CWS Market Review – August 17, 2018

“Look at market fluctuations as your friend rather than your enemy. Profit from folly rather than participate in it.” – Warren Buffett

On Thursday, our Buy List closed at another high. We’re now up 6.87% for 2018. We also closed at a new relative-performance high. We’re running 62 basis points (or 0.62%) ahead of the S&P 500. (Note that these numbers don’t include dividends which I haven’t had time to calculate.)

This is a nice change of pace from the spring when our Buy List had a rough time. Since May 14, our Buy List is up 7.84% compared with 4.04% for the S&P 500. Fortunately, our “be a little patient” strategy is paying off. Best of all, we still haven’t made a single trade all year, nor will we!

In this week’s CWS Market Review, I’ll discuss the emerging sector rotation on Wall Street. Conservative stocks are suddenly hot. I’ll also preview three Buy List earnings reports coming our way next week. But first, let’s take a quick summary of our Buy List’s performance so far.

Buy List Summary

As I mentioned before, our Buy List is up 6.87% so far this year, but that’s coming after a soggy start. By the middle of May, our Buy List was trailing the S&P 500 by more than 3%. We’ve had a pretty nice recovery since then.

I’ll be honest—I didn’t see the turnaround coming. I’m not so good at predicting the future, but what’s important is that we were prepared to take advantage of change when it finally came. This why we focus on high-quality stocks. We also don’t run and hide at the first sign of trouble.

I’ll also note that our three best performers this year are Continental Building Products (CBPX), Wabtec (WAB) and RPM International (RPM). Sexy, right? I know, these aren’t exactly household names. It’s a nice lesson for investors to consider that our wallboard stock is doing roughly six times better than the rest of the market.

Of course, it’s not all good news. On the downside, our worst stock is Ingredion (INGR), and it’s much worse then everybody else. INGR is down nearly twice as much as our second-worst stock. I’m not making excuses for it, but I want to show you why diversification is so important. It’s not uncommon that your median performer (the middle guy) winds up being a better performer than the average of your entire portfolio. That’s happening to us this year. On Wall Street, the downs tend to be down a lot more than the ups are up. This is a crucial lesson for investors.

All told, Ingredion has knocked about 1.41% off the total performance of the Buy List this year, and that includes a 5% jump on Thursday. Too many investors hurt themselves by failing to diversify. You’ll notice that our Buy List covers many different sectors and industries. That’s not an accident.

The High-Beta Crackup

The Buy List has been helped recently by a shift in the stock market’s risk profile. Starting in February 2016, the stock market rallied and High Beta stocks did the best while conservative stocks were left far behind. (Forgive me for the financial mumbo-jumbo. By “High Beta,” I mean riskier stocks, and by “Low Vol,” I mean more conservative stocks.)

The most prominent aspect of this rally was the FAANG stocks. The high-profile FAANGs powered the High Beta stocks higher. In terms of relative performance, the High Beta sector peaked in June. They still went higher, but not by as much as the rest of the market. This was the moment for conservative stocks to shine as the Low Vol sector gradually outpaced the broader market.

I’ve touched on this subject a few times in recent issues of CWS Market Review, but the trend has gotten much bolder. Twice recently—first on Friday, then again on Wednesday—High Beta stocks did very badly. What started as a trickle has turned into some serious pain. The risky stocks are hurting, and conservative stocks are doing just fine. In fact, a bedrock sector in the Low Vol world is consumer staples. Some Buy List favorites here are Hormel (HRL) and Smucker (SJM), the Spam and Jam twins, plus Church & Dwight (CHD). After a long slumber, these consumer staples are getting the attention of investors.

But the $30 trillion question is, will this trend last? I don’t know, but the previous trend is quite old. Also, the shift towards conservative stocks seems to be more than a blip. I’m inclined to believe that this is a true turning point for the market, and more stable stocks will thrive. Investors’ love affair with trendy stocks like Tesla is on the rocks. All those hi-flying Chinese tech stocks are on the outs as well (see the FXI fund which has been the go-to fund here). I’ll add that historically, when the risk cycle changes, the new trend tends to last for a few years.

Three Buy List Earnings Reports Next Week

We have three Buy List earnings reports next week. These are for our three stocks with quarters that ended in July. I’ll be curious to hear the earnings report from JM Smucker (SJM). This will be for the first quarter of their fiscal year, and it’s due out on Tuesday, August 21.

Some background. In June, the stock got dinged after Smucker released a pretty bad earnings report for fiscal Q4. The company told us to expect earnings between $2.17 and $2.27 per share. Instead, they made $1.93 per share. Not surprisingly, traders punished the stock.

What happened? The CEO blamed the miss on “industrywide headwinds and certain discrete items.” Hmm. Smucker also had disappointing guidance for the current fiscal year. The company sees this year’s earnings (ending in April) coming in between $8.40 and $8.65 per share. Wall Street had been expecting $9.18 per share.

There were a few reasons for Smucker’s poor Q4. For one, Canada announced retaliatory tariffs on American jam which is a core SJM product. The company also faces higher costs which places it in the tough position of passing said costs on to consumers. This is a difficult environment in which to raise prices. Bear in mind that Smucker is a lot more than jelly. They also make Jif peanut butter and Folger’s coffee, and they have a pet-food division which is the company’s largest.

For Q4, sales of Smucker’s consumer foods fell by 1.8%. Pet food was flat while coffee was up 0.5%. For the quarter, net sales fell by 0.1%. The issue really comes down to pricing and how much latitude Smucker truly has. Frankly, everyone in the industry is facing the same issue. The Q4 results suggest that Smucker may have to give in and deal with lower margins. To be fair, Smucker has already started to adjust its business model to better compete in a challenging market. For example, a few weeks ago, Smucker sold off Pillsbury, their baking division, to a private-equity firm. That brought in a nice wad of cash.

Last year, Smucker made $7.96 per share. There’s a lot I like about Smucker. The company recently bumped up its dividend from 78 to 85 cents per share. That was their 17th consecutive annual dividend increase. For Tuesday, Well Street expects earnings of $1.79 per share.

On Thursday, August 23, Ross Stores (ROST) and Hormel Foods (HRL) are due to report. (These two seem to always report on the same day.)

Let’s start with Ross because I’m expecting good news from them. Three months ago, the deep discounter reported fiscal Q1 earnings of $1.11 per share. They had projected earnings between $1.04 and $1.07 per share.

The details were pretty solid. Q1 sales rose 9% to $3.6 billion, and comparable-stores sales were up 3%. Ross had been expecting 1% to 2%. (I knew that forecast was too low.) The company said it was hurt by poor weather during the quarter. I’m usually pretty skeptical of weather as an excuse. Ross’s operating margin fell to 15.1%. That’s still pretty good for a retailer.

For fiscal Q2, Ross expects earnings of 95 to 99 cents per share. They see same-store sales growth of 1% to 2%. Once again, that’s too low. In June, Ross raised its full-year guidance. The old range was $3.86 to $4.03 per share, and the new range is $3.92 to $4.05 per share.

I’m pretty confident Ross earned more than $1 per share last quarter. Probably more than $1.03. The real question is how strong same-store sales growth was. For now, I’m keeping a tight Buy Below price at $90, but I may raise it soon depending on their results.

Three months ago, Hormel Foods missed their fiscal Q2 earnings by a penny per share, but I’m not too concerned about a miss like that. Hormel’s business still looks pretty good. Profits were up 13% over last year’s Q2. Most importantly, the Spam folks reiterated their full-year earnings range of $1.81 to $1.95 per share. This November, I’m expecting another dividend increase which will be their 53rd in a row. On Thursday, shares of HRL closed at an 18-month high. For this report, Wall Street expects earnings of 39 cents per share.

Before I go, I wanted to pass along an update on Signature Bank (SBNY). The bank has been a lousy performer for us this year. Still, on Thursday, the bank announced that it had approved a share buyback of up to $500 million. That’s about 8% of the bank’s market cap. The deal still has to be approved by shareholders. I don’t think they’ll mind terribly since SBNY jumped 4.2% on Thursday. The bank is going for less than 13 times this year’s earnings.

That’s all for now. There are a few things to look out for next week. On Wednesday, we’ll get the report on existing-home sales. We’ll also get the minutes from the last Fed meeting. That could be interesting. Then on Thursday, we’ll get a look at new-home sales, plus another jobless claims report. Then on Friday, the durable-goods report comes out. Also on Friday, the Fed will kick off its annual shindig in Jackson Hole. 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 on August 17th, 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.