CWS Market Review – August 24, 2018

“It amazes me how people are often more willing to act based on little or no data than to use data that is a challenge to assemble.” – Robert J. Shiller

On Tuesday, it finally happened. Shortly before 1 p.m. ET on August 21, the S&P 500 went above 2,872.87 to reach its highest level ever. True, it didn’t get there by much; the index wound up topping out at 2,873.23 a few minutes later. But still, it was an all-time record, and it took nearly seven months of trying. This now counts as the longest bull market in history (although some folks may quibble on definitions). Basically, every two dollars invested in the market nine and a half years ago is ten dollars today.

In retrospect, this was a pretty tame correction we had earlier this year. From top to bottom, the S&P 500 lost a little more than 10% which is the traditional definition of a correction. However, most of that loss came over two trading days. By the time folks on Wall Street were debating if we were truly in a correction, it was already mostly over. There’s a lesson for investors in that.

In this week’s CWS Market Review, I’ll talk about President Trump’s recent stock market comments. Plus, I’ll cover our three Buy List earnings reports from this week. The reports were fine, but the stocks did not respond well. That’s frustrating, but it’s not uncommon on Wall Street. As we know well, the market gods are capricious. But first, will impeachment make us all poor?

Don’t Expect Any President to Sink or Save the Market

I prefer to steer clear of politics around here, but about once a day, an investor will ask me, “So…when will Trump sink the market?” At the other end, President Trump offered his take that impeachment would wreck the market. The president added, ominously, that, “everybody would be very poor.”

Eh, I’m not so sure about that. It’s true that the stock market got shellacked during Watergate, but it did well after President Clinton’s difficulties. (Sorry, I don’t have data on Andrew Johnson.) To be fair to President Nixon, there were a lot of other things going on during Watergate. The economy was tanking, inflation was soaring, and the Middle East was in flames. The 1973-74 market bust-up was one of the worst on record.

In reality, I don’t think the occupant of the White House has a large influence on the financial markets. I realize that may sound heretical to some, but I stand by it. After the election in 2016, Paul Krugman wrote, “If the question is when markets will recover, a first-pass answer is never.” And he has a Nobel Prize! Politics and investing don’t mix well. In the short-run, sure—the president certainly matters. But in the long run, it’s all about sales, earnings and interest rates. Money stuff: that’s what counts.

After President Trump’s election in 2016, there was a definite Trump Bump, but it didn’t last long. You can also see the impact on certain sectors. Healthcare stocks got spooked during Hillary Clinton’s healthcare initiative in 1994. Gun stocks often jump after a shooting on fears (or hopes) that folks will rush to buy before a new anti-gun law is passed.

My take is that financial markets are probably more influential on policy makers than vice versa. In 1981, François Mitterrand shocked the world by getting elected president of France. He had a bold socialist program. Unfortunately for him, forex traders found out, and the franc got sautéed. The weak currency started to hurt the French economy. In other words, Mitterand’s brand of socialism was hurting workers, and within two years, he did an about-face (Tournant de la rigueur).

It’s odd how we act like politicians are players in a game and the market is the scoreboard. I sometimes wonder if it’s the other way around. I’ll reiterate my position that the U.S. economy is mostly good right now. Not perfect, but good. On Thursday, jobless claims again came close to their lowest level since Altamont. Corporate earnings are pretty good. Inflation and interest rates are still low. In fact, the real Fed funds rate is still negative!

The growing Trade War is a concern. In fact, this week’s Fed minutes indicated that FOMC members discussed the issue at their last meeting. Even Hormel, a Buy List member, said that tariffs could hurt them this year. Still, trade probably isn’t large enough to sink the economy.

Truthfully, the most important sector to watch is housing. This is the tail that wags the dog. For the most part, housing looks pretty good. Mortgage delinquencies are running at a 12-year low. There could be some cracks showing in housing’s facade. For example, Redfin’s stock got pummeled earlier this month. I don’t want to overstate the case. There could be big problems soon, but for now, there’s no reason to believe any president or any party will wreck the stock market.

The key for investors is to focus on good stocks with good earnings. Don’t overthink it. Now let’s turn to this week’s Buy List earnings reports.

Three Buy List Earnings Reports this Week

We had three Buy List earnings reports this week. Unfortunately, the stocks did not respond well to what the companies had to say. Note that all these companies had quarters that ended in July.

Let’s start with JM Smucker (SJM). On Tuesday, the jelly people reported fiscal Q1 earnings of $1.78 per share. That was two cents better than estimates. However, that total included a charge of seven cents due to “a purchase accounting adjustment attributable to acquired Ainsworth inventory.”

Let me explain what’s going on with Smucker and some other big food companies. This is basically a fine company. At the moment, however, they’re caught by rising prices. The cost for a lot of the things they make is falling, and that means they have to pass on the lower prices to consumers. As a result, dollar sales are flat even though sales by volume are doing fine.

Smucker knows what the problem is, and they’re working to address it. That’s why they recently sold off Pillsbury and picked up Ainsworth. Of course, it will take a few quarters to see the results of this strategy.

For Q1, the company had this to say:

“Our strong first-quarter earnings reflect the execution of our strategy, aligning our portfolio for growth in pet food, coffee, and snacking,” said Mark Smucker, Chief Executive Officer. “During the first quarter, we completed the Ainsworth acquisition, which drove much of our year-over-year sales growth, and we are making significant progress toward integrating the business. We also announced a planned divestiture of our U.S. baking business, which is expected to close at the end of this month. In addition, we had strong first quarter performance for key growth brands, including Dunkin’ Donuts®, Smucker’s® Uncrustables®, Nature’s Recipe® and Café Bustelo®, while continuing to execute our cost-reduction programs to enhance margins and provide fuel for investments in future growth.”

Smucker updated its financial guidance. Importantly, they didn’t alter their full-year EPS range, which is still $8.40 to $8.65 per share. They did pare back their revenue estimate from $8.3 billion to $8.0 billion. Smucker also lowered their free-cash range from between $800 million and $850 million to between $770 million and $820 million. The updated guidance reflects “the anticipated impact from the pending divestiture of its U.S. baking business.”

This is from the Wall Street Journal:

Divesting the baking line, which makes Pillsbury cake mixes, and acquiring pet-snack maker Ainsworth were appropriate moves to adjust Smucker’s portfolio. Ainsworth sales were up 28% from a year earlier in the July quarter, and the company said it expects this growth to be sustained for the full year.

But what Smucker really needs, like fellow struggling food giant Campbell, is a convincing plan to turn around its core brands. With respect to Folgers, Chief Executive Mark Smucker said the company is working on “longer-term initiatives to reinvigorate coffee rituals for this iconic brand.” It was unclear what he meant.

I know what he meant. Smucker will continue to jettison older businesses while concentrating on niche areas. That’s the smart play. This is a company that generates a lot of cash and can easily put those dollars to use. On Tuesday, shares of SJM fell 6.62%, and they continued to lose ground on Wednesday and Thursday. SJM is now going for just 12 to 12.4 times this year’s guidance range, plus the dividend yields 3.25%. Smucker is worth holding onto.

On Thursday morning, Hormel Foods (HRL) said they made 39 cents per share for their fiscal third quarter which was up 15% from a year ago. The results matched Wall Street’s expectations. The company reaffirmed its full-year guidance of $1.81 to $1.95 per share. Net sales were up 7%, while organic sales were flat. Many of the same issues impacting Smucker are at play with Hormel. The company said that tariffs could ping them as much as six cents per share in earnings.

Overall, this was an OK earnings report, but it was nothing great. The downside is that Hormel trimmed its full-year sales estimate to a range of $9.4 billion to $9.6 billion.

The CEO said:

“We reported record sales and earnings for the quarter and remain on track to deliver our full-year-earnings guidance range amid volatility due to tariffs and broader industry dynamics,” said Jim Snee, chairman of the board, president, and chief executive officer. “We continue to execute on our strategic initiatives while investing in growth for the future.”

“Grocery Products and International delivered solid results this quarter,” Snee said. “Refrigerated Foods’ branded value-added strategy was able to offset a dramatic decline in commodity profits. We also saw a strong increase in value-added sales at Jennie-O Turkey Store.”

“We increased our advertising investment this quarter and those investments are paying off with growth from brands such as Skippy®, Natural Choice®, Jennie-O®, Applegate®, Wholly Guacamole® and Herdez®,” Snee said. “I’m also pleased to report that our recent strategic acquisitions of Columbus Craft Meats, Fontanini and Ceratti are on track with expectations.”

The story is the same—it all comes down to prices. There’s a glut of beef, chicken and pork. That’s holding down prices, and that cuts into Hormel’s business. This year, lean hog prices are down 26%. As a result, Hormel is forced to cut prices just to keep up.

Just like Smucker, Hormel has worked to alter its business. That’s why they picked up businesses like Applegate Farms. During Thursday’s trading, Hormel lost about 3%. I’m not worried about Hormel Foods. In fact, I’m raising our Buy Below on Hormel to $40 per share.

After the bell on Thursday, Ross Stores (ROST) reported fiscal Q2 earnings of $1.04 per share. That’s up from 82 cents per share last year. Sales were up 9%, and same-store sales were up 5%. Ross gave us a range for Q2 of 95 to 99 cents per share. I know that was too low. In last week’s issue, I said I expected something like $1.03 per share, and I was a penny off.

Barbara Rentler, Chief Executive Officer, commented, “We are pleased with the above-plan growth we delivered in both sales and earnings in the second quarter. Though better than expected, operating margin of 13.8% was down from last year as higher merchandise margin and leverage on occupancy and buying costs were more than offset by a combination of unfavorable timing of packaway-related expenses, higher freight costs, and this year’s wage investments.”

Ms. Rentler continued, “During the second quarter and first six months of fiscal 2018, we repurchased 3.2 million and 6.5 million shares of common stock, respectively, for an aggregate price of $273 million in the quarter and $529 million year-to-date. As planned, we expect to buy back a total of $1.075 billion in common stock during fiscal 2018.”

Ross gave some financial guidance for the second half of the fiscal year. For Q3 and Q4, the company is aiming for same-store sales growth of 1% to 2%. For Q3, Ross sees EPS between 84 and 88 cents. Wall Street had been expecting 88 cents per share. For Q4, Ross expects between $1.02 and $1.07 per share. That works out to full-year guidance of $4.01 to $4.10 per share. Wall Street had been expecting $4.08 per share.

Ross has bold plans for the future. The company now aims to open 3,000 stores which is up from the previous goal of 2,500. The after-hours market on Thursday showed Ross losing about 5%. That seems overdone to me, but it’s only erasing the last three weeks’ worth of gains. Ross continues to be a solid outfit. For now, I’m keeping our Buy Below at $90 per share.

That’s all for now. There will be no newsletter next week. I’m taking a little break. Remember that the stock market will be closed on Monday, September 3 in honor of Labor Day. There’s not a lot scheduled for next week ahead of the holiday. On Wednesday, we’ll see the first revision to the Q2 GDP report. The initial report was 4.1%, which is quite good. 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 24th, 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.