CWS Market Review – April 1, 2016

“As in roulette, the same is true of the stock trader, who will find
that the expense of trading weighs the dice heavily against him.”
– Benjamin Graham

The first quarter of 2016 is officially on the books, and it was one of the more dramatic quarters in Wall Street history. Imagine if you hadn’t followed the market one iota since the close of business on New Year’s Eve. Like Rip Van Winkle, you fell asleep.

Then, three months later, you suddenly awoke and asked how the market did. I’d tell you that the S&P 500 gained 0.77%, and that with dividends, it’s up 1.35% YTD. You’d probably assume it was a flat and boring market.

In reality, it was anything but. At its low, on February 11, the S&P 500 was down more than 11.4% for the year. That made it one of the worst starts to a year in Wall Street history. Then, suddenly, the bulls took charge. The S&P 500 soared 12.8% off its low. This was the greatest quarterly comeback in the index’s history.

(I should point out that I appeared on Bloomberg on February 12. I’m not saying that I caused the market to turn around all by myself. Obviously, there may have been some minor factors at play. Who really knows?)

The first quarter has been a tale of two markets, and it was also a good lesson in the futility of trying to time Wall Street. I’ll give you a good example: Wabtec (WAB), one of my favorite stocks, went from being a 15% loser on the year to being an 11.5% winner. This all happened in one quarter!

In this week’s CWS Market Review, we’ll take a closer look at the frenetic first quarter. I’ll also preview the upcoming earnings report from Bed Bath & Beyond (BBBY). Later on, I’ll look at the Buy List’s performance so far. We’re losing to the market, but not by much. Also, Barron’s had some nice things to say about Cerner (CERN), one of our quieter stocks. But first, let’s look at the market’s dramatic comeback.

The Greatest Quarterly Comeback in History

This was a jarring quarter for many investors. At first, folks were heading for the hills. During January, investors pulled nearly $5 billion out of global equity mutual funds. Since then, they’ve plowed nearly $7.5 billion back. Stocks are suddenly popular again.

Ryan Detrick notes a fun stat. Over the past five quarters, the S&P 500 has gained a grand total of 0.84 points. Yet, it moved a total of 4,735 points to get there. In other words, so much of the market’s day-to-day volatility is meaningless. Maybe Rip Van Winkle was on to something.

Much of the market’s direction-changing has been due to the Federal Reserve. Or more accurately, it’s been the factors that have come to influence the Fed. In December, the Fed raised interest rates for the first time in nine years. The Fed went out of its way to telegraph its plans, and the market still flopped. At the start of the year, the Fed was planning to raise interest rates four times in 2016, and another four times in 2017.

The market thought that was too much too soon, and stocks started to fall. It looked as if the S&P 500 would get its first 20% decline in years. Bank stocks were in especially bad shape. But the Fed got the word and gradually started to backtrack on it plans.

On February 10, Chairwoman Yellen testified before the House Financial Services Committee and sounded noticeably more concerned about the economy. Central bankers are trained to speak in bland jargony phrases, so when Yellen said, “Financial conditions in the United States have recently become less supportive of growth,” you knew something was up.

Investors took the cue that the Fed was no longer in a hurry to raise interest rates. The S&P 500 broke the “Tchaikovsky Low” of 1,812 and started to rally. The market got more good news when the Fed passed on raising rates at its mid-March meeting. The FOMC also released a “dovish” policy statement, meaning it was less concerned about the threat of inflation.

What’s also struck me has been the remarkable decline in volatility. It’s interesting how the arrival of a volatile market is considered an event. But when volatility fades, no one seems to notice. In my opinion, that’s a big mistake.

The S&P 500 has now run 13 straight days without closing up or down by more than 1%. Before then, the market had been averaging 1% days more than every other day. That’s a stunning change. In fact, seven of the 13 days have had changes of less than 0.2%. In the S&P 500 chart above, notice how the daily high-low bars get progressively narrower. Bottom line: Things are a heckuva lot calmer these days.

We got more good news this week from the Fed when Janet Yellen made some encouraging remarks. I think the best way to look at this is by calling it a “stealth rate cut.” Yellen knows that she can influence the market more easily with her words than with her actions. After all, the “C” in FOMC stands for “committee,” so she needs to get her colleagues to go along with her policies.

On Tuesday, she spoke before the Economic Club of New York and said that the uncertain economic environment justified a slower path towards interest-rate increases. Of course, this had been implied at the March meeting, but now we’re hearing it more clearly.

The stock market responded by rallying on Tuesday and Wednesday. The S&P 500 got to its highest point all year. Many defensive sectors broke out to new 52-week highs. Interestingly, stocks had their first departure from oil in several months. Since October, the movement in stocks has been closely mirrored by a move in oil. That’s probably a case of the market serving as a proxy for consumer demand. However, the recent bump up in stock prices came as the price of oil fell. It’s not a major departure, and we can’t say if it’s the beginning of a trend, but it’s certainly noticeable. I suspect it’s bad news for oil bulls, especially with a big OPEC meeting coming in two weeks.

The futures market reacted quickly to Janet’s words. Not that long ago, investors had been expecting the Fed to move. Now, not so much. The futures market is now about evenly divided on whether there will be a rate hike in November.

In the bond pits, the yield on the two-year Treasury is down to 0.73% (see above). In the middle of March, it was at 0.98%. Here’s a fascinating stat: In January, the two-year Treasury was yielding 42 basis points more than the one-year Treasury. Now that spread is down to 14 basis points. What that means is that the market had been expecting a series of rate hikes next year. Now it’s not so sure.

As I’ve been saying, this is good news for investors. I can’t predict where stocks will go, but we can certainly recognize that the math is on the side of stocks. The dividend yield of the S&P 500 is more than 30 basis points better than the yield on the 10-year Treasury. Many individual stocks are yielding even more. Look for another dividend hike from Microsoft later this month.

Some of my favorite Buy List stocks at the moment include Signature Bank (SBNY) and Biogen (BIIB). I also like Cognizant Technology Solutions (CTSH). This week, I’m raising my Buy Below on Cognizant to $65 per share. Now let’s look at how the Buy List did during Q1.

Our Buy List YTD

Unfortunately, our Buy List trailed the overall market for Q1, but not by much. I’m not trying to put a happy spin on the numbers; we’re only slightly behind the market. Through the first three months of this year, our Buy List is down 0.66%, while the S&P 500 gained 0.77%. With dividends, our Buy List is down 0.30%, while the S&P 500 is up 1.43%. That’s a pretty small deficit, and I believe we can easily make it up before the year is done.

Interestingly, most of our stocks (11 of 20) are actually beating the S&P 500. The problem is, our losers have been losing more than our winners are winning. With investing, that’s not uncommon. Our top performer so far is Stryker, with a 15% YTD gain. Fiserv, Wabtec, HEICO and Hormel Foods fill out the Top 5.

Our two big losers are Alliance Data Systems (ADS), which is down 20.4%, and Express Scripts (ESRX), which is down 21.4%. You may recall that in January, ADS lost 19% in a single day. That’s a big part of our deficit right there. Still, I think our portfolio is poised for a strong earnings season, which begins later this month. Speaking of earnings, we have an off-cycle report coming our way next week from Bed Bath & Beyond.

Earnings Preview for Bed Bath & Beyond

I know I surprised a number of readers when I decided to keep Bed Bath & Beyond (BBBY) on this year’s Buy List, but I’m not sorry I did (it’s currently up 2.88% YTD). The home-furnishings store had a horrible 2015, and it seemed like all the news was bad.

I wouldn’t call our strategy straight “value investing,” but I won’t turn down a good bargain. Last year, BBBY fell more than 36% and closed the year at $48.25 per share. By February, the stock fell below $42 per share.

Bed Bath will report its fiscal Q4 earnings on Wednesday, April 6. This will be for December, January and February. Earlier this year, BBBY said they see Q4 earnings ranging between $1.72 and $1.86 per share. While that’s not great, it’s not that bad either. For comparison, BBBY made $1.80 per share in last year’s Q4.

The company has already made $3.19 per share for the first three quarters of its fiscal year, so its guidance works out to a full-year range of $4.91 to $5.05 per share. That’s compared with $5.03 per share last year. Basically, the company has been having a flat year, which is also what much of the rest of the corporate world has had. BBBY has also been buying back lots of shares, which has aided EPS growth. Their diluted share count is down 11% in the last year.

I’ll be curious to hear if they give a profit outlook for the current fiscal year. I think they can earn between $5 and $5.30 per share. That still means the stock is going for less than 10 times earnings. That’s not a bad deal.

Barron’s Gives Cerner Some Love

Cerner (CERN) is one of my favorite new stocks this year, but I’m afraid their business, healthcare IT, is a bit boring. The stock hasn’t done very well in the past year, but I have high hopes for it.

In this weekend’s Barron’s, Vito J. Racanelli had some nice things to say about Cerner. The following is an extended excerpt from the article, which I thought was important enough to pass along. Racanelli first notes the weakness in the stock, but adds:

Nevertheless, the company’s still-robust earnings visibility, a hefty $14.2 billion backlog, and ongoing demand to reduce the country’s rampaging health-care costs, suggest that Cerner could turn out to be a quiet winner for long-term-oriented investors.

A return to a higher P/E isn’t necessary for the stock to rise by as much as a third in the next 24 months. Cerner needs to maintain its impressive track record of double-digit percentage growth in sales and profit.

With a $17.5 billion market capitalization, this North Kansas City, Mo.-based company sells and services software and systems, both clinical and financial, for 20,000 healthcare organizations around the world. Its clients include hospitals, clinics, physician practices, laboratories, and retail pharmacies.

Cerner is in a stable industry, and its big backlog provides predictability, says Tom Weary, chief investment officer at Lau Associates in Delaware. There’s a high economic moat, too, because Cerner’s installations have high switching costs and come with years of maintenance and support contracts, the latter totaling nearly a quarter of sales.

Racanelli then breaks down some numbers:

Cerner sports a decade-long record of 15% sales growth and 20%-plus growth in earnings per share. Perhaps sales growth has slowed to 10%, and EPS growth to 15%. But both are growing much faster than the broad market.

Given its current size, Cerner might not be able to grow as fast as it once did, but the P/E discounts a slower pace of growth already, and probably more. The P/E doesn’t have to expand for the stock to work, Weary says.

In the past 12 months, analysts’ 2016 consensus earnings estimate has fallen 7%, to $2.34, for a P/E of 22 times. That’s the lowest P/E since the financial crisis of 2008-09, a period in which Cerner increased sales and EPS. Applying the current P/E to 2017 consensus earnings of $2.70 a share yields a $60 target price, up 15%. Doing the same with the 2018 consensus estimate of $3.13 a share puts the stock at $69, up 34%.

Shares of CERN closed Thursday at $52.96. Cerner’s Q1 earnings report will probably come out in late April. The company said they expect Q1 revenue between $1.15 billion and $1.2 billion, and EPS between 52 and 54 cents. For all of 2016, Cerner sees revenue ranging between $4.9 billion and $5.1 billion, and EPS between $2.30 and $2.40. Cerner has a solid business.

That’s all for now. The March jobs report is due out later this morning. It’s interesting how much the jobs report has declined in influence, now that the Fed finally raised rates. On Wednesday of next week, the Fed will release the minutes of its mid-March meeting. It will be interesting to hear the details of what they discussed. Next week, we’ll also get reports on factory orders, trade and consumer credit. 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 April 1st, 2016 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.