CWS Market Review – November 30, 2018

“Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy.” – Federal Reserve Top Banana Jerome Powell

See those two words “just below” in bold in the quote above? Those two little words rocked the entire market this week. Thanks to “The Two Little Words” (T2LW) on Wednesday, the S&P 500 had its best day in eight months.

How could that be? In this week’s issue, I’ll explain what it all means. I’ll also take a look at three of our recent Buy List earnings reports. Wall Street was less than pleased, but I’ll break it down for you. We also got a nice dividend hike from Hormel. The Spam people have now raised their dividend for 53 years in a row. Also, ADS is planning to sell off its marketing business.

But first, let’s look at what Jay Powell had to say and why it sparked a big rally on Wall Street.

What ”Just Below” Means

Let’s turn back the clock to October 3. That’s when Mr. Powell said in an interview, “We may go past neutral, but we’re a long way from neutral at this point, probably.” That’s Fedspeak for “I will absolutely wreck this economy if I have to in order to kill inflation.” Not surprisingly, that comment really spooked Wall Street. Traders took it to mean that the Fed was going to continue raising interest rates even though the yield curve was getting close to flat. The Fed might even raise rates a lot.

By neutral rate, they mean there’s some magic interest rate out there, and if we’re below it, the economy is being helped, but if we’re above it, the economy is being constrained. The problem is, no one knows where the neutral rate is, so we have to guess. Even though we don’t know where the neutral is, we can occasionally get a faint hint as to its whereabouts. (If you want to be among the cool kids, the neutral rate is called “R-Star”.)

People were unnerved by Powell’s remark and by October 10, the market finally cracked. The S&P 500 lost 5.3% in two days, and the pain lasted during much of the month of October. Looking inside the market, we can see that much of the damage from Red October was focused on housing stocks and construction in general. This makes sense because higher rates from the Fed means higher mortgage costs, and that means few home sales. We also saw some soggy housing reports recently. In other words, footprints of R-Star.

On our Buy List, stocks like Sherwin-Williams (SHW) got absolutely clobbered in October even though there was little stock-specific news. When the earnings report finally came, it was a bit below expectations, but nothing terrible. Interestingly, the shares have been recovering quite nicely since the earnings report. I suppose true expectations were for disaster, and that didn’t come.

What was Powell thinking in being so aggressive? Sure, the jobs market was looking better, but there haven’t been signs of inflation. In fact, commodity prices have been dropping. Oil is down, and the dollar has been strong.

In September, the Fed’s “dot plot” was forecasting three more rate hikes for next year on top of one more increase next month. As recently as three weeks ago, the futures market pegged a 23% chance of three more rate increases next year.

But the stock slide has changed perceptions. President Trump has also criticized the Fed. The president told the Washington Post, “So far, I’m not even a little bit happy with my selection of Jay. Not even a little bit. And I’m not blaming anybody, but I’m just telling you I think that the Fed is way off-base with what they’re doing.”

The president isn’t alone in his thinking, and that brings us to Powell’s comments from Wednesday. The Fed Chairman seems to have changed his tune by saying that we’re “just below” neutral. In other words, many more rate hikes are not coming. In fact, by looking at the stock chart, you can tell the exact moment at which Powell started speaking.

Let’s look at a possible game plan for the Fed. I think it’s very likely that they’ll hike next month, but after that, they may take a pause. In fact, I think it’s very reasonable that the Fed will hike rates just once in 2019.

A pause from the Fed is very good for stocks, and that’s what we saw. Let’s also remember that stocks had not been doing well. The S&P 500 “tested” its closing low from late October. In fact, last Friday, the index closed at 2,632.56, which is the lowest close since early May. On top of that, the stock market’s P/E Ratio has been falling for much of this year.

There’s one more hurdle left, and that’s the 200-day moving average. The S&P 500 is now less than 1% from its 200-DMA. If we can convincingly break above that, then I think we’ll see many more months of gains. Now let’s look at some of our recent Buy List earnings reports.

Earnings from Ross Stores, Hormel Foods and Smucker

Over the Thanksgiving break, we had three Buy List earnings reports. These are our three Buy List stocks that have quarters ending in October.

Ross Stores (ROST) has been in a major funk lately, which is odd because I still like the deep-discounter a lot. The stock recently fell for ten days in a row for a total loss of 22%. That’s basically the same as the entire stock market’s one-day crash in 1987.

Despite that, on Tuesday, November 20, Ross Stores reported fiscal Q3 earnings of 91 cents per share. Sales rose 7% to $3.5 billion. The important metric for us, same-store sales, rose by 3%. Going into this quarter, Ross told us to expect earnings between 84 and 88 cents per share and same-store sales growth of 1% to 2%. Wall Street had been expecting 90 cents per share.

Barbara Rentler, Chief Executive Officer, commented, “Both sales and earnings for the quarter were ahead of our forecast, despite being up against very strong multi-year comparisons. Though above plan, operating margin of 12.4% was down from last year as higher merchandise margin was more than offset by increases in freight costs and this year’s wage investments.”

Ms. Rentler continued, “During the third quarter and first nine months of fiscal 2018, we repurchased 2.9 million and 9.4 million shares of common stock, respectively, for an aggregate price of $278 million in the quarter and $807 million year-to-date. We remain on track to buy back a total of $1.075 billion in common stock during fiscal 2018.”

For Q4, which is the all-important holiday quarter, Ross projects same-store sales growth of 1% to 2%. For EPS, they see that ranging between $1.09 and $1.14 per share. That’s the same as the previous guidance, but it now includes a gain of seven cents per share due to the resolution of a tax matter.

For the entire year, Ross sees earnings of $4.15 to $4.20 per share. In the earnings report, Ms. Rentler sounded cautious: “As we enter this year’s holiday season, not only are we up against our toughest sales comparisons from 2017, but we are also expecting another fiercely competitive retail environment.”

This is basically what I expected. Their Q3 guidance was low, but that’s what they often do. The outlook for Q4 is the same as before. That didn’t stop the stock from getting hammered. ROST rebounded a little this week. I’m still a Ross fan, but I’m lowering our Buy Below to $92 per share.

Also on November 20, Hormel Foods (HRL) reported fiscal Q4 earnings of 51 cents per share. That was two cents above estimates. Unfortunately, their revenues were pretty weak. Organic sales fell 1%, and operating margin slipped to 12.6%. For the year, the Spam folks made $1.57 per share.

For 2019, Hormel sees revenue ranging between $9.7 and $10.2 billion and EPS between $1.77 and $1.91. That’s not bad. The shares initially got dinged after the report but have since recovered. The stock is now about where it was prior to the earnings report.

Hormel also raised its dividend from 18.75 cents to 21 cents per share. (I had predicted 20 cents per share.) That’s their 53rd consecutive dividend increase. It’s also their tenth-straight year of double-digit increases. Not bad. I’m raising my Buy Below on Hormel Foods to $49 per share.

On Wednesday, JM Smucker (SJM) reported fiscal Q2 earnings of $2.17 per share. That missed Wall Street’s consensus by 17 cents per share. Net sales rose 5% to $2 billion which was $100 million below consensus. Traders were not pleased. The stock got slammed for a 7% loss on Wednesday.

Smucker is in a bit of a jam. One problem is the pet-foods business. Overall, growth has been good for pet foods, but it still hasn’t matched expectations. The business has also been hurt by higher transportation costs. Also, Smucker’s overall business has been plagued by a weak pricing environment. The company said it expects better performance next year.

Smucker also lowered its full-year guidance. The company now expects net sales of $7.9 billion and earnings between $8.00 and $8.20 per share. The previous forecast was for $8.0 billion and earnings between $8.40 and $8.65 per share. I’m keeping our Buy Below at $114 per share.

Buy List Updates

There are two Buy List stocks with quarters ending in November, RPM International (RPM) and FactSet (FDS). RPM probably won’t report until the first week of 2019. FDS said they’ll report their fiscal Q1 results on Tuesday, December 18. That will be our final Buy List earnings report for the calendar year.

On Tuesday, Alliance Data Systems (ADS) said it’s looking at selling its Epsilon marketing business. There’s no guarantee that ADS will sell, but the company is seriously exploring that option.

Last month, Acxiom sold its marketing business for $2.3 billion, which probably planted the idea in Alliance’s mind. Last year, Epsilon made up about 30% of Alliance’s total revenue. The company said it would use the proceeds to pay down debt, buy back shares and pay out dividends.

That’s all for now. Next week is December, and we’ll get some of the key monthly economic reports. On Monday, the ISM Manufacturing Index comes out. The last one was 57.7 which is little weaker than I had expected. On Wednesday is the ISM Non-Manufacturing Index. We’ll also get the ADP payrolls report, plus Fed Chairman Powell will be speaking. Thursday is jobless claims. Then Friday is the big November jobs report. Last month, the economy created 250,000 new jobs, and the unemployment rate stayed at 3.7%. 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

P.S. On Monday, I’ll be on Bloomberg TV’s “The Close” between 3:50 pm and 4:10 pm.

Posted by on November 30th, 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.