CWS Market Review – December 13, 2013

“You don’t have to be brilliant, only a little bit wiser than the
other guys, on average, for a long, long time.” – Charlie Munger

Despite a strong 2013, the stock market seems to be limping into the end of the year. On Thursday, the S&P 500 dipped down to its lowest level in nearly a month. The index has lost ground on eight of the last ten days, and we’re on track for our worst weekly performance in the last 15 weeks.

Of course, since volatility is so low, the overall loss ain’t that much (see the chart below). This is a minor pullback at best. The S&P 500 is currently less than 1.8% below its all-time high close. That’s right folks, we’ve dropped all the way back to those grim and hopeless days of early November. Naturally, some folks are already calling this the beginning of a new bear market. Please: We’re trading at less than 14.5 times next year’s earnings, and estimates have been moving higher.

Before we get into this week’s issue, I want to remind you that I’ll be unveiling the 2014 Buy List in next week’s issue. As usual, I’m adding five new names to the Buy List, and I’m deleting five names. The Buy List always stays at 20 stocks.

The new Buy List takes effect on January 2nd, the first day of trading of the new year, and it’s locked and sealed for the entire year. I can’t make any changes. For tracking purposes, I assume the Buy List is a $1 million portfolio, equally divided among the 20 stocks. Whenever I mention how well (or poorly) our Buy List is doing, that’s what I’m referring to. And don’t forget that you can always see how well we’re doing by visiting the Buy List page of our website.

In this week’s issue, I want to look at more encouraging economic signs. There’s a very good chance that 2014 will be the strongest year for economic growth in quite some time. Will stocks follow? Well, that’s another matter. We’ll also take a look at upcoming earnings reports from FactSet Research Systems and Oracle. I also want to update a few other Buy List stocks. But first, let’s take a closer look at why the economy is looking up.

The Balance Sheet Recession Is Finally Over

One of the big turning points we’ve seen recently is that economic news has improved considerably. I still wouldn’t say that the economy is strong, but we’re a lot better than where we were. The key is that many of the risks that plagued us have slowly melted away. Even our hopelessly dysfunctional Congress seems to have gotten its act together and reached a deal to avert yet another government shutdown. I’ve also been pleased to see things look better in Europe. It was the euro crisis that weighed heavily on U.S. stocks in 2011 and 2012.

While a lot of people have been calling the stock market a bubble, I think we’ve witnessed very much the opposite. Namely, the tremendous fear bubble has deflated. It was only two years ago that the S&P 500 hit its lowest P/E Ratio in over two decades.

Another area where we can see the dissipation of fear is in the credit markets. Bond traders are paid to worry about things, and they’re having a harder time of it. Bespoke Investment Group pointed out that high-yield spreads are at a six-year low, which is a clear sign of optimism. When lenders are afraid, they pull back, and when credit markets freeze up, the whole economy is in trouble. That’s not what’s going on right now.

Things are also looking good for consumers. David Rosenberg, who’s been a long-time bear, has defected to Camp Bull. He noted that the Fed’s recent Beige Book referred to wage pressures 26 times. Folks are also hitting the stores. Retail sales for November rose 0.7%, and the October figure was revised upward to 0.6%. That’s good news for Buy List retailers like Ross Stores ($ROST) and Bed Bath & Beyond ($BBBY).

Consumers have also been getting their finances in order. Cullen Roche, who’s one of the most astute writers on the economy today, recently declared an end to the “balance sheet recession.” For the first time in several years, households are adding on debt. I realize that may sound like something bad, but in econo-speak, it’s actually good news. More household debt is what needs to happen during an expansion. The long trend of paying down debt was a necessary and painful obstacle for the economy. It’s come to an end.

Even Uncle Sam’s finances are getting better. The U.S. budget deficit, while still massive, is much less massive than it was a few years ago. The deficit for this year will probably be about 3% of GDP, which is down from 10% in 2009. Also, cost-cutting at the local government level (what some people call “austerity”) is largely over.

I’ve also noted that the spread between the 2- and 10-year Treasuries is widening, which is a classic forward-looking indicator for the economy. In fact, it’s one of the most reliable macro indicators around. What’s particularly interesting is that the yield on the two-year has been fairly stable, while the 10-year has been rising. The 2-10 spread is near the highest it’s been in more than two years. This is a particularly good omen for Buy List financial stocks like Wells Fargo ($WFC) and JPMorgan Chase ($JPM). Remember that a bank is basically the yield curve with incorporation papers. Now let’s take a look at some upcoming earnings reports.

FactSet Research Systems Is a Steady Winner

Three of our Buy List stocks have reporting quarters that end in November, and two of them, Oracle and FactSet Research Systems, will report earnings next week. FactSet ($FDS) is due to release its fiscal Q1 earnings report on Tuesday, December 17th, and Oracle follows the next day with its fiscal Q2 earnings report. The third stock, Bed Bath & Beyond, won’t report its earnings until January 8.

Let’s start with FactSet, which has been a solid performer for us this year. The stock, which makes software that tracks all the geeky financial data that Wall Street loves to play around with, is up 30% this year. Six months ago, FactSet merely “met” Wall Street’s consensus, and you can probably guess what happened. Traders panicked. The stock dropped. We sat and watched. After a bit, the stock quietly rallied to a new high. That’s our game, and we play it well.

Then three months ago, FactSet had an earnings “miss.” Well, technically it was a miss, since it was one whole penny below Wall Street’s consensus—never mind that it was well within FactSet’s own guidance for the quarter. But because it was a miss, the shares dropped. Like clockwork, the stock settled down and again quietly rallied to another all-time high. FDS came close to making another new high yesterday, even though the broader market was retreating.

Now let’s get into some numbers. When looking at FactSet, the important metric to watch is ASV, which is annual subscription value. The ASV for last quarter rose by 6%, which is a good number. For the upcoming earnings report, FactSet said they expect to see revenues between $222 and $225 million and earnings between $1.21 and $1.24 per share. That’s strong growth. For comparison, FDS earned $1.11 in last year’s fiscal Q1.

Here’s the bottom line: Business is going well for FactSet. It’s still early, but I think the company can churn out $5 per share this fiscal year (which ends in August). This is a steady winner. FactSet remains a very good buy up to $119 per share.

Oracle Is a Buy up to $36 per Share

Oracle ($ORCL) is due to report its earnings on Wednesday, December 18. On Monday, ORCL hit a nine-month high, but it suddenly got chopped down later this week. On Thursday, two Wall Street firms, Morgan Stanley and RBC, downgraded Oracle. Both analysts think the valuation is too high, which I think is nuts. But one of the analysts cited concerns about cloud computing, which I think is a valid concern but probably overstated.

I have to admit that Oracle had been frustrating us for much of this year. It’s by far our worst-performing stock on the Buy List. Their new software sales, in particular, have been disappointing. But I’ve learned to never count Larry Ellison out. If there’s one lesson I’ve learned in life, it’s that businessmen who own their own Hawaiian island probably know what they’re doing. Just a rule of thumb there.

Oracle’s last earnings report was pretty good. Whenever I look at an earnings report, I like to dig into see the numbers below the surface. One key metric is free cash flow, and for Oracle that was a cool $6 billion last quarter, and about half of that went to share buybacks. Actually, the earnings would have been even better this time if it weren’t for those meddling currency effects. I was also pleased to see Oracle double its dividend in June. That’s always a strong sign of confidence from management.

Three months ago, Oracle told us to expect Q2 earnings to range between 64 and 69 cents per share. They should be able to top that, but I’m curious to see what guidance they’ll offer for fiscal Q3. I suspect Oracle enjoys low-balling Wall Street. For this fiscal year, I think Oracle has a chance to earn as much as $3 per share, which means the stock is going for about 11 times forward earnings. That’s a good deal. Don’t let this week’s downdraft rattle you. Oracle is a good buy up to $36 per share.

Buy List Updates

Now here are a few updates to some of our other Buy List stocks. This week, AFLAC ($AFL), our favorite duck stock, gave a presentation at a Goldman Sachs conference. One of things I like about AFLAC, besides its being very well run, is that it’s a fairly transparent company. They’re up front about what’s going on, which is frustratingly rare. Supplemental health insurance can be rather opaque, but AFLAC tries to bring some clarity. If you remember, when the stock dropped over concerns about its European investments, management kept investors in the loop.

While I like AFLAC a lot, it’s no secret what one of their major problems is: Bond yields around the world are pitifully low, and that’s not fun if you’re running a $100 billion fixed-income portfolio. At the Goldman conference, the company explained that they want to diversify their portfolio outside of Japanese government bonds. They even hired a top manager away from Goldman to run their portfolio. AFLAC said they want to start buying other assets, including more U.S. corporate debt. I think this is a smart move. The company has strong cash flow, so they have to keep plowing that coin back into suitable fixed income. Right now, AFLAC is going for about 10 times next year’s earnings. My take: It’s a solid buy up to $70 per share.

A few months ago, there was some mindless chatter that Google ($GOOG) was about to buy the very lucrative NFL Sunday ticket away from DirecTV. Suddenly, everybody thought that football was going to be broadcast over YouTube. Oh brother. At the time, I said this was complete nonsense. The truth is that the NFL is very happy with DTV, and vice versa. Of course whenever a contract is up, you want to hear offers from other parties. What’s the word for that? Oh right, business.

Sure enough, the latest word is that DTV and the NFL are close to reaching a deal to keep the NFL Sunday Ticket at DirecTV. The Sunday Ticket has two million subscribers, and the package starts at $49.99 per month. On Thursday, shares of DirecTV gapped up to a new all-time high. DirecTV is a buy up to $70 per share.

Ford Motor ($F) continues to be a bargain hidden in plain sight. The company has impressive plans for the future. Ford said they’re hiring 11,000 new people next year, 5,000 in the U.S. and 6,000 in Asia. This will be the most people they’ve hired since 2000. Ford plans to introduce 23 new vehicles next year, 16 of which will be in the U.S. The stock is now going for less than nine times next year’s estimate. I rate Ford a buy up to $18 per share.

Finally Fiserv ($FISV) splits 2 for 1 next Tuesday. Don’t be surprised when you see the lower share price. The stock remains a buy up to $112 per share, and post-split, the Buy Below will be $56 per share. This is a good stock.

That’s all for now. Next week is the last full trading week of the year. We’ll get earnings reports from FactSet on Tuesday and Oracle on Wednesday. The Fed meets on Tuesday and Wednesday, and Bernanke will hold his last post-meeting press conference, but I doubt we’ll see a taper announcement. Next week, we’ll also get an important report on Industrial Production, plus we’ll see another revision to Q3 GDP. 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. Here’s a segment I did earlier this week on CNBC’s “Fast Money.”

Posted by Eddy Elfenbein on December 13th, 2013 at 7:06 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.