CWS Market Review – October 10, 2014

“There is scarcely an instance of a man who has made a
fortune by speculation and kept it.” – Andrew Carnegie

The stock market decided to get a whole lot more interesting this week. On Thursday, the S&P 500 fell 2.09% for its worst day in six months. This was surprising, considering how calm the markets had been. Earlier this year, there was a three-month stretch when the index never had a 1% day. Now it’s happened four times in the last five days.

During Thursday’s trading, the Volatility Index ($VIX) spiked to over 19. Just a few days ago, it was less than 12. In the last few issues, I’ve talked about the distorting impact that the strong dollar has had on the markets. Now we’re seeing some of the negative fallout. On Thursday, the S&P 500 closed at 1,928.21. That’s a two-month low, and it’s a loss of 4.13% from the all-time high close of September 18. (Notice how the spread between the daily high and low has gradually increased.)

That’s not a big loss, but remember, we haven’t had a 10% correction in three years. I should remind all investors that every few years, stocks go down. It’s just the nature of the beast. But now we’re in earnings season, and this is when every stock is judged by the market. For disciplined investors, we also want to pay close attention to the earnings guidance from our stocks.

In this week’s issue, I’ll walk you through what’s been roiling the market. I’ll also highlight three of our Buy List stocks which have earnings reports coming next week. For the broader market, I’m expecting a mild earnings season. Nothing great, but not terrible either. I’ll also have some updates on our Buy List stocks, but first, let’s look at what has the market so rattled lately.

Volatility Makes a Comeback this Week

Last Friday, the government reported that the U.S. economy created 248,000 jobs last month. That’s a pretty strong number. The Feds also revised higher the figures for July and August, and the unemployment rate dropped down to 5.9%. This was the first time the jobless rate has dipped below 6% since July 2008.

The market briefly enjoyed the good news, and the S&P 500 rallied back over 1,970, but it wasn’t to last. Stocks sunk lower on Monday and Tuesday, but the heated action came on Wednesday and Thursday.

Stocks started out poorly on Wednesday, but that afternoon, the Federal Reserve released the minutes from their last meeting. We never know exactly what happens behind the scenes at these meetings, but three weeks after each one, the Fed releases the minutes. In them, the Fed expressed some concerns about the rising dollar. While a rising dollar carries benefits, it can also impinge on growth and keep inflation down. The Fed has tried desperately to keep the economy afloat, and we know that inflation is running below their target, so you can see their concern.

So does this mean there’s a growing chorus of doves at the Fed? Not exactly. I have to mention that reading the minutes from any Fed meeting is an arcane study in indefinite pronouns; “some participants say” this or “others” say that. In this week’s minutes, the concerns about the strong dollar were aired by “some” and “a couple.” Well, a few of us have a number of concerns some of the time about several of these minutes. What exactly are they saying?

In any case, traders were quite pleased, and the market staged an impressive turnaround on Wednesday afternoon. In fact, it was the best day for the S&P 500 all year. I think they’re correct that the Fed has a bias towards keeping rates low, but we simply can’t say how much they’re weighing the impact of the strong dollar.

Then on Thursday, concerns from Europe sent our stocks lower again. Mario Draghi, the head of the ECB, is clearly frustrated with the European economy. He’s particularly worried about the threat of deflation. The German economy is moving backward and there are concerns about its impact here. The sanctions against Russia aren’t helping either. So we followed the best day of the year with the fourth-worst day of the year. Market historians often tell us that weird things happen in October.

The Fed’s minutes caused a brief pullback from the greenback, but the effects on the strong dollar trade are still evident. Small-caps are doing poorly. The relative strength of the Russell 2000 has been terrible. Gold has been awful, although it got a little bounce this week. Conversely, the dollar fell a little bit, but commodity stocks have lagged badly. The Energy Sector ETF ($XLE) has dropped from over $100 on July 24 to just under $85 on Thursday. The yield on the 10-year Treasury dropped to 2.33%, which is its lowest yield in more than 15 months. At the start of the year, the yield was near 3%. It’s not just Treasuries; 30-year fixed-rated mortgages are back below 4%.

Several of our Buy List stocks got hit hard this week, including some of my favorites. AFLAC ($AFL), CA Technologies ($CA) and Ford Motor ($F) all touched new 52-week lows this week. I was really surprised by the falloff in Ford. The stock had already turned south after the lower guidance, but the selling has continued. A few weeks ago, Ford was closing in on $18 per share, and this week, it dropped below $14 per share. This week, an analyst at Morgan Stanley downgraded the automakers, not because of any weakness in their operations, but because of lower gas prices. The analysts said that cheaper gasoline won’t cause such a rush of buyers to snatch up Ford’s new aluminum trucks. Frankly, I think he’s missing the larger picture. What Ford is doing could be a massive change for the industry. I apologize for the volatility, but I haven’t altered my outlook on Ford. If their forecast for next year is correct, Ford is going for a great price here.

What to do now: Investors should focus on earnings instead of day-to-day volatility. For Q3 earnings season, analysts currently expect profit growth of 4.9%. Three months ago, the expectation was for growth of 7.8%. As I said, I expect mild growth this season. Some of the most attractive Buy List stocks at the moment are Ford Motor ($F), AFLAC ($AFL), eBay ($EBAY), Cognizant ($CTSH) and Microsoft ($MSFT). Now let’s take a look at some earnings reports coming our way next week.

Three Buy List Earnings Reports Next Week

Next week is the start of earnings season for our Buy List. On Tuesday, Wells Fargo ($WFC) will become our first Buy List stock to report. Three months ago, the big bank earned $1.01 per share, which matched expectations. I’ve been impressed by how Wells has managed itself during an important juncture in the industry (see the chart below). Mortgage revenue has plunged, but Wells is well ahead of the curve. The bank has broadened its footprint in credit cards, cars loans and investment banking.

Wells Fargo has managed to increase its earnings for 18 quarters in a row. Until last quarter, they beat expectations for 10 quarters in a row. The consensus on Wall Street is for Wells to earn $1.02 per share for Q3. My numbers say that’s about right. Frankly, the stock isn’t that exciting right now, but that’s a plus in this market. The stock is currently going for 12.4 times earnings, which is quite reasonable. This is a good stock for conservative investors. In a downturn, WFC probably won’t fall as much as other stocks and the dividend is secure. Wells Fargo is a buy up to $54 per share.

On Wednesday, eBay ($EBAY) is due to report. The online auction house has had a rough year, although it’s improved since the spring. The big news recently was the announcement that they’re going to spin off PayPal next year. I think that’s a smart move, and I expect to hear more details about this on the conference call.

For Q2, eBay beat by a penny per share. They said they expect Q3 earnings to range between 65 and 67 cents per share. Since that range is so narrow, I’m assuming that’s what it will be. Honestly, I’m surprised eBay is still below $55 per share. The business looks pretty good right now, and naturally, a stronger economy would help.

For the entire year, eBay sees earnings coming in between $2.95 and $3.00 per share. They see revenues ranging between $18.0 billion and $18.3 billion. I’ll be curious to hear what they have to say about Q4 guidance. Wall Street expects 91 cents per share, but there’s a chance it could be higher. I’m keeping a fairly tight Buy Below here; eBay is a buy up to $55 per share. I may raise it if earnings and guidance are strong.

On Thursday, it’s Stryker’s ($SYK) turn. The orthopedic company rarely surprises us, but they did last earnings season when they lowered the high end of their full-year guidance by ten cents per share. For Q3, they see earnings ranging between $1.12 and $1.16 per share. I think there’s a good chance SYK can top that. For the full year, Stryker projects earnings between $4.75 and 4.80 per share.

I don’t always trust guidance from companies, but in Stryker’s case, I‘m more inclined to believe them. I should also point out that Stryker may be in the works for a merger. I’m not predicting anything will happen, but merger mania seems to be spreading across their industry. If the price is right, a deal might come about. Stryker is a buy up to $87 per share.

Buy List Updates

Shares of Bed Bath & Beyond ($BBBY) spiked higher on Tuesday after rumors broke that Carl Icahn had taken a position in the stock. Let me stress that there’s absolutely zero confirmation that the story is true.

Traders naturally prefer to move first and wait for facts later. Sometimes that works for you, and sometimes it doesn’t. This week, it worked in BBBY’s advantage. Later on in the week, the shares kept their heads while the rest of the market got shaky. I doubt Carl made any move into BBBY, but you never know. Either way, we’re in this for the long term. Despite all the drama in this stock, the company hasn’t altered its long-term guidance. Bed Bath & Beyond remains a buy up to $70 per share.

Earlier this year, Medtronic ($MDT) announced its big “tax inversion” deal with Covidien ($COV), a company based in Ireland. Recently, however, shares of Medtronic pulled back after the Obama administration announced new rules regarding such inversions. Some investors thought that might cause the deal to be scrapped. Not so.

This week, Medtronic said they’re reworking the deal to be in compliance with the new rules. The combined entity will be domiciled on the Emerald Isle, and they’ll probably be able to cut their tax bill as well.

Not to get too technical, but Medtronic was going to use their cash held outside the U.S., and loan that to Covidien to complete the deal. Now Medtronic will use cash from another source. I’ve been impressed by Medtronic’s insistence that they’re doing this deal for operational reasons, not solely for a cheaper tax bill. You’d expect them to say that publicly, but now we have further proof that both companies are on board. Medtronic is a buy up to $67 per share.

That’s all for now. Next week will be about earnings. We’re also going to get important reports on retail sales and industrial production. You can see an earnings calendar for our Buy List stocks. 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 October 10th, 2014 at 7:07 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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