CWS Market Review – August 28, 2020

“There is a danger of expecting the results of the future to be predicted from the past.” – John Maynard Keynes

On Thursday, the stock market closed higher for the sixth day in a row, and it was the fifth all-time high close in a row. This has been an incredible run for the stock market. Over the last two months, the S&P 500 has gained nearly 16%.

This is quickly becoming the Honey Badger market—it simply doesn’t care about anything. Lockdowns, no problem. Social unrest, who cares? Mass unemployment, hold my beer. No matter what comes our way, the market just keeps going and going.

In this week’s issue, I want to discuss a recent speech by Federal Reserve Poobah Jerome Powell. Normally, I try not to pay too much attention to what the Fed says, but this time, it’s worth some closer inspection. I’ll break it all down for you.

We also had a good earnings report from Hormel Foods. The Spam folks beat expectations. I’ll have a summary. I also have some new Buy Below prices for you.

The Fed Ditches Its 2% Inflation Target

The Federal Reserve is holding its annual shindig in Jackson Hole, Wyoming. This event is sponsored by the Kansas City Fed, and it’s notable because the Fed has historically used the late-summer conference to announce important policy changes.

The theme this year is “Navigating the Decade Ahead: Implications for Monetary Policy.” I know, it sounds kind of dry, but this year’s conference is worth some attention. More specifically, I’m referring to Powell’s speech on Thursday, which was entitled “New Economic Challenges and the Fed’s Monetary Policy Review.”

Let me pause for a moment to warn you that central bankers are bred to speak in convoluted jargon. Some of this is by design. It’s a nice advantage to have when no one understands what the heck you’re talking about. Former Fed Chairman Alan Greenspan once said, “If I’ve made myself too clear, you must have misunderstood me.”

Fortunately, your humble newsletter writer is well versed in the arcane dialect of Fedspeak, so I can translate it for you. In his remarks, Powell said that the Fed will shift its emphasis when deciding to adjust interest rates. Previously, the Fed stressed the need to raise interest rates early in an effort to combat inflation. The feeling was that inflation needed to be fought before it showed up.

Powell now says that’s no longer needed. The battle against inflation is over. Just looking at recent history, the threats to the U.S. economy have been a pandemic and a financial crisis. For the most part, inflation has been safely bottled up. With this, the Fed is ditching its 2% inflation target.

In 2012, the Federal Reserve adopted a policy of targeting inflation at 2%. They weren’t alone. Many central banks around the world adopted similar policies. The benefit of targeting inflation is that it gave the public a clear view of what the Fed was trying to do. With this, the Fed got better (much better) at communication, and the Fed also has improved its transparency.

The Fed has undershot 2% inflation so consistently that no one bats an eye anymore. At root, Powell is officially adopting a policy that’s already existed. The Fed’s just admitting it. Powell cited four major changes in the Fed’s understanding of the economy. One is that normal economic growth is now assumed to be much less than what it had been. During latter third of the 20th century, the U.S. economy routinely grew by 3% per year in real terms. Not anymore. Now we’re lucky if we can get 2%.

The Fed also assumes that interest rates now need to be much lower than they have been. Under the old playbook, during an expansion, the Fed would raise interest rates to 2% or 3% above inflation. During a recession, it would cut rates to about the level of inflation. That hasn’t been the case in over 10 years.

Here’s a look at real short-term interest rates. Notice how much lower they are than in years past.

Economists speak of the natural rate of inflation. This is the rate at which everything comes into balance. No one knows exactly what the natural rate is, but it’s widely understood that whatever it is, it’s much lower than where it used to be.

Powell also noted that before Covid-19, the labor market was doing quite well. The unemployment rate dropped to a 50-year low. Even when the labor-force participation rate started to rise, it did absolutely nothing to spark inflation. How times have changed. In the 1980s, bond investors would have totally freaked out.

One problem with lower inflation is that the Fed has had less room to boost the economy with rate cuts. That explains why the Fed has embarked on some non-traditional policies.

To be blunt, the Fed needs some inflation. Powell said:

“Our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.”

To be clear, the Fed wants inflation to average 2%, but it’s not going to worry if it rises above 2%.

What does this mean for us? It’s good news. For one, I don’t like to see central bankers wedded to outmoded ways of thinking. Theories should fit the facts, not the other way around.

It’s also good to keep interest rates low. The Fed has killed many stock rallies with overly aggressive rate hikes.

Most importantly, stocks have performed well under modest inflation. I’ve run the numbers and found that inflation doesn’t became a problem for stocks until it hits 5.7%, and we’re a long way from there.

The story out of Jackson Hole simply confirms what we all knew. The Fed was never going to sacrifice the health of the U.S. economy in order to preserve some random inflation target.

Now let’s look at our one Buy List earnings report from this week.

Hormel Foods Beats Earnings

On Tuesday, Hormel Foods (HRL) reported fiscal Q3 earnings of 37 cents per share. That beat Wall Street’s estimate of 34 cents per share. This was for the quarter that ended on July 31.

Looking at the numbers, this was a solid quarter for Hormel. Overall sales rose 4% to $2.4 billion. Sales volume also rose by 4%. That’s important, because you don’t want to rely overly on price increases. Hormel’s operating free-cash flow rose 72% to $242 million. That’s a good sign.

“We had an excellent third quarter with strength across our retail and deli businesses, along with a rebound in our foodservice business,” said Jim Snee, chairman of the board, president and chief executive officer. “The intentional balance we have built across our portfolio has once again enabled us to generate stable cash flows in a very dynamic time period, even as we absorbed significant incremental costs in our supply chain due to the COVID-19 pandemic.”

Here’s how the quarter broke down by Hormel’s different business units:

Refrigerated Foods
Volume up 8%; organic volume up 7%
Net sales up 5%; organic net sales up 2%
Segment profit down 11%

Grocery Products
Volume up 6%
Net sales up 7%
Segment profit up 36%

Jennie-O Turkey Store
Volume down 9%
Net sales down 4%
Segment profit down 67%

International & Other
Volume down 5%
Net sales up 2%
Segment profit up 26%

I also like that Hormel has a solid balance sheet. Its cash on hand is now $1.7 billion. That’s up from $0.7 billion a year ago. The big gain is due to the bond offering and also halting share buybacks. Total debt is up to $1.3 billion from $0.3 billion a year ago.

For Hormel’s outlook, Snee said he expects to see the current quarter mirror the strength of Q3, but he was cautious to add that it’s an uncertain environment. He also said he expects the food service to post a year-over-year decrease for Q4.

HRL pulled back, but that’s after a pretty nice run. Hormel remains a buy up to $53 per share.

That’s it for our Buy List earnings report. The next stock to report is FactSet (FDS), and it won’t report until September 24. RPM International (RPM) will probably report in early October. Things won’t get busy again until the Q3 earning season heats up in mid-October. Now let’s look at some updates to our Buy Below prices.

Buy List Updates

Shares of Ansys (ANSS) got to another new high on Thursday. We now have a 29.1% gain in ANSS this year. This week, I’m raising our Buy Below on Ansys to $340 per share.

Shares of Globe Life (GL) have been trending higher recently. The insurance company recently resumed its share repurchases. GL’s last earnings report was pretty good, and the stock is only going for about 12 times estimates earnings. I’m raising my Buy Below on Globe Life to $90 per share.

I covered the recent earnings report from Ross Stores (ROST) in last week’s issue. The deep-discounter surprised us by reporting a small profit. Ross was widely expected to report a loss. I held off on changing our Buy Below price. Now that I’ve had more time to consider it, I’m going to lift our Buy Below on Ross Stores to $98 per share.

That’s all for now. There are some important economic reports due out next week. On Tuesday, the ISM Manufacturing Index comes out. It will be interesting to see if the economy is still rebounding. On Wednesday, the ADP releases its payroll report. On Thursday, we’ll get to see another initial-jobless-claims report. Then on Friday, the August jobs report comes out. For July, the unemployment rate was 10.2%. 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

P.S. Please join me for a webinar this Tuesday, September 1 at 4 p.m. ET. Noah Hamman, the CEO of AdvisorShares, will be joining me. Noah is an expert on all things ETF. You can register here.

Posted by on August 28th, 2020 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.