• The Fed Backs Off from the Natural Rate
    Posted by on October 8th, 2018 at 3:54 pm

    Tim Duy recently noted in Bloomberg that the Federal Reserve is no longer guided by the natural rate of interest. Let me explain a bit. With monetary policy veering off into unchartered territory, the Fed needed some new ways of measuring what they were doing. John Williams, who had been at the San Francisco Fed and is now at the New York Fed, had advocated for watching the natural rate of interest, also known as R-star.

    The idea of the natural rate is that there’s some sort of perfect rate of interest that exists everywhere in the globe, and at this rate, everything comes into perfect balance. The thing about this rate is you never know what it is exactly. You can only tell by inference. If we’re above it, then X, Y and Z are supposed to happen. If we’re below, then A, B and C are supposed to happen.

    Is this right? I’m not sure but I think this is one of those things where it’s probably wiser to act as if it’s true. Importantly, the natural rate is expressed as a real rate, meaning after inflation.

    Williams has argued that the natural rate has fallen, and I suspect he’s right. However, he recently gave a speech saying there’s been an overemphasis on the natural rate. He doesn’t say that it’s bad, but now that things are back to something like normal, tracking a natural rate is far too blurry to use as an effective monetary tool.

    “At times r-star has actually gotten too much attention in commentary about Fed policy,” Williams said. “As we have gotten closer to the range of estimates of neutral, what appeared to be a bright point of light is really a fuzzy blur.”

    Some market participants are concerned that interest rates have increased. Let’s remember that real short rates have gone from -2% to 0%. If I had to guess, I’d say the natural rate is at 1%. The Fed is far from putting the breaks on the economy.

  • Weakness in the Semis
    Posted by on October 8th, 2018 at 12:10 pm

    The semiconductor sector has been looking weak lately. This is notable because the sector has been strong consistently for the last 10 years.

    Consider this performance. On November 20, 2008, the VanEck Vectors Semiconductor ETF (SMH) closed at $14.70 per share. On March 12 of this year, the SMH closed at $113.07. That’s an increase of 669% in 9-1/2 years.

    But lately….

  • Nordhaus and Romer Win Nobel
    Posted by on October 8th, 2018 at 10:34 am

    Congratulations to William Nordhaus and Paul Romer for winning this year’s Nobel Prize in Economics. (Yes, I know. The Econ Nobel isn’t a Nobel Nobel. But still, it’s nice recognition.)

    Nordhaus, a professor at Yale University, is best known for his work on climate economics. Romer, of NYU’s Stern School of Business, is a proponent of a theory that examines how the world can achieve sustainable growth.

    “This year’s Laureates have designed methods for addressing some of our time’s most basic and pressing questions about how we create long-term sustained and sustainable economic growth,” the Royal Swedish Academy of Sciences said in a statement.

    Nordhaus developed an influential model that examines the consequences of climate policy interventions, including carbon taxes, on the global economy.

    His work on climate was recognized the same day that a key UN panel warned that governments around the world must take “rapid, far-reaching and unprecedented changes” to avoid disastrous levels of global warming.

    A former chief economist at the World Bank, Romer has shown that economic forces govern the willingness of companies to innovate. The concept is the foundation of what is now called “endogenous growth theory,” which states that new ideas and technology help drive economic activity.

    Romer is a particular hero of mine for his criticism of poor economic writing. He threatened to block a development report if it contained too many “and’s.” Romer determined the acceptable “and” level to be 2.6%.

    Here’s Romer’s TED Talk on charter cities.

  • Morning News: October 8, 2018
    Posted by on October 8th, 2018 at 7:08 am

    Nordhaus, Romer Win 2018 Nobel Prize in Economic Sciences

    Saudi Crown Prince’s 2021 Aramco IPO Deadline Is a Daunting Test

    China to Pump $175 Billion Into Its Economy as Slowdown and Trade War Loom

    Norway Is Plowing Cash Back Into Its Wealth Fund

    Tech Workers Want to Know: What Are We Building This For?

    Silicon Valley Investors Shunned Juul but Backed Other Nicotine Startups

    UK Seeks Additional Reassurances from Comcast on Independence of Sky News

    Toy Makers May Struggle This Holiday Season Amid the Absence of Toys ‘R’ Us and More Trade War Fears

    Walmart Partners With MGM to Boost Video-on-Demand Service Vudu

    Tesla’s Autonomous Driving Narrative Has Hit A Brick Wall

    Comcast’s Revenge: Never Sell Hulu

    UBS Goes on Trial in France Over Alleged Tax Fraud

    Ben Carlson: Checking In on Bond Market Losses

    Jeff Carter: The Fed And Valuation

    Roger Nusbaum: FIRE Wars Escalate

    Be sure to follow me on Twitter.

  • September NFP +134K, Unemployment 3.7%
    Posted by on October 5th, 2018 at 8:37 am

    The jobs report is out. The US economy created 134,000 new new jobs last month. The unemployment rate fell to 3.7%. That’s the lowest since December 1969. Revisions added another 87,000 to nonfarm payrolls. Labor force participation rate was 62.7%.

    A separate measure of unemployment that includes discouraged workers and those holding jobs part-time for economic reasons — sometimes called the “real unemployment rate” — edged higher to 7.5 percent.

    Unemployment among black Americans declined three-tenths of a point to 6 percent, slightly above its record low of 5.9 percent achieved in May.

    The closely watched average hourly earnings component showed a 2.8 percent year-over-year increase, in line with Wall Street estimates. The average work week was unchanged at 34.5 hours.

    After the report, the 10-year Treasury yield climbed to the highest in seven years.

  • CWS Market Review – October 5, 2018
    Posted by on October 5th, 2018 at 7:08 am

    “The economy looks very good.” – Fed Chairman Jerome Powell

    The fourth quarter is underway, and for the first time in several weeks, the stock market looks a bit nervous. Of course, that’s in a relative sense. The stock market’s been so calm lately that even a mild breeze gets your attention.

    On Thursday, the S&P 500 fell by 0.82% which made it the worst day for stocks in 99 calendar days. Actually, the S&P 500 got off light. The Nasdaq fell more than twice as much (see below). But honestly, a 0.82% drop ain’t that bad. Thursday ranks as only the 20th worst day this year, and most of the 19 others came near the start of the year. Volatility has chilled out so much that we’ve almost forgotten what it feels like.

    It’s way too early to say if this is the start of something big, but we know that the bears attacked and got away with it. (So far.) Make no mistake—they’ll be back. Remember the adage that “the market goes up via the staircase but goes down out the window.” That certainly was the case in February when the S&P 500 lost 8.5% in a week.

    If you’ve been with us for a while, you won’t be surprised to hear that I’m not terribly worried. Even if we’re headed for a rocky few days, our stocks are in good shape. Plus, we have Q3 earnings coming up soon. In this week’s CWS Market Review, I want to discuss the current market climate in greater detail. I’ll also talk about this week’s earnings miss from RPM International. Despite the miss, the company just raised its dividend for the 45th year in a row. But first, let’s look at the ruckus in the bond market and what it means for investors.

    The Bond Market Sneezes—Now What?

    Even though the Federal Reserve raised interest rates last week, the effect has finally been felt this week. But the impact hasn’t been apparent in the stock market as much as it has in the bond market. Traditionally, the bond market leads the stock market by around six to nine months, give or take.

    On Wednesday, the 10-year yield rose by 10 basis points to 3.15%. Then on Thursday, it rose another four points to 3.19%. The 10-year now has its highest yield in more than seven years. When the yield moves up like that, we also want to look at what’s happening with the inflation-protected bonds. Sure enough, they’ve been moving up too. On Thursday, the 10-year TIPs yield closed above 1%. That’s up from 0.25% thirteen months ago.

    In other words, this isn’t an inflation story. It’s a demand-for-money story. Lenders are demanding more money, in real terms, from borrowers, and they’re getting it. Investors need to understand that this has a big impact on the economy. For example, one effect of higher bond yields is on the mortgage market, and, by extension, the housing market. The Homebuilder ETF (XHB) has now fallen for 12 straight days. I’m not saying housing is headed for a bust, but investors are clearly more cautious. There are cracks showing up in housing, but the overall market seems mostly healthy.

    The market can turn very quickly. At recently as Wednesday, the S&P 500 traded above its all-time high close during the day, but it couldn’t hold on by the closing bell. Now the S&P 500 is less than 1% away from its 50-day moving average. The index hasn’t closed below its 50-DMA in more three months.

    The market has also experienced poor market breadth. That’s a fancy way of saying that even though the overall stock market raced higher, fewer and fewer stocks were doing the heavy lifting. Michael Batnick noted that even though the S&P 500 was on the doorstep of a new high, just 27 stocks in the index were within 1% of their high. Meanwhile, 38 stocks were more than 30% off their high. Quietly, a large group of stocks has sat out this last rally.

    This same effect has been reflected in the poor relative performance of small-cap stocks. During the first half of the year, small-caps did quite well in comparison to the rest of the market. But at the beginning of the summer, the little guys started to lag, and the gap really started to widen in the last few weeks. September was the worst relative performance month for small-caps in four years. This could be the result of the Trade War rhetoric from Washington. Larger companies tend to be skewed toward large multinationals, while small-caps are skewed towards domestic manufacturing.

    This has also been an unusual rough patch for our Buy List. Since September 13, our Buy List is down 3.6%, while the S&P 500 is down only 0.1%. That kind of deviation from the market is typical for many mutual funds and hedge funds, but it’s rare for us. What’s also notable is that it’s come at a time when there hasn’t been a lot of news, good or bad, impacting our stocks. I’d be concerned if we were hearing lower guidance or seeing big earnings misses. That’s not the case. Instead, it appears that the market is shifting away from high-quality stocks.

    What to Do Now?

    I think there’s a decent chance that we’ll see a slide in stock prices before the end of the year. It really depends on what happens with the bond market. Also, I think if the S&P 500 breaks below its 50-DMA, that would give confidence to the bears. I’d also be on the lookout for a deep dive from a well-known glamour stock.

    But I’m not urging investors to head for the exits. Instead, this is a good time for investors to remain calm and cautious. Investors should make sure they have plenty of dividend stocks.

    One of our Buy List stocks that looks particularly good right now is Torchmark (TMK), the insurance company. TMK is about as conservative as they come. The shares are going for 13.5 times next year’s earnings. That’s a 17% discount below the rest of the market.

    RPM International’s Earnings Miss

    On Wednesday, RPM International (RPM) reported earnings for the first quarter of its fiscal year. For Q1, the company earned 76 cents per share which was well below Wall Street’s estimate of 88 cents per share. Net sales rose 8.5% to $1.46 billion.

    Wall Street was not pleased. On Wednesday, the stock dropped 5.4%. Frankly, this was not a very good quarter for RPM. What went wrong? This is what the company had to say:

    “We saw strong top-line sales growth in the first quarter, with organic sales growth up 7.8%, while profitability continued to be adversely affected by rising raw material costs. In addition, bottom-line results reflected the impact of restructuring charges, higher legal and advertising costs in our consumer segment, and the adverse effect of transactional foreign exchange,” stated Frank C. Sullivan, RPM chairman and chief executive officer.

    “Our team is focused on driving increased profitability, long-term growth and enhanced value for our shareholders, and we are making good progress in executing on our operating improvement plan, which is specifically designed to increase margins, reduce working capital, and improve overall operating efficiency. During the quarter, we continued our strategic restructuring initiatives, including the reduction of more than 150 positions and the announced closure of four manufacturing facilities, all in line with our 2020 Margin Acceleration Plan,” stated Sullivan.

    Now for the good news. On Thursday, RPM raised its quarterly dividend by 9.4% to 35 cents per share. Going by Thursday’s close, RPM now yields 2.34%. The new dividend will be payable on October 31 to shareholders of record as of October 16. This is the 45th consecutive annual dividend increase. That’s quite a track record. This week, I’m dropping our Buy Below on RPM International down to $64 per share.

    Buy List Updates

    This week, Intercontinental Exchange (ICE) said they’re buying all of MERS, the Mortgage Electronic Registrations Systems. ICE already owned an undisclosed amount of MERS. This could be a big deal. The mortgage industry has been woefully behind in going from paper to digital. The financial crisis probably put off any real reform for a few years. Perhaps that time has passed. ICE’s business model has been to buy out older incumbents and give them a shot of advanced technology.

    This doesn’t really affect us, but General Electric chose Larry Culp, the former CEO of Danaher (DHR), to be their new CEO. Culp is a great choice, and GE’s stock shot up on the news. My only fear is that GE is in bad enough shape that Culp can’t do much. By the way, the change at the top at GE won’t have any impact on the deal with Wabtec (WAB). Danaher reports earnings on October 18.

    Stryker (SYK) said this week that it’s buying HyperBranch for $220 million. “HyperBranch is dedicated to developing medical devices based on its proprietary polymers and cross-linked hydrogels. Its Adherus AutoSpray Dural Sealant product is one of only two FDA-approved dural sealants on the market.”

    Additionally, last Friday it was announced that Stryker will pay $7.8 million to “settle charges it violated the Foreign Corrupt Practices Act, without admitting or denying the allegations.”

    That’s all for now. The first batch of third-quarter earnings reports will start coming next week, though not yet for any of our Buy List stocks. Monday is Columbus Day. While many government offices and businesses will be closed, the stock market will be open. There’s not much in the way of economic reports next week, but I want to see what Thursday’s CPI report has to say. So far, inflation has been well contained, and I hope that trend continues. (So does the Fed.) 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

    Syndication Partners

    I’ve teamed up with Investors Alley to feature some of their content. I think they have really good stuff. Check it out!

    Buy These 3 High-Yield Stocks Raising Dividends in October

    I always look forward to the start of a new calendar quarter. Within a few weeks stocks with policies of quarterly dividend increases will start to declare the next dividend rates. It is an interesting market effect that the investing public doesn’t take into account that some companies grow dividends every quarter. The market acts surprised every time it happens. Investors can get ahead of the share price gains by getting in before the dividend announcements.

    The best places to find stocks with quarterly dividend increases and current great yields are energy infrastructure stocks and the renewable energy providers. These companies have long term contracts often with built in rate escalators, providing steady income streams. They generate growth by developing or acquiring new assets, each with its own long term service contract. These assets range from interstate energy pipelines, to natural gas liquids processing facilities to wind or solar energy projects.

    For the best long term investment results, you want companies that have histories of dividend growth and a solid plan to continue that growth. Look for a balance of current yield and the annual dividend growth prospects. Here are three stocks that fit these criteria.

    Buy These 5 Stocks to Beat One of the Most Popular High Yield ETFs

    A lot of income investors own shares of the iShares Mortgage Real Estate Capped ETF (NYSE: REM) as a stock market investment that pays a high (over 10%) current dividend yield. The problem with REM is that it holds a lot of the highly leveraged, dangerous to your wealth, residential mortgage-backed securities, or as they are regularly referred to (MBS REITs).

    Since the middle of 2017, the REM share price has been slowly eroding. That drop indicates that for many companies in the fund’s portfolio, higher interest rates and a flat yield curve are a danger to profits and continued dividend payments. A better option for the high-income focused investor is to build a portfolio from the financially strongest stocks out of the REM holdings list.

    According to the tax rules that govern their operation, a REIT can own real estate property or participate in the financing of real estate assets. REITs that focus on owning real estate are referred to as equity REITs, while those that focus on the mortgage side of real estate are called finance REITs. The finance REIT side of the REIT universe typically carries much higher dividend yields, which are very attractive to income-focused investors.

    A significant number of finance REITs employ a business model that involves owning government agency guaranteed MBS and leveraging their MBS portfolios to turn the 3% bond yields paid by these safe MBS into the cash flow to pay a double-digit dividend yield. Changing interest rates at either the short or long end of the yield curve will eat into one of these company’s cash flow generation ability. If you look at their histories, most are now paying dividends that are much lower than just a few years ago.

    To build a mini-REM portfolio that gives a higher yield and does not destroy principal value, the strategy is to buy those finance REITs that have not been slashing dividend rates because their business models failed to adjust for changing interest rates.

    Here are five stocks out of the REM holdings that have not reduced dividends in the last five years.

  • Morning News: October 5, 2018
    Posted by on October 5th, 2018 at 7:05 am

    Nafta’s China Clause Is Latest Blow to Trudeau’s Asia Ambitions

    China Spy Chips Report Adds Pressure on Pentagon Cloud Security

    Macron, With Popularity Slumping, Tries Tax Cuts for France’s Working Class

    Era of Bank Secrecy Ends as Swiss Start Sharing Account Data

    Will U.S. Economic Growth Dip, or Will the Rest of the World Catch Up?

    Lindsey Graham Welcomed Trump’s China Tariffs, Then Helped Companies Avoid Them

    The Big Problem at the Heart of Tech’s Latest Spy Scandal

    SoftBank Deepening Ties to Ride-Hailing Firm Grab With $500 Million Funding

    Unilever Backs Down on Dutch HQ Move After British Investor Revolt

    Yale Invests in Crypto Fund That Raised $400 Million

    Elon Musk Calls the SEC the `Shortseller Enrichment Commission’ on Twitter

    Amazon CEO Jeff Bezos Just Overtook Bill Gates on Forbes’ List of the Richest Americans

    Blue Harbinger: Is Breaking News Useless Noise Or Trading Fuel?

    Cullen Roche: Debunking Passive Investing Myths on Bloomberg TV

    Howard Lindzon: The Elastic IPO

    Be sure to follow me on Twitter.

  • The NYSE’s Proposal to Alter Exchange Fees
    Posted by on October 4th, 2018 at 10:15 am

    Bloomberg has an interesting story on Intercontinental Exchange‘s (ICE) proposal to alter how stock exchanges make money. ICE (owner of the NYSE) wants to freeze rates they can charge for market data.

    The SEC wants an incentive system. The drawback under that plan is that trades would be routed to the exchange that paid the most, not that best served the client.

    ICE’s plan is to “reduce the maximum amount exchanges can charge for trades to 10 cents per 100 shares, from 30 cents.” They claim that would dramatically reduce the amount of rebates. More importantly, ICE wants exchanges to agree not to raise fees for “existing market data products, connectivity services and co-location.” This is a sensitive topic, and many investors already think the data fees are too high.

    “We recognize that a large part of the industry’s support for the Transaction Fee Pilot is driven by a desire to reduce their cost to trade,” according to the NYSE letter. “We propose addressing this concern by taking fixed cost growth off the table during the Alternative Pilot and reducing the existing Access Fee Cap.”

    Some in the industry would like to see market-data rates comes down, so simply freezing them, and thereby keeping the status quo, might not alleviate their concerns.

  • Morning News: October 4, 2018
    Posted by on October 4th, 2018 at 7:06 am

    The Big Hack: How China Used a Tiny Chip to Infiltrate U.S. Companies

    Congress Backs F.A.A. Measure But With Few New Traveler Protections

    What Happened To Treasurys On Wednesday?

    Bond Bears Popping Champagne Say U.S. Yields Have Room to Rise

    Firing Back at Trump in the Trade War With Tariffs Aimed at His Base

    Wealth Managers Count Cost of U.S.-Chinese Trade War on Asian Business

    The Republican Attack on California

    eBay Claims Amazon Illegally Tried to Poach Top Sellers

    Cadillac Edges Tesla in Semi-Automated Driving Test

    Honda Putting $2.75 Billion Into G.M.’s Self-Driving Venture

    Barnes & Noble Names Board Committee to Review Possible Sale, Shares Soar

    E-Cigarette Maker Juul Files Complaints Against ‘Copycat Products’

    Roger Nusbaum: Only One Fund? That’s Crazy!

    Michael Batnick: The End is Nigh

    Joshua Brown: Jerome Powell Making Sense

    Be sure to follow me on Twitter.

  • RPM Earns 76 Cents per Share
    Posted by on October 3rd, 2018 at 7:56 am

    Fiscal 2019 first-quarter net sales were a record $1.46 billion, up 8.5% over the $1.35 billion reported a year ago. Including the impact of restructuring charges, first-quarter net income was $69.8 million versus $116.4 million in the year-ago period, and diluted earnings per share (EPS) were $0.52 compared to $0.86 in the year-ago quarter. Income before income taxes (IBT) was $91.9 million compared to $155.3 million reported in the fiscal 2018 first quarter. RPM’s consolidated earnings before interest and taxes (EBIT) were $113.9 million compared to $177.6 million reported in the fiscal 2018 first quarter. The fiscal 2019 first quarter included asset write-offs and other restructuring-related expenses of $39.8 million. Excluding these charges, RPM’s adjusted EBIT was $153.7 million and diluted EPS was $0.76.

    “We saw strong top-line sales growth in the first quarter, with organic sales growth up 7.8%, while profitability continued to be adversely affected by rising raw material costs. In addition, bottom-line results reflected the impact of restructuring charges, higher legal and advertising costs in our consumer segment, and the adverse effect of transactional foreign exchange,” stated Frank C. Sullivan, RPM chairman and chief executive officer.

    “Our team is focused on driving increased profitability, long-term growth and enhanced value for our shareholders, and we are making good progress in executing on our operating improvement plan, which is specifically designed to increase margins, reduce working capital, and improve overall operating efficiency. During the quarter, we continued our strategic restructuring initiatives, including the reduction of more than 150 positions and the announced closure of four manufacturing facilities, all in line with our 2020 Margin Acceleration Plan,” stated Sullivan.