CWS Market Review – August 22, 2014
“There is a danger of expecting the results of the future
to be predicted from the past.” – John Maynard Keynes
Ladies and gentlemen, I have a very important announcement to make: the Summer Swoon is officially over!
Yep, it’s true. From July 24 to August 7, the S&P 500 shed 3.94%. The market’s low came right as the Dow barely touched its 200-day moving average. But since then, the market has rallied impressively. In two weeks, U.S. equities have gained more than $900 billion in value. The S&P 500 has closed higher in eight of the last ten sessions. On Thursday, the index closed at 1,992.37, which is its highest all-time close. Believe it or not, we’re now within striking distance of 2,000.
Think about this: The stock market has nearly tripled in less than five and a half years. That’s simply amazing. As long-time followers know, our Buy List has done even better.
We’ve had more good news for our Buy List this week. Ross Stores, the deep discounter, just did our favorite two-step—the beat-and-raise polka. Medtronic, the large-cap medical devices company, beat earnings as well. Finally, on Thursday, eBay broke out with a 5% gain on news that it might spin off its PayPal unit. I’ll have full details later on.
We’ve also had some more promising general economic news. The Commerce Department said that housing starts were up sharply last month, and last week’s report on Industrial Production was also quite good. Some folks at the Fed are even talking about raising rates sooner than expected (I doubt it will happen). I want to be careful to put this in proper perspective, though. There are signs that the economy is improving, but we’re still far from healthy. I’ll run down the economic outlook in just a bit, and I’ll highlight what Buy List stocks look especially good right now. But first, let’s look at two big shifts that have been quietly underway on Wall Street.
The Shift Toward Large-Caps and Growth
The Summer Swoon caught a lot of folks off guard. Investors need to understand that summertime investing can be weirdly interesting because a lot of Wall Street bigwigs head off to the Hamptons or Martha’s Vineyard. As a result, trading volume drops off, and smaller events can have an outsized impact.
To boil it down, the market was tripped up by “headline risk,” which refers to political events not related to the market. Every night we’ve seen troubling stories about conflicts in places like Ukraine, Syria and Gaza. Naturally, this has scared investors, especially since volatility had been so low during the spring. I’ve mentioned this statistic before, but it bears repeating: The S&P 500 went 62 days in a row without a single close greater or less than 1%. The market hadn’t had a streak that long in nearly 20 years.
But what’s caught my eye now is that this rally has been a party for the big boys. Large-cap stocks are outperforming, and the smaller guys are lagging behind. While the large-cap S&P 500 finally topped its high from July 3, the small-cap Russell 2000 is still lagging at 4% below its July high. In fact, the Russell 2000 reached its all-time high close on March 4. On July 3, the Russell ran up to its previous high, falling short by just 0.5 points. Technical analysts are always on the lookout for “failures” like this, as they may portend more bad news. Since March 4, the S&P 500 is up more than 6%, while the Russell is down 4%. That’s a surprisingly wide gap between the two indexes.
Large-caps aren’t the only favored sector. Growth stocks are also doing well. This is a big change from the spring. In March and early April, the stock market turned sharply against Growth stocks in favor of Value. But since April 11, the Vanguard Growth ETF ($VUG) is up by 12.5%, and the relative performance of Growth has gotten even stronger lately.
What do these two market shifts, large-cap and growth, mean for the market? It’s hard to say exactly, but I think they reflect greater confidence in the economy. When people get scared, they turn to Value, so the newfound love for Growth probably reflects investor optimism. The last GDP report was certainly encouraging, and it bolsters the view that the economy is improving. Another bit of evidence was last Friday’s Industrial Production report. In July, Industrial Production rose by 4%. That’s twice the rate that economists were expecting. Industrial Production is up 5% in the last year.
The turn to large-caps is a bit more complicated. The big difference between large- and small-cap indexes is that large-cap stocks tend to get more of their revenue from overseas. The smaller stocks are skewed towards domestic manufactures. As a result, the large-cap surge could reflect more optimism about Europe and other foreign markets. For example, Ford Motor ($F) recently turned a profit from their European operations, which was earlier than expected.
The U.S. dollar is also improving against many currencies (bond yields in Europe are crazy low). A stronger dollar is typically correlated with large-caps outperforming small-caps. This makes sense since a stronger currency has a tendency to impede smaller domestic manufacturers.
The positive economic news is clearly influencing the Federal Reserve. On Wednesday, the Fed released the minutes from their July meeting. The minutes suggested that some Fed members are beginning to think that interest rates may have to go up sooner than expected. I’m skeptical. Of course, looking at the minutes from any Fed meeting is an extended exercise in indefinite adjectives; “some” members say this, while “many” members say that. We never know exactly how many members feel a certain way on a given issue.
I suspect the majority on the FOMC is in favor of letting short-term rates ride for several more months. Earlier this week, we learned that inflation continues to be very subdued. The CPI rose by just 0.1% in July. That’s the lowest rate in five months. There are few things that scare central bankers more than inflation, so this news gives the Fed a little more breathing room to keep rates low. For its part, the bond market is still holding up. The 10-year yield recently closed at its lowest level in 15 months. Until there’s more evidence of inflation, Janet Yellen and her friends at the Fed are quite content to keep rates near the floor. This is good for the economy, the stock market and Growth-oriented stocks. Now let’s turn to some of our recent earnings reports.
Medtronic Beats by a Penny
On Tuesday, Medtronic ($MDT) reported fiscal Q1 earnings of 93 cents per share. That was one penny better than expectations. Quarterly revenues rose 4.7% to $4.27 billion, which was $20 million better than expectations. Medtronic had its strongest growth for U.S. medical devices in five years.
I was pleased to hear the company reaffirm its commitment to the Covidien deal. Medtronic also stood by its full-year earnings guidance range of $4.00 to $4.15 per share. I like this company a lot, but I’m going to keep our Buy Below at $67 per share, which is fairly tight. At the current price, MDT is going for less than 16 times this year’s estimate. Medtronic is an ideal stock for conservative investors.
Ross Stores Is a Buy up to $77 per Share
After the closing bell on Thursday, Ross Stores ($ROST) reported very good numbers for their fiscal Q2. For May, June and July, the deep discounter earned $1.14 per share. That was six cents better than Wall Street’s consensus. It was also well above Ross’s own guidance of $1.05 to $1.09 per share. I should add that Ross tends to be fairly conservative with its guidance. Quarterly revenue rose by 7%, which was also better than expectations.
The results from Ross tell us that consumers are willing to spend money if they see good deals. I was very pleased to see the company’s operating margins rise to a company record. In the earnings report, Ross gave us earnings guidance for Q3 and Q4. For the current quarter, they see earnings ranging between 83 and 87 cents per share. The Street was at 86 cents. For Q4, they project earnings between $1.05 and $1.09 per share. Wall Street was at $1.12 per share. Bear in mind that Q4 is a biggie for a retailer like Ross.
Ross’s CEO said, “Our second-quarter sales performed at the high end of our expectations as today’s value-focused consumers continued to respond to our wide assortment of competitive name-brand bargains. Merchandise gross margin was above plan, which, coupled with strong expense controls, enabled us to deliver quarterly earnings per share that were above the high end of our guidance.”
Ross raised guidance for the entire year. Previously, they said they expected earnings to range between $4.09 and $4.21 per share. Now they see earnings coming in between $4.18 and $4.26 per share. Last week, I said that I wanted to see better guidance from Ross before I would touch the Buy Below price. Well, we got our evidence and business is going well. I’m raising our Buy Below on Ross Stores to $77 per share.
Will eBay Ditch PayPal?
Shares of eBay ($EBAY) spiked upward on Thursday on rumors that the company is considering spinning off its PayPal subsidiary. If you recall, Carl Icahn had been pressuring eBay earlier to make such a move. The company repeatedly shot down the idea, but PayPal makes a lot of money, and it could be very lucrative for eBay to let them go.
On Thursday, the online magazine “The Information” said that eBay has been telling prospective candidates for PayPal’s new CEO that a spinoff could be in the works. Honestly, that doesn’t strike me as that big of a deal. It seems quite natural that the spinoff topic would be addressed in a job interview. That doesn’t mean it will happen. Publicly, I expect eBay will still speak out against any spin-off.
What’s more interesting to me is how strongly the market reacted to the idea. The market clearly wants PayPal spun off, and that will cause shareholders to pressure the board to make a deal happen. I’ve been following stocks long enough to know that if a board of directors thought wearing clown shoes would help their stock, they’d do it before sunrise. Look for a deal to happen at some point, but it may take time. In the meantime, I’m raising our Buy Below on eBay to $58 per share.
Before I go, let me highlight a few Buy List stocks that look especially good right now. I really like Ford Motor ($F). I think the automaker will make another run at $18 very soon. Cognizant Technology Solutions ($CTSH) is also a very good buy if you’re able to get it below $47 per share. Shares of Qualcomm ($QCOM) pulled back sharply after the last earnings report. It’s coming back quickly, and I think that trend will continue. My Buy Below for QCOM is $79, but if you can pick up shares below $77, then you got a good deal.
That’s all for now. Next week is the final trading week for August. The year is nearly two-thirds over. The next big econ report will come on Thursday when the government revises the Q2 GDP report. The initial report came in at 4%, which surprised a lot of people. Not many folks had been expecting such a strong number. Now we have some more trade data, so the updated figure could be different. On Friday, we’ll get the report for Personal Income. This is usually a reliable metric for how well the overall economy us doing. 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 22nd, 2014 at 7:12 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.
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