The Inflation Divide
Posted by Eddy Elfenbein on July 10th, 2018 at 1:03 pm

Economist Mark Perry has created a fascinating chart. It shows the increase in prices in several sectors of the economy. In the areas that are subject to foreign competition, prices have collapsed. But in areas protected from foreign competition, prices have soared.

Globalism has created winners and losers. The problem is that it’s hard to see the victories. People come to see goods are correctly priced, not as far below what they would have been in another scenario.

Just as globalization has been a headwind holding back inflation, its unraveling could end up being a tailwind in the years ahead, pushing costs higher as countries and companies retreat from the international marketplace. That would be on top of the one-time effect that Trump’s tariffs will have on prices of selected imports, putting pressure on the Fed to raise interest rates at a faster pace than the gradual path it has currently mapped out.

The president has already imposed import duties on a wide range of products, from steel and aluminum to washing machines and farm equipment. He’s taken particular aim at shipments from China, levying $34 billion in tariffs on goods from that country last week. China, Canada and some of the other nations affected have responded in kind.

Administration officials argue that Trump’s tariffs are designed to convince other countries to dismantle trade barriers, not erect new ones. Yet experts are skeptical, pointing to the president’s focus on getting rid of America’s bilateral deficits and his repeated attacks on the North American Free Trade Agreement, which eliminated many tariffs among the U.S., Canada and Mexico.

One Upgrade and One Downgrade
Posted by Eddy Elfenbein on July 10th, 2018 at 11:50 am

I usually don’t pay much attention to analyst moves on our Buy List stocks, but today we had two that are noteworthy.

Check Point Software (CHKP) was upgraded by BTIG analyst Joel Fishbein who upgraded the stock to buy from neutral. He wrote, “After three quarters of stagnant stock performance and four quarters of disappointing guidance from Check Point, we believe it is now time to get constructive on the name again.”

The other move was that Evercore ISI downgraded Cerner (CERN) from inline to underperform. They lowered their price target from $75 to $55.

Morning News: July 10, 2018
Posted by Eddy Elfenbein on July 10th, 2018 at 7:09 am

Japan’s Takeda Gains U.S. Approval for $62 Billion Shire Buy

Son Has a Plan for Yahoo Japan. It Begins With D.

BMW Finalizes Accord to Start Producing Electric Minis in China

Tesla Drops Reservation System, Opens Model 3 Orders to Anyone With $3,500. (No Refunds.)

Tesla Hikes Prices in China as Trade War Hits Carmakers

Nissan Falsifies Exhaust Emission Data in New Issue for Saikawa

Xiaomi Gains $6 Billion in a Rebound From Weak Hong Kong Debut

AT&T’s Big Plan for HBO Is to Fill It With More Random Trash Like Netflix

IHOP Has Officially Changed its Name Back from IHOb and is Slashing the Price of Pancakes

Trump Slams Pfizer, Other Drug Companies, for Raising Prices, Vows Government Response

Starbucks: Goodbye, Plastic Straws

States Want Fast Food Chains to Allow Employee Poaching

Lawrence Hamtil: A Cautionary Tale for Index-only Investors

Cullen Roche: Who Are the Greatest Investors of All-Time?

Joshua Brown: The Nine Essential Conditions to Commit Massive Fraud

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Smucker Ditches the Doughboy
Posted by Eddy Elfenbein on July 9th, 2018 at 4:30 pm

JM Smucker (SJM) announced today that it’s selling its Pillsbury baking division. This was hardly a surprise. We knew this move was coming for some time.

J.M. Smucker is selling its U.S. baking business to a private-equity firm for $375 million, including debt, mirroring moves by other food companies to divest decades-old brands whose sales are in decline because of changing consumer tastes.

Smucker said Monday that Greenwich, Conn.-based Brynwood Partners would buy Funfetti and Pillsbury baking mixes and Hungry Jack pancakes, among other brands. Smucker put the baking business, which generated 5% of its revenues, up for sale in April.

While the fluffy, white Pillsbury’s Doughboy wearing a chef’s hat charmed Americans into buying the brand for decades after his 1965 debut, his effectiveness has waned.

Mark Smucker, chief executive of the Orrville, Ohio company, said in February that he hadn’t invested much in Pillsbury over the prior year because it would have hurt profit. “We consciously chose not to go deep,” he said on an earnings call.

This was the right move for Smucker, and they’ll get some cash from the deal.

Small-Caps Near All-Time High
Posted by Eddy Elfenbein on July 9th, 2018 at 10:15 am

After lagging for the first part of this year, small-cap stocks have been popular lately. Here’s a chart showing the S&P 500 (blue) along with the Russell 2000 (red). The Russell is close to hitting a new all-time high today.

Even though the Russell is near a new high while the S&P 500 is not, the Russell has still lagged the S&P 500 over the past few years. The Russell/S&P Ratio peaked on March 4, 2014. That ended 15 years of outperformance.

Stock Buybacks Soar While Stocks Haven’t
Posted by Eddy Elfenbein on July 9th, 2018 at 9:31 am

Share buybacks seem to be one of those topics, along with the Fed, that many investors are determined to not understand. There’s nothing underhanded about them. The issue I have with them is that they can be swallowed up in normal volatility. While buybacks continue to rise, share prices haven’t kept up.

U.S. companies are buying back record amounts of stock this year, but their shares aren’t getting the boost they bargained for.

S&P 500 companies are on track to repurchase as much as $800 billion in stock this year, a record that would eclipse 2007’s buyback bonanza. Among the biggest buyers are companies like Oracle Corp. , Bank of America Corp. and JPMorgan Chase & Co.

But 57% of the more than 350 companies in the S&P 500 that bought back shares so far this year are trailing the index’s 3.2% increase. That is the highest percentage of companies to fall short of the benchmark’s gain since the onset of the financial crisis in 2008, according to a Wall Street Journal analysis of share buyback and performance data from FactSet.

Most companies are not very good market-timers. As a result, a lot of firms are paying too much for their own shares.

The S&P 500 Buyback index, which tracks the share performance of the 100 biggest stock repurchasers, has gained just 1.3% this year, well underperforming the S&P 500.

Morning News: July 9, 2018
Posted by Eddy Elfenbein on July 9th, 2018 at 7:08 am

Legal Marijuana Is Coming to Canada. Investors Catch the Buzz.

Trump’s And China’s Tariffs Could Do Permanent Damage To Soybean Farmers

U.S. Exporters Will Be a Surprise Loser From Tariff Fight

Ford: Potential Impact From Lower Global Auto Tariffs

Leandra English Clocks Out

Xiaomi, a Chinese Technology Darling, Slumps After I.P.O.

Tencent’s U.S. Music IPO Reflects More Upbeat Recording Industry

China’s Cosco Gets U.S. Security Clearance to Purchase Shipping Rival

HBO Must Get Bigger and Broader, Says Its New Overseer

Dreams of Goldman Doing Big Takeover Meet Stress Test’s Reality

Inside China’s Dystopian Dreams: A.I., Shame and Lots of Cameras

Takeaway From the New Billionaires Ranking: Zuckerberg and Bezos Don’t Give Away Enough Money

Jeff Miller: Inflation on the Horizon?

Roger Nusbaum: Sharpening The Pencil On Factor Funds

Michael Batnick: These Are the Goods

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June NFP = +213K
Posted by Eddy Elfenbein on July 6th, 2018 at 12:03 pm

The June jobs report is out, and the numbers are pretty good. The U.S. economy created 213,000 net new jobs last month.

The unemployment rate ticked up from 3.8% to 4.0%. Actually, I dug into the decimals and the increase was closer to 0.3%. That’s the largest monthly increase in the unemployment rate since November 2010.

Part of the effect is more workers joining the labor pool. That can create the oxymoron of more jobs leading to a higher unemployment rate. After nine years of economic expansion, the jobs-to-population ratio is still lower than at any point from 1987 to 2008.

Here’s the growth of NFP along with a trend line that increases by 201,000 each month. They seem quite similar.

Morningstar on Check Point
Posted by Eddy Elfenbein on July 6th, 2018 at 9:58 am

From Morningstar:

Check Out Check Point

Check Point Software Technologies (CHKP), an Israel-based network security incumbent, has adapted its product portfolio in recent years to strategically position itself as enterprises migrate toward hybrid cloud environments. Its expertise in software-defined security environments, relative to peers’ reliance on physical infrastructure, should result in margin expansion.

As mobile and cloud become more important for customers, the potential vectors of attack become increasingly serpentine, which we think could expand Check Point’s market opportunity. Check Point excels because of its large-enterprise-focused model and a broad product portfolio, yielding high renewal rates and a growing recurring revenue base. Further, we think the company’s ability to churn out new offerings allows it to meet the rapidly evolving technological needs of its client base. Check Point continues to earn exemplary marks in its threat detection rates from independent reviews. We estimate that nearly 70% of the company’s revenue is recurring, and we see switching costs from its mission-critical security offerings for sprawling enterprise clients whose demands necessitate a vendor with ubiquitous solutions like Check Point. The company’s focus on software blade subscriptions (suites of integrable software products that can be selected or deselected based on the client’s preference) sold into the enterprise allows Check Point to extract respectable pricing from clients and post outstanding gross and operating margins.

Check Point’s Infinity product represents the next iteration of its management console. We think clients are in a consolidation phase as they limit security subscriptions to a single vendor, which should benefit Check Point based on its reputation and expansive product portfolio.

Check Point is a market leader, but secular trends such as the growth in cloud computing, the Internet of Things, and artificial intelligence remain on the periphery. We see these themes as potential avenues for disruption, but because each spawns added threats to Check Point’s client base, they create additional vectors for Check Point to secure.

Robust Switching Costs Result in Narrow Moat
We believe that the mountainous undertaking of deploying a large enterprise network firewall, coupled with the macro trend of cybersecurity product consolidation, benefits Check Point’s relatively diverse ecosystem of available offerings and creates a robust degree of switching costs, resulting in a narrow economic moat. Typically, the rapidly evolving nature of the cybersecurity industry has made it difficult to construct a moat, particularly as malicious actors have shown a propensity to outpace the ability of security providers to detect, protect against, and respond to new malevolent threats. However, we believe Check Point is in a league of its own because of its operational reputation, the fairly high attach rate of its core firewall business, and its comprehensive suite of integrable software subscriptions. These factors yield unparalleled margins and returns on invested capital among the security vendors we cover. Check Point’s many services, which include supplying firewall, endpoint, and mobile protection, among many others, become embedded in the IT infrastructure of large organizations. We believe any potential benefit of switching to a competitor would pale in comparison with the costs of implementation and training required when deploying a new solution, not to mention the risks of a potential breach allowed by technology from a less reputable vendor.

Check Point originally established itself as a pre-eminent supplier of network firewall technology. A company’s IT security teams would install a firewall to limit the access into internal IT environments. Check Point was well positioned to build share in large enterprises thanks to its long record of reliability, innovation, and an international presence. We believe firewalls benefit from a multiyear refresh life cycle. Recently, the industry has undergone a metamorphosis as network security has become increasingly complex, with organizations moving away from the data center. Software as a service, endpoint protection, mobile, and the hybrid cloud have all made the IT environments increasingly byzantine. As Check Point has built subscription-based software offerings to meet the protection needs of its customers across each of these potential penetration vectors, switching costs have become entrenched.

Check Point offers a plethora of solutions, including small and midsize and enterprise firewalls, endpoint protection, mobile security, malware protection, advanced threat protection for public, private, and mobile cloud environments. We see this as a more complete solution set than certain rivals have. We conclude that with each subsequent product or subscription a customer purchases from Check Point, the stickier the relationship becomes. Many current clients began using Check Point’s firewall product and added a software blade product as their businesses grew. Given the Internet of Things, whereupon a customer’s light, lock, or thermostat may eventually need protection at the enterprise level, we believe complexity will only increase.

We believe there is evidence of product consolidation, with clients now wanting all their applications managed in one place, by a single vendor. In the past, the cybersecurity market was characterized by companies that specialized in one niche. Today, however, for many businesses it no longer makes sense to have separate cybersecurity vendors for each area. Thus, as enterprises and small and midsize businesses consolidate under one platform, we believe Check Point will benefit as it arguably has the most comprehensive suite of subscription-based offerings. Threats to its customers can be managed under one console. Check Point anticipated this trend, as it expanded its software blade offerings to cater to a multitude of clients, allowing customers to mix and match subscriptions to fit their needs as their respective businesses scale. We believe the recently launched Infinity product cements this trend; as clients use several of Check Point’s offerings in this single console, switching costs increase.

Large and New Competitors a Concern
One concern for Check Point remains the secular shift away from the data center to public cloud infrastructure vendors such as Amazon (AMZN) and Microsoft (MSFT). While AWS and Azure provide basic security features, we believe they lack the cohesive offerings and functionality that incumbent firewall vendors like Check Point can provide, in addition to what security-conscious enterprises have historically shown they have needed. Amazon, Microsoft, and Google (GOOG) could conceivably build out their respective software offerings, which could be supported by their scale and marketing power as enterprises migrate to the cloud.

Newer voracious competitors such as Palo Alto Networks (PANW) and Fortinet (FTNT) have adopted an aggressive go-to-market strategy, with Palo Alto spending 50% of its revenue on sales and marketing (compared with Check Point’s 23% in 2017). These competitors have attempted to disrupt incumbents such as Check Point, Cisco (CSCO), and Juniper Networks (JNPR). The firewall space was disrupted by Palo Alto’s launch of its next-generation firewall, demonstrating that a competitor can take share with an innovative offering. We can’t rule out the threat of other innovative startups over time. Check Point may need to respond to this intense competition with renewed investment in sales and marketing, potentially weighing on margins. Finally, we think Check Point has been marred by execution issues with regard to relaying the breadth and depth of its product portfolio to clients and shedding its reputation as an “old world” firewall vendor.

Check Point is in exemplary financial health. It now has $4 billion in cash and marketable securities on its balance sheet. We expect the company to perennially buy back its own stock. Check Point has historically been opportunistic in its acquisitions, only buying businesses that it believed to be well below fair value or in instances where management believed it could not build the product internally. Given the cash balance and decelerating growth, we would be amenable to bolt-on acquisitions to move the company into high-growth areas.

CWS Market Review – July 6, 2018
Posted by Eddy Elfenbein on July 6th, 2018 at 7:08 am

“Economics is extremely useful as a form of employment for economists.”
– John Kenneth Galbraith

I’ll be honest: this is a slow time for the stock market. Most of the big-time money guys are chilling in the Hamptons. Trading volume has been dead. Plus, this week the stock market closed early on Tuesday and was shut all day on Wednesday.

Yep, it’s summertime on Wall Street. Soon, however, things will get a lot more interesting. Second-quarter earnings season is set to begin in a few days. Most of our Buy List earnings reports will start coming out later this month. Of the 25 stocks on our Buy List, 21 will report earnings over the next few weeks.

In this week’s issue of CWS Market Review, I want to review some of the recent economic news. The good news is that the economy is behaving pretty well. What concerns me, however, is that the Trade War is quickly moving from rhetoric to reality. This could be trouble for the economy. I’m not the only one concerned. So is the Federal Reserve. Later on, I’ll update you on some of our Buy List stocks. I’m pleased to report that our Buy List has been beating the market quite soundly over the past few weeks. Before I get to that, though, let’s focus on where the economy is headed.

The Economy Is Improving, but a Trade War Could Spoil It

The jobs report for June will come out later today. I’ll have a chance to address it later, but we do know that the report for May was very good. Unemployment fell to its lowest level since the 1960s. The jobless rate for women hasn’t been this low in 65 years. The consensus on Wall Street is for the economy to have created 190,000 net new jobs in June.

Earlier this week, we got a preview of the jobs report with the ADP private payrolls report. According to ADP, the economy added 177,00 new jobs last month. In the last reading, initial unemployment claims fell to 231,000. That’s quite strong. We’re not far from the best report since 1969.

While the labor market looks better, the overall economy is growing, but not very fast. This could change soon. We won’t get the first estimate of Q2 GDP until the end of this month, but expectations are high. Q1 GDP came in at 2.0% (that’s annualized and adjusted for inflation). The economy has pretty much stuck to 2% for the last few years. Policy makers couldn’t have done a better job if they had tried, but the Atlanta Fed now estimates that the economy grew by 4.1% in the second quarter. That would be amazing if it turned out to be right. The New York Fed’s model is less optimistic, predicting 2.8% growth for Q2.

What about earnings? There the outlook is quite good. Wall Street expects Q2 earnings of $38.65 per share for the S&P 500. (That’s the index-adjusted number. Every point in the S&P 500 represents about $8.5 billion.) If that forecast is correct, it would be an all-time record. It would also be a healthy 27% jump over last year’s Q2. Bear in mind that these forecasts are usually a bit low.

What’s notable is that the Q2 earnings forecasts have been increasing. Typically, the forecasts start out high and are pared back until they’re slightly under the actual results. (That’s right. On Wall Street, it’s expected that you’ll beat expectations.) This time, expectations are much higher thanks to tax reform. At the start of the year, the Street had been expecting Q2 earnings of $35.95 per share. The current estimate is already 7.5% above that.

It’s not just earnings. We’ve also seen good news on the dividend front. During Q2, dividends for the S&P 500 rose by 8.1% over last year. This year, the S&P 500 will probably pay out $53 per share in dividends. That works out to a yield of just under 2%. On a side note, the S&P 500 has tracked a 2% dividend yield fairly closely for 15 years. The only exception was during the financial crisis. After that blew over, we went right back to 2%. A lot of people are paid a lot of money to value the stock market. Yet simple arithmetic probably would have done a better job.

We’re also concerned by the direction of Fed policy. The central bank has already raised interest rates twice this year. Two more hikes are probably coming. The Fed seems very likely to raise rates again in late September and possibly once more just before Christmas. Soon, this will put a squeeze on the economy.

On Thursday, the Fed released the minutes from its last meeting. This is the one where they decided to lift rates. The FOMC members were impressed by the strength of the economy. However, they said they were concerned over issues related to trade. “Most participants noted that uncertainty and risks associated with trade policy had intensified and were concerned that such uncertainty and risks eventually could have negative effects on business sentiment and investment spending.”

I share this concern. We’ve already seen that Harley-Davidson is looking to shift some production outside of the United States. Starting on July 6, the U.S. government will impose a 25% tariff on Chinese goods shipped to the U.S. Not surprisingly, China has said they’ll hit back. I don’t think anyone really “wins” a trade war. The Chinese stock market has been getting crushed recently. Honestly, these opening shots in the trade war probably won’t hurt the U.S. economy very much. The problem is how far this escalates. Let’s remember that China holds a cool $1.2 trillion in U.S. Treasuries, so it’s wise not to anger them too much.

Speaking of the Treasury bond market, the spread between the two- and ten-year Treasuries is now down to 29 basis points. One more hike could push it negative. The 2/10 spread hasn’t been negative in more than 11 years. This isn’t something to worry about now, but it could become a major theme in 2019. I talk about the 2/10 spread a lot, but I want to caution you not to think of it as a panic button. Since 1976, whenever the 2/10 spread has been between 0% and 0.50%, the stock market has gained an average of 13% the following year.

The proper outlook for us as investors isn’t one of fear but of prudence. This is related to a theme I’ve talked about recently, the market’s more defensive nature. Since June 6, the S&P 500 Low Vol Index is up 1.91% while the S&P 500 High Beta Index is down 4.42%. But before then, the market was all about High Beta. If we measure starting in early 2016, High Beta had a lead of more than 50%. That’s why the defensive market can last for a while.

It’s precisely this turn towards defensiveness that connects the themes of a tightening Fed and a looming trade war. Fortunately for us, the defensiveness has been a net position for our Buy List.

Buy List Updates

I want to be careful not to overstate this, but our Buy List has been acting much better than the overall market recently. As we know, the market can be very fickle, especially in the short term. This is why we’re so focused on the long term. Still, I want to highlight some of our improved performance.

Since June 1, our Buy List is up by 3.23% (not including dividends) while the S&P 500 is up a scant 0.07%. The Buy List is now up 2.82% for the year. This is the highest level for the Buy List since mid-March. Let’s look at some individual names.

Shares of Church & Dwight (CHD) touched a new 52-week high on Thursday. The stock has rallied impressively in the last month. I think of CHD as a classic defensive stock because a recession won’t have much of an impact on their household products.

Three months ago, CHD reported Q1 earnings of 63 cents per share. That was two cents better than estimates. The company also reaffirmed full-year guidance of $2.24 to $2.28 per share. CHD increased its expected sales growth to 9%. For Q2, they expect earnings of 46 cents per share. This week, I’m lifting my Buy Below on Church & Dwight to $57 per share.

Becton, Dickinson (BDX) is quietly turning into a nice winner for us this year. Through Thursday, shares of BDX are up 13.1%. With the last earnings report, Becton raised its full-year guidance by five cents per share at both ends. The company sees 2018 coming in between $10.90 and $11.05 per share. I’m raising our Buy Below to $250 per share.

Cerner (CERN) was our big disappointment last earnings season, as the company lowered guidance. At one point, CERN got down to $52 per share. Lately, however, the stock has acted much better. On Thursday, the shares closed at a three-month high. I hope to see improvement in the next earnings report. This week, I’m raising our Buy Below on CERN to $65 per share.

Sherwin-Williams (SHW) is another stock that’s turned a corner for us. The company started off the year on the wrong foot. Two months ago, SHW got down to $362 per share. The company now expects full-year EPS of $18.35 to $18.95. On Thursday, it broke $410. I’m lifting our Buy Below on SHW to $414 per share.

That’s all for now. We’ll start getting some early earnings reports next week. There’s not much in the way of economic reports although I’ll be on the lookout for Tuesday’s Small Business Optimism report. Also, the CPI report will come out on Thursday. So far, inflation has been fairly well contained. Typically, when unemployment gets this low, pricing pressures increase. We haven’t seen much of that yet. Let’s hope it continues. 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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3 High Yield Stocks for Bottom Fishers

Dividend investors face an extra challenge of timing stock purchases. No dividends will be earned until shares are bought. There are several techniques on when to buy that I use and recommend to investors who follow my Dividend Hunter system. For more aggressive income stock investors, jumping into out-of-favor high yield stocks can produce excellent returns.

In my previous article, I discussed three stocks that have done well so far in 2018 (all up over 20% YTD) and which I expect to continue to post gains for the rest of the year. Buying stocks in an uptrend is the safer strategy. If the moves are driven by underlying fundamentals, you can expect the trend to continue if the fundamentals remain positive. The trade off is that rising stocks have been discovered, and usually carry lower yields. The three that I highlighted on Monday have an average current yield of 5.4%.

For investors searching for higher yields, there is the challenge in analyzing whether dividends are secure or in danger of reduction or elimination. These are often stocks that have dropped significantly in value, and most investors get scared or nervous about jumping on shares where the price has recently gone through a steep decline. Bottom fishing for high-yield stocks is a more aggressive strategy. The investor must be able to determine if the company can continue to pay dividends, and there is a need for patience. It can take months or even years for a stock to recover to pre-crash levels. The good part is that these stocks can pay double-digit yields, which is a nice wage to earn while you wait. Here are three high yield stocks that illustrate the strategy.

What Does This Huge Options Trade Mean For Oil?

When I write about large options block trades, it’s generally for one of two reasons. First, a lot of smart money is active in the options market. If a very big (i.e. capital intensive) trade occurs with options, it can often be a signal that there’s going to be action in the underlying asset.

Second, sometimes I just find an options trade very interesting and worth discussing. It could be because it’s an unusual trade or is an original way to handle risk management. Of course there are times when I write about a large trade because it’s interesting and may provide meaningful insight into the underlying asset.

A trade last week I came across meets both of those criteria. More specifically, I noticed a massive covered call trade in United States Oil (NYSE: USO).

USO is the most active oil ETF. While it has its flaws, trading USO is probably the easiest way for the average trader/investor to trade oil. Beyond trading oil futures themselves, USO is likely the most direct way to trade oil as well.

Covered calls can be intriguing to analyze because they can be successful in many different types of market conditions. However, one of the few situations which are “bad” for covered calls are when the underlying asset price blows through the short call strike. (It’s not entirely bad since you are still making money, but you could have made more money by just being long the asset.)

So, is this covered call trade suggesting there’s a limit on how far oil prices are going to rise? Let’s take a closer look at the position.