CWS Market Review – April 15, 2016

“Doubt is not a pleasant condition, but certainty is absurd.” – Voltaire

Earnings season has begun, and so far, the market seems quite pleased. On Thursday, the S&P 500 closed at its highest point this year. What a turnaround for stocks. The index is up nearly 14% from its February low, and it’s now less than 2.5% from a new all-time high.

On Thursday, Wells Fargo (WFC) was our first Buy List stock to report earnings for this season. The big bank beat Wall Street’s consensus by two cents per share. Wells is continuing to churn out a steady profit despite a tough environment for banks. I’ll have more details in a bit.

Several of our Buy List stocks have been quietly rallying lately ahead of their earnings reports. Stocks like AFLAC (AFL), Stryker (SYK) and CR Bard (BCR) just hit fresh 52-week highs. Other stocks like HEICO (HEI) aren’t far from new highs. The earnings parade is about to get much busier. Next week, we have five Buy List earnings reports including Microsoft (MSFT) and Biogen (BIIB). I’ll preview them later on.

But first, I want to focus on some recent economic news. I realize this sounds like a parody of an economist, but the numbers have been mixed. Some good and some bad. Let’s take a look.

Retail Sales Unexpectedly Tank

Since the Financial Crisis, there’s been a small industry of folks predicting the imminent return of inflation. So far, all those predictions have gone bust. Personally, I try to avoid the macro-forecasting game and instead focus on the numbers.

That’s why I was concerned about the consumer inflation reports for January and February. The headline numbers were quite tame, but the “core” number, which excludes food and energy, started to concern me.

In January, seasonally-adjusted core inflation rose by 0.293% (that’s monthly, not annualized). That may not sound like a lot, and quite frankly, it’s not, but it was the highest in more than nine years. Then in February, the core rate came in at 0.283%, which was the fourth highest in the past nine years.

On Wall Street, two data points count as a trend. Personally, I like to see a little more data, which is why I chose M. Voltaire for today’s epigraph. On Thursday, the government reported that the core inflation rate for March was a tame 0.069%. So there’s no apparent trend. At least not yet.

I wouldn’t mind seeing a bit of inflation. They key part here is “a bit.” It would give the Federal Reserve some more latitude with interest rates. Inflation expectations are very low. As it stands right now, there’s a good chance that the Fed won’t touch interest rates until after the election. I still believe investors are overpaying for risk-averse assets while they’re ignoring assets that are slightly more risky but have much more potential.

Of course, an improving economy needs more shoppers, and that means more people with jobs. The jobs reports have gradually improved, but the best news this week was that the initial jobless report fell to 253,000. That’s the lowest in more than 42 years. Obviously, the country has a lot more people than it did back then. Initial jobless claims have now been below 300,000 for 58 consecutive weeks.

These good numbers are probably due to seasonal factors as much as the jobs market. While the labor picture has improved, there are still many Americans out of work or not even looking for work. There have been some signs of improvement here. The labor-force participation rate finally ticked higher, and wage growth is slowly picking up after a long stretch of flatlining.

I had expected that this would cause more folks to head out shopping. That wasn’t the case. Maybe it was March Madness, but too many people sat at home last month instead of buying things at the mall. On Wednesday, the Commerce Department reported that retail sales fell 0.3% last month. Wall Street had been expecting an increase of 0.1%.

The Atlanta Fed has a cool new estimate of future GDP. They dump tons of numbers into a blender, hit puree, and somehow get an estimate for GDP growth. Right now, they say Q1 real GDP rose by just 0.3%. I had thought their estimate was too pessimistic, but this week’s retail sales report tells me they may be right. We’ll get the first estimates of Q1 GDP on April 28.

Heading into this earnings season, analysts had pared back their estimates by the most since the financial crisis. At the start of the year, Wall Street had been expecting flat earnings for Q1. Now expectations are down 10%. The Wall Street Journal noted that a near-record number of companies in the S&P 500 issued guidance below Wall Street’s expectations. This is expected to be the first earnings season where earnings growth, excluding energy, is negative.

I’m optimistic for our stocks this earnings season because they tend to be much higher quality than the rest of the market. When investors get nervous, they seek out quality. I especially think we’ll see good results from companies like Biogen (BIIB) and Microsoft (MSFT). More on those soon, but first let’s look at this week’s earnings report from Wells Fargo.

Wells Fargo Earns 99 Cents per Share

On Thursday, Wells Fargo (WFC) reported Q1 earnings of 99 cents per share. That was two cents better than Wall Street’s expectations and one penny below my expectations.

There’s not much new to this story. Wells is doing fine, but the environment for banks is choppy. Some bank stocks started to perk up last year. But once it seemed that interest rates would stay lower for longer, the bank stocks got crushed. So far, this has been a terrible year for the big names like JPMorgan Chase, Citigroup and Bank of America.

Going into earnings season, one question mark about Wells was how big was the damage from bum energy loans? The plunging price of crude has wrecked the balance sheets of tons of energy firms, and they owed money to Wells. Now we have some numbers: during Q1, Wells charged off more than $200 million in energy loans. That’s an increase of 75%. The bank also added $200 million to reserves for potential losses. This was the first time they raised reserves in seven years.

The energy loans are an issue, but it’s a small part of their overall business. Last quarter, Wells’s total loan portfolio rose by 10% to $947.26 billion, and commercial loans were up 19% thanks to GE’s commercial lending unit. The bank’s “efficiency ratio” for Q1 was 58.7%. The ratio is expense as a percent of revenues. Wells’s net interest margin is down to 2.9%. I’d like to see that improve, but it’s tough to do in a low-rate world.

Wells also got stung this week when the government rejected its living will. The government has required any of the “too big to fail” banks to explain what they would do in the case of bankruptcy. WFC wasn’t the only bank to have its plan criticized. The CEO has said they’ll work to address whatever issues the government has.

Overall, I think this was a decent quarter for Wells. They’re working their way through some rough seas. The stock is cheap here, but I don’t expect any fireworks. Investors should know that Wells is a stock for the long term. I’m keeping my Buy Below for Wells Fargo at $53 per share.

Q1 Buy List Earnings Calendar

Over the next month, 16 of our 20 Buy List stocks are due to report Q1 earnings. Here’s a handy calendar. I’ve included each stock’s name, ticker, reporting date, Wall Street’s consensus estimate and actual reported result. Please note that some of these dates and numbers are subject to change. This info is the latest I have.

Company	Ticker	Date	Estimate	Result
Wells Fargo	WFC	14-Apr	$0.97	$0.99
Stryker	SYK	20-Apr	$1.20
Alliance Data	ADS	21-Apr	$3.84
Biogen	BIIB	21-Apr	$4.48
Microsoft	MSFT	21-Apr	$0.64
Snap-on	SNA	21-Apr	$2.09
Express Scripts	ESRX	25-Apr	$1.22
AFLAC	AFL	26-Apr	$1.61
CR Bard	BCR	27-Apr	$2.17
Ford Motor	F	28-Apr	$0.47
Stericycle	SRCL	28-Apr	$1.16
Cerner	CERN	5-May	$0.53
Fiserv	FISV	5-May	$1.02
Cognizant Tech	CTSH	6-May	$0.79
Signature Bank	SBNY	TBD	$1.95
Wabtec	WAB	TBD	$1.00

Five Earnings Reports Next Week

Let’s focus on the five Buy List earnings for next week. On Wednesday, April 20, Stryker (SYK) will report its first quarter earnings. Shares of SYK have been doing quite well lately. The stock is up more than 27% from its January low.

Stryker said to expect Q1 earnings to range between $1.17 and $1.22 per share. Like a lot of companies, Stryker has seen its earnings squeezed by the strong dollar. In January, they said that if the exchange remains constant, that will shave two to three cents per share off Q1 earnings. The dollar, however, has been weaker, which may explain some of Stryker’s rally. The stock is currently above my $105 Buy Below price. I’ll probably raise that next week, but I want to see the earnings results first.

On Thursday, April 21, four more Buy List stocks are due to report. Alliance Data Systems (ADS) is one of our new stocks this year, and it’s not been a good start. After the last earnings report, ADS got crushed for a 19.4% loss.

The reason for the steep drop was ADS’s Q1 guidance. They see earnings of $3.83 per share for Q1. Adjusted for currency, that would be $3.93 per share. Wall Street had been expecting $4.14 per share. Interestingly, ADS kept its full-year forecast unchanged at $17 per share.

Biogen (BIIB) is another new stock this year. The last earnings report was very strong. The stock soared after they beat earnings by more than 10%. The rally, however, didn’t last. Wall Street expects earnings of $4.47 per share.

Microsoft (MSFT) has been very stable recently. I’m a little surprised the stock hasn’t been able to break above $56 per share. Look for another good earnings report. Six months ago, shares of MSFT jumped 10% after its earnings report.

Snap-on (SNA) wrapped up a solid year for 2015. Wall Street sees quarterly earnings rising to $2.09, compared with $1.87 for last year’s Q1. I think the company can make $9 per share this year.

That’s all for now. Next week is a slow week for economic reports, but earnings reports will significantly heat up. On Tuesday, we’ll get reports on building permits and housing starts. The existing home-sales report is on Wednesday. Thursday is initial jobless claims. I’ll be curious to see if we can make another four-decade low. 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 15th, 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.