CWS Market Review – February 16, 2018

“Sometimes the hardest thing to do is to do nothing.” – David Tepper

Don’t be fooled, the storm hasn’t passed. Sure, stocks bounced back this week, and that’s nice to see. But mark my words–the bears will be back.

The big news this week, outside the stock bounce, was the CPI report. On Wednesday, we learned that January had the largest increase in “core” prices in nearly 13 years. Is inflation finally on its way back? For now, call me a doubter, but we’ll look at what this means for us and our portfolios.

The bond market seems to be taking inflation seriously. This week, the 10-year yield broke above 2.9% for the first time in four years, and the one-year came close to cracking 2% for the first time in nearly a decade. Do you realize what this means? Things are starting to look…normal. Dear Lord! Compared to where we’ve been, normal is downright strange. Consider that in October 2014, the one-year was yielding a microscopic 0.09%.

In this week’s issue, we’ll look at the market’s impressive recovery. We’ll also discuss good earnings from Moody’s and Carriage Services. Moody’s is already a 13% winner for us this year. I’ll also preview next week’s earnings report. We also got news that AFLAC is splitting its stock for the first time in 17 years. But first, let’s look at the five-day bounce.

Stocks Rally Back but the Storm Hasn’t Passed

This was the first time in more than six years that the S&P 500 gained more than 1% four times in five days. So far, the S&P 500 has made back half of what it lost. We had nine rough days followed by five good ones.

Still, we have to be aware of a few things. The bears knocked the market hard. That’s something they haven’t done in years. Bears are easily startled, but they’ll be back—and in greater numbers. The recent low came last Friday when the S&P 500 bounced off its 200-day moving average (see the lower right corner in the chart below). I think it’s very likely the index will “test” that support level again. Maybe a few times. That’s just how markets work.

The difference between this latest downturn and the previous drops like Brexit is that this one involves something far more important to the stock market, rising interest rates.

As I’ve said before, the odd thing wasn’t the market drop. That happens all the time. The odd thing was the long period of very low volatility combined with very, very low interest rates. Now rates have been on the rise and the Fed appears determined to hike rates three times this year. Some Wall Streeters think a fourth is a real possibility.

The yield on the one-year Treasury bill is now more than the dividend yield of the S&P 500. Sure, in an absolute sense, yields are still quite low, but they’re much higher than they’ve been in years. The higher yields provide more competition for investors’ money vis-à-vis stocks. That puts the squeeze on equity valuations.

We also have to remember that by most metrics, stocks are on the pricey side. According to the latest numbers, the S&P 500 is going for 17.7 times this year’s estimated earnings and 16.1 times 2019’s. This doesn’t portend a crash, but if equity prices flat-line for a few months, it would help bring valuations down.

The higher bond yields aren’t just about inflation. Some of the increase is due to the stronger economy. Just look at the yield on the five-year inflation-protected note. It recently hit 0.74%, which is an eight-year high. In an absolute sense, bonds are becoming better values.

Inflation is still a big issue for the bond market. This week, we got the inflation report for January, and it came in above expectations. The headline rate showed prices rose by 0.5% last month. That was the highest jump in five years. The core rate, which excludes food and energy prices, rose by 0.3% (0.349% to be precise), the highest increase since March 2005. I’ll caution you that this is one number. We need to see more data before we can call it a trend.

So we have a paradox. The stronger economy is lifting profits, which helps stocks, but it’s also causing bond yields to rise, which hurts valuations. So what’s an investor to do? The key is to remain calm and not let short-term events scare you. I suspect we’re going to see more volatility spikes over the next few weeks. If we’re lucky, that will give us some very good buying opportunities.

Stay focused on our Buy List stocks. Pay attention to our Buy Below Prices, and make sure you’re well diversified. Now let’s look at our recent earnings reports.

Good Earnings from Moody’s and Carriage Services

Last week, we had a stack of earnings reports to cover. Fortunately, this week was a lot lighter. In last week’s CWS Market Review, I said I expected Moody’s (MCO) to beat Wall Street’s estimates. I was right. Last Friday, the credit-ratings agency reported Q4 earnings of $1.51 per share. That was six cents better than estimates. Moody’s had quarterly revenue of $1.17 billion which topped expectations of $1.08 billion.

For the year, Moody’s made $6.07 per share which is a nice increase over the $4.94 they made in 2016. For 2018, Moody’s expects earnings to range between $7.65 and $7.85 per share. That’s quite good.

From their press release:

Moody’s expects full-year 2018 revenue to increase in the low-double-digit percent range. Operating expenses are also expected to increase in the low-double-digit percent range.

Moody’s projects an operating margin of 43% to 44% and an adjusted operating margin of approximately 48%.

The effective tax rate is expected to be 22% to 23%.

Full-year 2018 diluted EPS is expected to be $7.20 to $7.40. The company expects full-year 2018 adjusted diluted EPS to be $7.65 to $7.85. Both ranges include an approximate $0.65 benefit resulting from U.S. tax reform, as well as an estimated $0.20 benefit related to the tax accounting for equity compensation, in line with the benefit recognized in 2017. The majority of the latter benefit is expected to be recognized in the first quarter of 2018.

After some initial turbulence along with the rest of the market, shares of MCO responded well. The stock has rallied for five days in a row. Moody’s is now our second-biggest winner this year with a gain of 13.1%. MCO came close to making a new high on Thursday. This week, I’m raising my Buy Below to $172 per share.

After the closing bell on Wednesday, Carriage Services (CSV) reported Q4 earnings of 39 cents per share. Technically, this was a penny below expectations, but since only two analysts cover the stock, it can hardly be called “a consensus.”

Carriage Services is our funeral-home stock. Yeah, I know, but somebody has to do it. I have to explain that value investing oftentimes means buying “dented merchandise.” That’s the case with Carriage. The company didn’t have a good year last year, and the good news for us is that that brought down the share price. As investors, the key question is “how serious are the problems?” For Carriage, I believe they can move past them.

The CEO addressed these concerns in the press release:

Mel Payne, Chief Executive Officer, stated, “After eight consecutive years of record performance, our 2017 consolidated operational and financial performance did not meet our reported high-performance expectations, as adjusted diluted earnings per share declined 14.2% to $1.39, adjusted consolidated EBITDA declined 6.8% to $68.7 million, adjusted consolidated EBITDA margin declined 310 basis points to 26.6% and adjusted free-cash flow declined 21.4% to $37.4 million.

Many of the reasons behind the decline in our operating performance were addressed in our second- and third-quarter earnings releases, e.g. weak cemetery preneed sales, lower field EBITDA margins of funeral-home acquisitions made in 2016 not yet integrated under our standards operating model and investment in overhead infrastructure and people. However, beneath the covers of the reported performance, our company was continuously improving in many areas during the year. We were encouraged by the fourth-quarter results from our acquisition funeral-home and cemetery segments as these businesses achieved year-over-year improvement in both organic revenue growth and field EBITDA margins. The momentum shown in these segments in the fourth quarter has accelerated into 2018.

Carriage is in a much better position. For the year, EPS fell 14.2% to $1.39, but for the quarter, EPS rose 8% to 39 cents. The best news is that Carriage is increasing its outlook:

We are increasing our rolling four-quarter ‘roughly right outlook range’ of adjusted diluted EPS to $2.00 – $2.05, a 16% increase compared to the previous outlook. The rolling four-quarter outlook includes the impact from the recently enacted tax-reform legislation and a continuation of the positive operating momentum we experienced in the latter part of 2017 that has continued into 2018. The outlook does not include any future acquisition activity, although we are more excited than ever about the industry consolidation landscape and the pipeline of high-quality candidates produced by our corporate-development team. We expect our effective GAAP tax rate to be in a range of 26%-28% in 2018, compared to our historic rate of 40%.

Carriage sees earnings of $2.00 to $2.05 per share for 2018. (I’m not aware of other stocks that provide rolling four-quarter guidance, but I like the idea.) Shares of CSV gained 3.2% on Thursday. The stock is now going for about 13 times projected earnings. That’s a good deal. Have patience with this one. Carriage remains a buy up to $28 per share.

Earnings Next Week from Wabtec, Hormel Foods and Continental Building

Still more earnings reports to come. Later today, JM Smucker (SJM) will report its fiscal Q3 earnings. This is for their quarter ending January 31. The jelly folks now expect full-year earnings of $7.75 to $7.90 per share. For the quarter, Wall Street expects $2.12 per share.

Now let’s look ahead to next week. We’ll get earnings reports from Wabtec, Hormel Foods and Continental Building Products.

Wabtec (WAB) is due to report before the bell on Tuesday, February 20. Two weeks ago, the stock took a tumble. The rail equipment company released preliminary results for Q4, saying they made 90 cents per share. If that’s accurate, it means WAB made $3.42 per share for the whole year which is below their previous guidance range of $3.45 to $3.55 per share. The company said they’ll provide updated guidance next week. This could be a good year for WAB.

Continental Building Products (CBPX) is due to report on Thursday, February 22. The results may be distorted due to last year’s hurricanes. The company estimates that the hurricanes pushed about 15 to 17 million square feet of wallboard into future quarters. Continental provides guidance for several metrics except earnings per share. Busting out some math, I estimate they made about 35 cents per share for Q3. The Street’s consensus is for 33 cents per share.

Hormel Foods (HRL) will also report its results on Thursday. Like Smucker, Hormel is off-cycle; their fiscal Q1 ended at the end of January.

Frankly, the Spam people didn’t have a good year in 2017, but I thought it’s worthwhile keeping them on our Buy List. They made $1.57 per share last year which was down seven cents from 2016. For fiscal 2018, Hormel sees earnings between $1.60 and $1.70 per share. The consensus for Q1 is for 43 cents per share. The stock is down from where it was two years ago.

AFLAC Announces 2-for-1 Stock Split

On Tuesday, AFLAC (AFL) announced it will be splitting its stock 2-for-1. Technically, the split will come in the form of a 100% stock dividend. What this means is that shareholders will have twice as many shares and the share price will drop in half.

A stock split doesn’t add any value in itself, but it’s usually the sign of a thriving enterprise. Some people claim that splits increase liquidity, but that seems like a stretch to me. This is AFLAC’s first split in 17 years. The new shares are payable on March 16 to shareholders of record as of March 2. Our Buy Below price will split along with the stock.

If you recall, the duck stock recently increased its dividend by 15.6%. The company has been benefiting recently from the strong Japanese yen. I don’t recommend AFLAC due to the yen, but I’m pointing out that forex fluctuations can help or hurt their bottom line. Recently, it’s been helping. On a final note, Fortune named AFLAC as one of its Best Places to Work for the 20th year in a row. Not bad.

That’s all for now. The stock market will be closed on Monday for President’s Day. (Technically, the NYSE recognizes this as Washington’s Birthday and not President’s Day.) It’s a fairly light week for economic news. On Wednesday, we’ll get the existing-home-sales report for January. We’ll also get the minutes from the last Fed meeting. These might contain clues as to more rate hikes this year. 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

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Buy This Stock Profiting From Out of Control Government Spending

To avoid near term chances of a government shutdown, last week the U.S. Senate and House passed a two-year spending plan, which the President signed. The new plan significantly boosts government spending over the next two years compared to the previously in effect sequestration plan.

No matter what your thoughts are on the big vs. smaller government debate, the fact is that government spending and government buying is a growth industry. In the spirit of “if you can’t beat them, join them”, one way to participate in the growth of the federal government is to invest in properties leased to government agencies.

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2 High Yield Stocks to Buy When the “Experts” Are Wrong (Hint: It’s Right Now)

Less than one month ago, bond “experts” were all over the financial news networks predicting the yield curve would invert in 2018. An inverted curve, where short-term rates are higher than long-term rates, is a reliable indicator that the economy will go to negative growth – a recession. At that time the stock market was setting new records higher, even as the fears of a recession grew. Now interest rates are rising, the yield curve is turning more positive, and the “experts” claim it is due to stronger economic growth and rising inflation.

This most recent interest rates news has pushed the stock market into a steep decline. So, what is it to be? An economic recession with higher stock prices or a strong economy with lower stock prices? Will the yield curve flatten or steepen? What will they say next week?

The point is that an investor who invests based on the latest “expert” opinions is likely to get whipsawed into losing money in the stock market. We are now in a stock market correction. It has been about two years since the last one. In the second half of 2015 through mid-February 2016 the S&P 500 declined in a double-dip correction by 13%. It then took five months for the index to recover from the correction.

If you are an investor, and not a trader, and want to grow your portfolio value, you need an investment strategy that accounts for market corrections.

Posted by Eddy Elfenbein on February 16th, 2018 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.