third-quarter earnings season soon. I’ll preview the first four earnings reports coming our way next week. But first, let’s look at the market’s October swoon.

Risk Returns to Wall Street

So what caused Wall Street’s ruction this week? That’s not so easy to say. Since something happened, we assume it has an identifiable cause, but that’s not the way it works with financial markets. Instead, a lot of different things happen all at once, in real time, and markets react.

Having said that, let’s round up some of the usual suspects. For one, the stock market has done so well for so long that it’s inevitable that we’re due for some sort of backlash. Not only have markets been happy, but they’ve also been calm. The S&P 500 went 74-straight sessions without a single one closing up or down by more than 1%. Many of those days, the index moved less than 0.5%. That’s not normal. Markets are dynamic things, and that demands action. This week, we got some.

There’s also the issue of interest rates. The Federal Reserve recently hiked interest rates. We all knew this was coming. The Fed has been pretty consistent about its intentions, so no one can claim they were caught off guard by the last rate hike.

What’s happened this time is that long-term interest rates have started to rise. Last Friday, the 10-year Treasury yield got to 3.23%. That’s up 90 basis points in the last year. The rise is because the economy has been getting better. The current climb in yields isn’t solely due to inflation, which continues to behave. Lenders are demanding more money for their money, and they’re getting it. For example, if we look at the inflation-protected bonds, we see yields rising. Last week, the yield on the five-year TIPs topped 1%. That’s stronger competition for stocks, so some reaction from stocks is expected.

Here’s the S&P 500 minute-by-minute over the last two weeks.

Rising rates also take some energy out of the economy, particularly in the housing market. Mortgage yields are now at a seven-year high, and the housing market is beginning to show some cracks. If rates go from 4% to 5%, that adds $150 per month to a $250,000 mortgage. That prices a lot of homebuyers out of the market. Existing home sales have fallen for six months in a row. There are cracks appearing in an otherwise solid foundation. For example, unsold high-end homes in New York City are piling up.

The Homebuilder ETF (XHB) fell for 13 days in a row. It rose slightly and then fell sharply for three more days. We can see the impact on our Buy List with stocks like Sherwin-Williams (SHW) and Continental Building Products (CBPX).

I should add that our Buy List has held up well during the recent selloff. On Wednesday, the Buy List beat the S&P 500 by 84 basis points. Interestingly, the selloffs on Wednesday and Thursday had very different profiles. Wednesday’s drop was heavily concentrated on tech stocks. The FAANG stocks lost $175 billion in market value. But on Thursday, defensive and value stocks fell more than riskier stocks did.

That’s the opposite of what you’d usually expect. If I were told that the Nasdaq beat the Dow by 1%, as it did on Thursday, then I’d naturally assume it was a strong up day for Wall Street. Instead, we lost over 2%.

Let’s remember that Wednesday’s fall doesn’t even crack the Top 50 of worst days of the last 20 years. There was a nine-week period in 2008 when we had five days twice as bad as Wednesday. This Wednesday was also the tenth anniversary of the greatest intra-day reversals in history. The Dow dropped 8.12%, then rallied to +3.75%, and closed for a measly loss of 1.49%. If you’re historically-minded, two bear markets ended on October 10th: one in 1990 when the Dow was at 2,365, and the other in 2002 when the Dow was at 7,181. The latter one ended at 10:10 am on 10/10.

There’s also the issue of trade. The Trump Administration has ratcheted up the rhetoric in its approach toward China. Trade is still a small part of our overall economy, but this is having an impact. Consider that 85% of toys sold in the United States are made in China. As I pointed out in this week’s epigraph, President Trump lays the blame for the recent turbulence on the Fed. Meanwhile, the Chinese stock market has been in a tailspin. High-profile Chinese stocks like Alibaba (BABA) and Tencent (TCEHY) have been getting smacked down.

It’s not good for us if the Chinese economy goes off the rails. They’re a key trading partner, plus they own a good share of our treasury debt. I think this is clearly a factor in this week’s drop. Hopefully, the Trade War talk and retaliations will subside before serious damage is done.

The bears are easily startled, but they’ll soon be back, and in greater numbers. For us, we need to focus on high-quality Buy List stocks. Here’s our game plan. In order.

1. Don’t panic
2. Expect more drops
3. Be patient
4. Wait for bargains

Let the other guys panic. The Buy List has outstanding stocks, and we’ll see more proof of that over the next few weeks as earnings season dominates the news.

Four Buy List Earnings Reports Next Week

Over the next three weeks, 20 of our 25 Buy List stocks are due to report Q3 earnings. Here’s a preliminary earnings calendar with each stock, the earnings data and Wall Street’s estimate. I don’t have all the dates just yet (some companies are better at that than others). Four of our stocks are due to report next Thursday.

Company Ticker Date Estimate
Alliance Data Systems ADS 18-Oct $6.24
Danaher DHR 18-Oct $1.08
Signature Bank SBNY 18-Oct $2.83
Snap-On SNA 18-Oct $2.86
AFLAC AFL 24-Oct $0.99
Check Point Software CHKP 24-Oct $1.36
Sherwin-Williams SHW 25-Oct $5.78
Stryker SYK 25-Oct $1.68
Cerner CERN 25-Oct $0.63
Moody’s MCO 26-Oct $1.80
Cognizant Technology Solutions CTSH 30-Oct $1.13
Fiserv FISV 31-Oct $0.77
Intercontinental Exchange ICE 31-Oct $0.80
Church & Dwight CHD 1-Nov $0.54
Ingredion INGR 1-Nov $1.97
Becton, Dickinson BDX 6-Nov $2.93
Wabtec WAB TBA $0.95
Torchmark TMK TBA $1.53
Carriage Services CSV TBA $0.22
Continental Building Products CPBX TBA $0.49

Alliance Data Systems (ADS), the loyalty rewards company, started off the year terribly By May, ADS was down more than 20% for us. But it turned around and regained a lot of lost ground. That rally hit the rocks a few weeks ago, and ADS has been trending lower again. This past week didn’t help matters.

I’ll credit ADS for consistently standing by its full-year earnings forecast of $22.50 to $23 per share. That means the stock is currently going for less than 10 times this year’s earnings. The consensus on Wall Street is for Q3 earnings of $6.24 per share. Recently, an analyst at Bank of America Merrill Lynch started coverage of ADS with a buy and gave it a $290 price target. I’ll be curious to hear any guidance for 2019.

Three months ago, Danaher (DHR) gave us another nice earnings beat, but that wasn’t the big news. The company also announced that it will spin off its dental business next year. That business currently accounts for about 20% of Danaher’s revenues. For Q2, Danaher made $1.15 per share. The company had told us to expect Q2 earnings between $1.07 and $1.10 per share. Danaher also raised its full-year earnings range to $4.43 to $4.50 per share. For Q3, Danaher expects earnings to range between $1.05 and $1.08 per share.

The company has been in the news lately because its former CEO, Larry Culp, has been selected as GE’s new CEO. Going by his performance at Danaher, that’s a very wise choice.

Snap-on (SNA) was our big winner last earnings season. The company said that Q2 earnings rose 20% to $3.11 per share. That beat the Street by 16 cents per share. The stock responded by jumping 9.5%. This could be a trend for Snap-on. The stock jumped more than 6% after the Q1 earnings came out in April.

For Thursday, Wall Street expects Q3 earnings of $2.86 per share. That’s an increase of 16% over last year. Thanks to the recent downdraft, SNA is going for 13 times next year’s earnings. I also expect to see another dividend increase from Snap-on in early November. In the last five years, SNA’s dividend has more than doubled.

I’m also going to include Signature Bank (SBNY). Although the bank hasn’t formerly announced its earnings date, going by its regular schedule, I’m guessing it will be on Thursday. This has been a frustrating stock to own. The shares are currently less than 3% above their 52-week low. The narrowing yield curve is taking its toll on Signature’s valuation.

Despite the drop, I think SBNY looks very good. The shares are going for about 10 times next year’s earnings estimate. The bank also initiated its first dividend of 56 cents per share. Going by Thursday’s close, that works out to a yield of 2%.

Total deposits now stand at $34 billion. That’s an increase of 5.5% in the last year. Loans are up 12.4% to $34.15 billion. Net interest margin, which is the key metric for banks, came in at 2.94% for Q2. Those are decent numbers. For Q3, the consensus on Wall Street is for earnings of $2.83 per share.

That’s all for now. Earnings season will start to ramp up next week. We’ll also get a few key economic reports. On Monday, the retail-sales report for September comes out. Then on Tuesday, we’ll get our latest look at industrial production. Wednesday is housing starts plus the minutes to the last Fed meeting. The exiting-home sales report comes out on Friday. 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

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Two Stocks to Buy in Japan’s Quiet Bull Market

It’s the bull market that almost no U.S. investor has heard about. But it is a very real and vibrant bull market. What am I talking about?

The Japanese stock market, which last week hit a 27-year high!

After Japan’s “bubble economy” collapsed in the early 1990s, its entered a long period of recession and stagnation. In the late 1990s, conditions got even worse as a financial crisis hit some of its leading financial companies, such as Yamaichi Securities and the Long-Term Credit Bank of Japan. The Nikkei index continued drifting downward after that, hitting the 7,054.98 mark on March 10, 2009 as the global financial crisis took its toll.

But then, the second Abe government began in December 2012, and its so-called Abenomics economic strategy, including an ultra-easy monetary policy from the Bank of Japan, took both Japan’s economy and stock market into a long upward trend, which has continued to this day.

If you are looking to invest into Japan’s bull market, please do NOT use ETFs. If you do, your performance will be held back by the banks and other similar companies in the index that offer little growth.

Instead, stick with individual stocks as I have with the Growth Stock Confidential portfolio that currently holds three Japanese stocks with great growth potential.

Posted by on October 12th, 2018 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.