More Volatility As The Market Retreats:
We all knew that when the market got within spitting distance of its October 2015 levels, not to mention the 2015 all-time highs, that it would not be an easy ride. For the second time in three weeks, stocks pulled back from these “almost high” levels. Each of the major indices lost about 1.3%. Taking center stage once again was Crude Oil ending the week with a gain of 8%. However, volatility was the real story. The difference between the early Monday trading low around $35 and the close on Friday was nearly 15%.
Various members of the Federal Reserve continued to wash their laundry in public, lending no help to bonds or the dollar. In uncertain times, the world turns to gold and that glittering commodity gained $18 on the week.
Here is how the week ended:
| Key Market Measures
(Friday’s Close) |
||
| Dow Jones | 17,577 | -266 -1.2% |
| S&P 500 | 2,047 | -26 -1.2% |
| Nasdaq | 4,915 | -64 -1.3% |
| Crude Oil | $40 | +3 +8.0% |
| Gold | 1,242 | +18 +1.5% |
Warning Signs of a Confused Market
We all know the feeling of being in either a bull market or bear market. Those are clear. Most everything is either good or bad. But what about the times when suddenly a reversal takes place and stocks change direction? It is only afterward that we think we understand the causes; it is only afterward that we come up with a rationale. But what are the signals that could have alerted us beforehand?
Right now, confusion is our signal for possible upcoming changes in market direction. Certain things don’t make sense. The stock market is near an all-time high yet corporate profits have been down for four quarters in a row. The first quarter 2016 results are expected to be down again; this time about 9%. No one seems to have a clue when the trend is going to reverse.
There continue to be downward revisions in economic forecasts for 1Q GDP. Consensus is for less than 1%. All day long talking heads ignore or dismiss this and the lower profit situation as though they are irrelevant. This is confusing since both growing GDP and profits are what drive stock values.
The puzzling part is in the contradictions between Crude Oil and Energy stocks, and the weakness of the dollar and interest rates. Wow, that’s a lot of things to digest so let’s take them one at a time. Keep in mind that Oil is the key to the puzzle. It’s important to “follow the Crude.”
Friday was a big day for Crude and every part of the Energy complex from Devon Energy (DVN: $29, up $2 and 8% for the week) in the Exploration & Production sector, to Exxon (XOM, $83, unch.) in the refining and marketing end. This is an inflationary signal that should send interest rates and the US dollar higher and stock prices lower. Instead what we got was a big opening for stocks and a weaker dollar. In addition, it was the best day of the week for the major transportation averages and for one of our favored companies United Parcel Service (UPS: $194, up 0.3%).
The release of the Panama Papers also hurt market sentiment, with the fallout from that high profile scandal just beginning. In a related development President Obama addressed the issue of “tax inversions” -- the common practice of companies avoiding paying U.S. taxes by qualifying as foreign-owned -- with the Treasury Department issuing new rules to prevent those deals. As a result, Pfizer (PFE: $33, up $3 for the week) and the Irish-domiciled Allergan (AGN: $236, down $32 for the week) immediately called off their pending $160 billion merger.
Buying interest in stocks was also capped by the expectation of disappointing earnings, as a slew of companies are set to report their quarterly performance metrics next week and the prognosis is not particularly positive.
Foggy Fed Befuddles Everyone
The outlook is being fogged over by continuing and conflicting noise from the Fed. While inflation hawks at the Fed continue their public push for higher interest rates, Janet Yellen and New York Fed President Dudley remain interest rate doves. To bring her case even more public, Yellen appeared Thursday in New York with several former Fed Chairs to further restate her position. We discuss this in more detail below in the High Yield Corner.
Earnings On Tap; Expectations Low
As we mentioned last week, U.S. stocks had been on a nice win streak -- supported by accommodative interest rates, contained inflation, growing consumer confidence, a buoyant housing market and improving labor. Many pundits, however, believe that we’re in for some tough sledding this earnings season, which traditionally begins with the release of Alcoa’s (AA, $9.37, down 3% for the week) quarterly report today. While there is more bearish than bullish sentiment regarding 2Q16 earnings, we can’t imagine a scenario where the market melts down due to a few bad earnings reports. If it becomes a trend though, stocks may run in place or fall. Bad news could become good news, however, as the macroeconomic conditions supporting a case for higher interest rates are fragile at best and could become reality. Stocks generally like that.
A New Opportunity is Coming
We are not here to declare the end of the world. What we see here are certain disconnections between the data and the market’s reaction to the data. We see that Wall Street’s consensus for 1Q 2016 GDP to be flat, and that corporate profits will be down 9%, but this is not a reason to be frightened. However, it is a great opportunity to prepare for a market pullback.
Upcoming Economic News
Put on your reading glasses this week, the Washington data machine is going to be busy. You get a break today, but be ready early Wednesday (Producer Price Index, Retail Sales and Business Inventories). Thursday brings more inflation reading (Consumer Price Index and Core CPI). In between the so-called Fed Beige Book gets released around 2PM on Wednesday. This provides insight into what actually goes on in these Fed confabs.
The most important single data point this week is Wednesday’s Producer Price Index. Forecasters call for a swing from -0.2% in February to +0.3% in March. That’s a lot of swinging but it includes the effect of recent Crude price increases. We have to wait to get the Core PPI before getting too concerned.
| RELEASE TIME (EST) | REPORT TITLE | PERIOD | FORECAST | PREVIOUS | |
| MONDAY, APRIL 11 | |||||
| None Scheduled | |||||
| TUESDAY, APRIL 12 | |||||
| 6:00 am | NFIB Small Business Index | March | -- | 92.9 | |
| 8:30 am | Import Price Index | March | -- | -0.3% | |
| 2 pm | Federal Budget | March | -- | -$53 billion | |
| WEDNESDAY, APRIL 13 | |||||
| 8:30 am | Retail Sales | March | 0.1% | -0.1% | |
| 8:30 am | Retail Sales Ex-Autos | March | 0.4% | -0.1% | |
| 8:30 am | Producer Price Index | March | 0.3% | -0.2% | |
| 10:00 am | Business Inventories | Feb. | -0.1% | 0.1% | |
| 2:00 pm | Beige Book | ||||
| THURSDAY, APRIL 14 | |||||
| 8:30 am | Weekly Jobless Claims | 4/9 | 269,000 | 267,000 | |
| 8:30 am | Consumer Price Index | March | 0.2% | -0.2% | |
| 8:30 am | Core CPI | March | 0.2% | 0.3% | |
| FRIDAY, APRIL 15 | |||||
| 8:30 am | Empire State Index | April | 2.5 | 0.6 | |
| 9:15 am | Industrial Production | March | -0.1% | -0.5% | |
| 9:15 am | Capacity Utilization | March | 75.3% | 75.4% | |
| 10:00 am | Consumer Sentiment | April | 92.0 | 91.0 | |
BMR Companies and Commentary
Our Stocks for Success, Special Opportunities and High Yield Portfolios have been carefully selected to provide diversification and best-in-class in each sector. This week we take a look at several companies that could not be further apart in business and yet still have one thing in common: They are all investment winners.
First Solar (FSLR: $60, down 10% for the week) We are big believers in alternative energy and Solar is where the biggest growth is occurring. First Solar avoids the pitfalls of residential instillation. It builds utility-scale solar plants that generate operating and maintenance contracts.
First Solar’s other advantage is employing a technique that more efficiently extracts energy from sunlight. They produce solar panels faster and thus more cost effectively. This is a winning combination and what led us to adding it to our favored list in February. Since then, the stock rewarded us by appreciating 18%, reaching $73 on March 17th. We have been hoping for the stock to pull back so we can buy more. Well, last week the stock pulled back. Big time. With no bad news! With a stock price correction of this magnitude, no bad news is good news for investors. It is time to pounce on First Solar.
Goldman Sachs (GS: $150, down 6% for the week) We are in a tough environment for financial stocks. Paper-thin interest spreads, quiet loan demand, an uneven stock market have all conspired against the guardians of our capital. For Goldman Sachs, April has been challenging as 1Q16 is headed for a drop in EPS (Est.: $2.73 versus $5.94) After that, things should improve. According to Wall Street analysts, full year earnings will reach $15.20 this year and $18.00 in 2017. Yes, you heard right, the Street is forecasting a 25% gain this year and a 20% bump next year. That’s something to get excited about. Go Goldman.
Splunk (SPLK: $50, unch) has treated all of us well since joining our list of favored stocks back on March 3rd at the $44 level. The company works with the US Government and other big time corporations providing key software that allows for rapid early detection of computer network hackers and other bad guys, a unique business model. As long as there is cyber warfare, there will always be a need to produce improvements in software and the service revenues that follow. Wall Street expects a 1Q loss of $0.02 per share but a full year gain of 60% to $0.30 per share.
Tesla (TSLA: $250, +$13, 5% for the week) Zoom, Zoom, Zoom! No wait. That’s Mazda’s theme. As it turned out, it was also what Tesla shares did in the trading pits this week. The stock skyrocketed alongside the massive number of pre-orders for Tesla’s new Model 3. By the end of the first week of availability, 325,000 customers had each ponied up a $1,000 deposit for the cars. That translates into $14 billion in implied future sales -- which would be the biggest one-week sales launch of any product in history. And, that’s $325 million of cash that the company can use for corporate purposes. WOW.
The way Tesla shares are trading reminds us of Netflix, which was often besieged by negative analyst comments, who usually fretted about “valuation.” You’ve seen what has happened to Netflix; the word “skyrocket” comes to mind again. Tesla is getting the same kind of treatment, with many also casting doubt about the company’s ability to deliver Model 3s fast enough to meet the demand. Perhaps that will matter far more to shareholders if the markets unexpectedly crater, but right now enthusiasm for the stock, the company and Elon Musk is undeniably electric. For shorts it must feel more like an electric chair.
High Yield Corner
We now have eight stocks in the High Yield Portfolio. We aren’t stopping here though. We are shooting for at least 15 stocks in this portfolio and may top out at 20. Dividend rates in the portfolio vary from 3.6% to 11.7%. Stay tuned in the coming weeks and months.
Macroeconomic developments overshadowed everything else for the High Yield world this week. Specifically, rumblings from the Federal Reserve have impacted U.S. Treasury expectations and market demand for high yield instruments, especially high yield debt. The story is one of actions and words: Chair Janet Yellen was joined by the three previous Chairmen to assure the world that the U.S. economy is really doing fine. At the same time, the Chairmen echoed each other in stating that a recession was almost impossible to show up in 2016.
Meanwhile, the Atlanta Federal Reserve’s data-driven GDPNow tracker shows GDP growth falling to 0.1% in the first quarter, far from the 1.9% predicted by the experts. This dramatic slowdown was also partly the driving force behind a report by ratings agency Moody’s, who warned that corporate bond prices have rallied too much in recent weeks and are set for a significant correction – (i.e., interest rates higher.)
High yield bonds ignored both Moody’s and the fundamental story implicit within the GDPNow data, ending the week virtually flat. Other parts of the high yield world had a more negative response: BDCs largely declined during the week, causing the Wells Fargo Business Development Companies Index (BDCS: $20) to fall 3% in the last week, while large-cap property REITs - SPDR Dow Jones REIT ETF (RWR: $94) fell 1%. Analyst reports have turned more lukewarm on the space, and expectations may sour further until the next earnings season.
Earnings season starts in May for both BDCs and property REITs. Earnings are likely to be strong, particularly for BDCs. Default rates in private corporate debts for middle market companies -- the sweet spot for BDCs -- have not risen significantly. If fear intensifies about the future over the next couple of weeks, which looks likely considering what happened this past week, we may find another “buy the dip” opportunity for high yield.
Significantly, this week showed a pretty substantial divergence between high yield and the broader market. The S&P 500 ended the week down over 1%, largely due to Friday’s market when the stock market erased almost all of its early morning gains.
The action was all Fed driven. After the four Chairmen gathered to give the historically unprecedented conference, investors mulled both the fact that the event happened, with what they said. Broadly, the conversation was an attempt to calm investors’ fears and insist that the economy is doing okay. On Friday, heavy early-morning buying seemed to be predicated on the belief that the Fed heads think things are all right, and there’s nothing to fear in the American economy now.
Later in the day, however, selling pressure seemed to express an unease with the presentation. A Nomura analyst vocalized the concern succinctly: "Our view is still that the Fed does not actually do anything more than jawbone until or unless the S&P 500 index is into the 1500s and the outlook for growth, employment and inflation get significantly worse.” This means the Fed isn’t speaking so much to assure the market that all is well, but to prepare investors for further interest rate hikes that the Fed has insisted will happen.
For high yield, the market seems ready to become more cautious and risk-averse in the expectation that tighter monetary policy pressures stocks and corporate bonds.
With all this risk avoidance, it’s interesting to see MLPs like Alerian MLP ETF (AMLP: $10.90) rise nearly 3% for the week as crude saw a massive strengthening. Note also that the divergence between oil and stock prices -- discussed in last week’s Bull Market Report newsletter -- seems to be continuing. This may mean more strength in the MLP world short term, but it could also mean more room for MLPs to fall if the broader stock market decides to turn sour.
Notes at the Margin
By Philip K. Verleger, Jr.
www.PKVerlegerLLC.com
Philip K. Verleger, Jr. is one of the world’s foremost experts on energy
The Doha Meeting: Commodity Markets Need Regulators for Stability
Representatives from 18 oil-exporting countries will meet in Doha in six days. The meeting is a triumph for Venezuela’s oil minister and president of PDVSA, the national oil company. He has circled the world tirelessly trying to convene a gathering of enough oil-exporting nations interested in taking action to raise oil prices. At the Doha meeting, he and ministers from several other countries will attempt to get exporting countries to freeze output at January 2016 levels for the rest of the year.
This will be a first step, should he succeed. It may also be the last desperate step in Venezuela’s effort to avoid total economic collapse.
President Maduro has made several attempts to get Venezuelans to use less power. The work week has been cut from five to four days. Friday he asked women to stop blow drying their hair. Readers can judge the absurdity of the situation.
Meanwhile, ships wait weeks to load because equipment breakdowns at many loading facilities are no longer serviceable. Spare parts are nonexistent. Venezuela has all the characteristics of a large beached fish desperately flapping about in a failing effort to catch up to the receding tide before it dies. Like a fish that beached itself in pursuit of food, Venezuela has killed its oil industry by pursuing the socialistic goals of Hugo Chavez.
To be clear, the shutdown of Venezuela’s electricity grid will likely result in total economic collapse. The already difficult life in the capital city of Caracas, a city of more than two million, would become impossible. There would be no gasoline, no refrigeration, and even fewer goods on shelves. Worse, twenty-first century business would stop as computers go dark. One might ask if the central bank would be able to operate. Does it have backup generators? If it does, are they operable and do they have fuel?
Will the other 17 countries gathered at Doha grant a dying nation its last wish? Probably. Russia and the large Middle East nations lose nothing by agreeing to hold production constant for a few months. The brutal calculus may show that a collapse in Venezuela’s production will be offset by increased Iranian output, leaving total supply roughly unchanged, at least until June or July.
Prices will stabilize and begin to increase if large producers are patient. They might even get back to $60 per barrel by year end if everything goes really well (which would require Venezuela’s total collapse).
The price recovery, though, could be transitory. The global economy continues to struggle. Last week markets responded to an optimistic forecast of economic growth given by Federal Reserve chair Janet Yellen on Thursday. Overlooked was a report on the consensus view of economists surveyed by The Wall Street Journal. In its latest survey report, the average of the 78 forecasts for growth has dropped from 2.4 percent in 2016 to 2.1 percent. This piece received less attention than usual because it appeared only on the Web.
[Some other bullet points made by Mr. Verleger:]
--- Europe’s economy is also slowing.
--- At the same time, some oil producers will boost exports even while holding production constant. (Like Saudi Arabia.)
--- Higher prices will also allow US independent producers to resume activities, completing unfinished wells and drilling new ones.
--- A successful Doha meeting will provide temporary, not permanent, succor to oil producers. It will play the same role as aspirin, offering short-term pain relief. It cannot resolve the long-term problems associated with oil production.
Conclusion:
Venezuela and many other oil-producing countries have been built around high-cost oil and little or no political freedom. Some are now adapting or attempting to adapt. Others, especially those such as Venezuela that need very high oil prices, are not adapting. These nations need some type of political regulator to survive. They must fail, however, because market forces have prevailed over regulation.
The Doha meeting will likely result in higher prices for a while. One can be sure that such prices will encourage more investors to buy into the increasing oil price story. The views of market realists such as this writer will be ignored. Those who search for, find, and develop oil will see the price rise as an opportunity to expand output and drill more. The smart ones will sell futures, swaps, or other instruments to lock in higher prices and ensure profitability. The surplus supply will flow into new tanks. Then, in time, it will dawn on the world’s low-cost producers that they have again been had by high-cost producers like Venezuela. Prices will plummet once more.
Oil is a commodity. Prices will fluctuate.
Why is a Large Short Position Bullish? And: A Discussion a Short Squeeze
Below is an actual correspondence with one of our subscribers who asked why shorting a stock is inherently bullish. Our answer:
When someone sells a stock short the stock has to be BORROWED from another owner. Merrill Lynch and all the brokers do it automatically for you so you don’t really see the transaction, but it does happen. If Merrill has accounts with say 1 million shares of Apple, then if various people wanted to short 1 million shares, they would just adjust the books accordingly. BUT if their customers wanted to short 1.5 million shares, then Merrill would have to go to their friendly competitors and borrow the stock from them. If THEY don’t have the stock then the stock can’t be shorted.
And note that if a stock is shorted, the only thing that person can do to unwind the trade is to BUY BACK his stock – thus the bullishness of a large short position.
Now, when things turn positive for a stock and people start buying the stock it could lead to a short squeeze. “A short squeeze is a rapid increase in the price of a stock that occurs when there is a lack of supply and an excess of demand for the stock. Short squeezes result when short sellers cover their positions on a stock.”
So you have two types of buyers -- the normal investor who sees value in the stock; and the guy who is short who has to buy back his stock, taking profits, and preventing further losses as the stock goes up. What happens in a squeeze is that the Merrills of the world have to get the stock back from those they borrowed it from -- for the new buyers and short coverers because there are no shares available to buy. And note that Merrill can FORCE a short seller to buy back his position, producing a squeeze. In a squeeze, you can see a stock zoom higher, sometimes doubling and tripling in a day or two.
Trader’s Corner
This is the first in a series of “tips” about small-cap, mid-cap and sometimes even micro-cap stocks that may be set to move higher. These are not the Apples and Teslas of the world, nor are they meant to be “bought and held” - although some may turn out to be great investments. Instead, they are issues that traders have circled their wagons around, and may have immediate business or technical catalysts to propel their stock higher.
EXFO, Inc. (EXFO, $3.89) Based in Quebec, and in business since 1985, EXFO, designs, manufactures, and markets test, service assurance, and network visibility solutions for fixed and mobile network operators, Web-scale service providers, and telecommunications equipment manufacturers worldwide. Although thinly-traded, with an average daily churn rate of 40,000 shares over the past 10 sessions, buyers have been swamping sellers since the company announced its 1Q16 results at the end of March. EXFO has jumped from the low $3 range to establish a fresh 52-week top of $3.95.
The company’s Q2 bottom line weighed in with EPS of $0.07, compared to EPS of $0.02 during the corresponding 2015 period. Sales hit $5 million, compared to $51 million, a 5% jump, after touching $55 million in 1Q16. Gross margins hit 65%, the highest level in four years, and bookings improved 9% Y/Y. The company reported cash and short-term investments of $45 million at the end 2Q16, compared to $30 million in the previous quarter, mainly due to $15 million in cash flows from operating activities.
Guidance was bullish as well, with the company CEO saying, "EXFO's first half of fiscal 2016 provides clear evidence that key transformations implemented last year are delivering robust results as reflected by strong bookings growth and book-to-bill ratio, along with significant improvements to our gross margin and adjusted EBITDA. Considering our solid book-to bill ratio in the first half of 2016 and the fact that our second half is typically stronger, we are well-positioned to surpass our $20 million adjusted EBITDA target for the full fiscal year." And in another piece of good news, EXFO management renewed its share repurchase program. The company authorized the renewal of its share repurchase program of up to 900,000 shares. During the previous renewal EXFO repurchased a total of 200,000 shares at an average of $3.25.
While the stock may be due for a pullback, we like the close proximity to its recently established 52-week high and the $4 level. If the issue can penetrate the $4 level with increasing volume, it may be off to the races, as round number breaks to fresh 52-week highs tend to appeal to the momentum crowd, attracted by the company’s smallish public float of 17 million shares.
By Jon Slotnick, Bull Market Report Analyst
Full Disclosure: Slotnick owns 3000 shares, purchased at $3.92.
The Apple Corner
Apple's new 4" iPhone SE continues to see shipping delays and empty inventory bins. The phone is now available for purchase and by the end of May, should be out in 110 countries. But demand is outstripping supply, with most stores completely out of stock and new orders not shipping for a few weeks. Virtually all models with all carriers are out of stock at Apple's retail stores. Demand is also exceeding supply internationally. In China, the earliest a new delivery is said to arrive is April 16. Emerging markets like China, India and Brazil are key target markets for the budget-priced SE.
The iPhone SE brings virtually all of the power of the iPhone 6s to a 4-inch device. In performance tests, it performs identically to the iPhone 6s. The camera is the same as found on the 6s. The phone starts at $399 without a contract, which is the iPhone’s lowest price to date.
Apple (AAPL, $109, down $1) had a calm week, dropping a point to close at $109. But they put another $800 million or so in cash in the bank. Can’t wait to see the total when then announce 1Q earnings on the 25th of April. Our guess? $225 billion, up from $216 billion when they last reported earnings in January. That’s about $7-800 billion A WEEK!
Under Armour (UA: $44, up $1 for the week) split their stock on Friday 2-1. So every 100 shares you have gives you another 100. But there's a twist. The company approved the issuance of a new non-voting class of shares (Class C) and is paying a 1-for-1 share dividend to existing shareholders of record on March 28. According to the March 16 press release: The Class C stock will be issued through a stock dividend on a one-for-one basis to all existing holders of Under Armour's Class A and Class B common stock, which will have the same effect as a two-for-one stock split. The shares of Class C stock will be distributed on or about April 7, 2016, to stockholders of record of Class A and Class B stock on March 28, 2016.
Have no fear. All is essentially the same for you, unless you own 1 million shares or more. If you do, write us and we will explain your options.
Good Investing this week!
Todd Shaver
Editor in Chief
Todd@BullMarket.com