The Week Ahead
This was the first week in history that the Dow Jones, S&P, and Nasdaq all moved higher every single day in a week. What a rally we are experiencing! Some of our subscribers have suggested worry over these new highs. Our thoughts below.
The week ahead brings a FOMC meeting and a certain rate hike. We will all need to watch to make sure Yellen doesn’t point to raising rates more than two times next year, which would turn down the music at this market rally party.
This week we provide some insights on our latest thinking for Athenahealth, Goldman Sachs, Under Armour, Aetna, Blackstone, and Bristol Myers-Squibb.
Key Market Measures (Friday’s Close)
Highlights From The Past Week
Financials Valuations. The sounding board of the stock market is arguably the Financials sector. These are controlled by the so-called money men. They live and breadth arbitrage, risk-parity, and all things finance. With the recent big run-up in the past several weeks in the Financial sector, what are we all to make of it? Here are two anecdotes. First, JP Morgan CEO Jamie Dimon was asked at this week’s Goldman Sachs Financials Conference what he was currently doing with the company’s stock buyback program. Dimon answered by saying the buyback program has been halted as he wants the staying shareholders to be getting a deal not the exiting shareholders. How telling! Second, Customers Bank (CUBI) issued a press release stating how big of an accomplishment that its market capitalization has reached $1 billion since the company was founded seven years ago, which is being ridiculed as an indicator of euphoria not seen in a long time - what company issues a press release regarding their market capitalization?!?
Looming Pension Crisis. Two days after the Mayor of Dallas filed a lawsuit against the Dallas Police and Fire Pension system to block withdrawals, which he referred to as a "run on the bank" of an "insolvent" pension system in "financial crisis”, the Pension's board has finally taken steps to halt further withdrawals. Of course, this delayed action has come only after $500 million in deposits have been withdrawn since just August. Nonetheless, The Dallas Police and Fire Pension System's Board of Trustees suspended lump-sum withdrawals from the pension fund Thursday, staving off a possible restraining order and stopping $154 million in withdrawal requests. Approving the request would have sent the pension below mandatory minimum liquid asset levels. This is just the tip of the iceberg of a looming pension crisis. It is unclear exactly how bad the situation will get.
ECB Starts Tapering. In an unexpected twist to the consensus announcement, Mario Draghi turned hawkish after all, and while the European Central Bank kept all rates unchanged, it announced that it would effectively taper its bond purchases from €80 billion a month to €60 billion starting in April, until the end of the year. This matters big time. We saw the taper tantrum in the US back in 2013 crush bond returns. The implications of Europe now heading this direction could spell at the very least volatility overseas that spreads to US markets.
BMR Companies and Commentary
Under Armour (UA: $28, +16%) Big news out of Under Armour this week! The company will outfit all Major League Baseball players starting in 2020 in a 10-year deal announced Monday, marking the brand's first uniform agreement with an American professional league. The sports apparel and footwear maker will supply all 30 MLB clubs with uniforms. Under Armour's partner in the agreement, sports merchandise retailer Fanatics, will have licensing rights to manufacture and distribute fan gear. The deal represents a "watershed moment" for the 20-year-old Baltimore-based company. You are watching Under Armour continue to cement itself as the millennials’ leading sports brand.
Separately, the company’s class A shares now trade under the ticker UAA and the class C shares have the old ticker UA. The A shares have one vote and the C shares have none. Founder and CEO Kevin Plank still owns all outstanding B shares, giving him 65% of the company's total voting rights. Thus, the voting rights that come with Class A shares offer virtually no benefit to the vast majority of smaller investors. For us, the jury is still out on which shares to track from here on out, although we think that ultimately the class C shares (UA) will be the stock to buy. We will let you know as time progresses which one we favor. For now, if you are an owner there is nothing for you to do. Just sit back and enjoy this stock getting back to its all-time highs of $72 in 2014. We will settle for $40 in the first half of 2017 though.
BMR Take: We remain very excited about the prospects for Under Armour. Management sees revenues hitting $10 billion in the years ahead versus current levels of $7-8 billion. We think the stock at this level is a compelling value.
Goldman Sachs (GS: $242, +8%) Goldman Sachs had another great week pushing to fresh new highs. What’s happening?
The large-cap banks and investment banks have been the most structurally impacted by the burdensome regulatory regime following the financial crisis. Accordingly, the Trump administration’s general proposals for “less regulation” will most positively impact these sectors, which includes Goldman Sachs.
What could change? Financial companies like Goldman Sachs may be required to hold less capital on their balance sheet as reserves for future losses. However, all the specifics remain unclear at this point. Looking at the Financial CHOICE Act as a potential blueprint, we note that both Morgan Stanley and Goldman Sachs are currently operating below the 10% leverage ratio threshold. (Goldman is at 6.3%.) What does this mean? In order to fall into the technical category for having "too much regulation", the Financial CHOICE Act states you would need to currently have a 10% leverage ratio or higher. Those with 10% leverage ratio or higher will be given an "off ramp" to less regulation in a Trump Administration. However, since Goldman doesn't meet the initial qualification in terms of capital levels, they may not even get to participate in what the Trump Administration is planning.
BMR Take: The stock is trading well above book value of $172 as of the most recent quarter. Goldman has been a great pick for is and the franchise is strong. This is a company that knows how to make money in good markets and bad. But good markets are always much better for Financial firms like Goldman. And we are in a big bull market now as you know. We issued a News Flash on Thursday raising the Target to $270 and moving the Sell Price to $234 which will cement our gains, having added the stock in January at $147.
Bristol Myers-Squibb (BMY: $57, +2%) Bristol shares are putting in a strong bottom at this point. The stock moved off of the $50 lows around the third quarter earnings release and it hasn’t looked back. This week Bristol announced it increased its quarterly dividend by 2.6% to $0.39 from $0.38 per share. The dividend hike is tiny, yes, but it is also a reminder to the market that Bristol is delivering very healthy profitability and returning a lot of money to shareholders. Recall, along with the release of 3Q16 results, Bristol announced a new $3 billion repurchase authorization and a commitment to flat operating expenses through 2020. Also note that Bristol has an extensive track record of not just paying their dividend, but hiking it, and current earnings are comfortably above the dividend level, meaning it is safe.
BMR Take: We see a turnaround ahead for Bristol and considerable upside. The immuno-oncology franchise has recently stumbled, but the core business is healthy and there remains prospects for a turnaround in immuno-oncology. The stock screams cheap relative to the 2017 EPS outlook of around $3.00 where expectations call for 15% EPS growth through 2020.
Athenahealth (ATHN: $96, flat) Athena shares are still finding their floor. We continue to like what we see from the company and would be buyers at this level. On the drug pricing front, Athena’s CEO did some public relations work this week to help people better understand the drug pricing debate that is crushing sentiment for many Healthcare stocks including Athena. He said a lot of the criticism is misplaced. If new drugs are keeping people out of the hospital, and offsetting the much higher cost of surgery, then they're worth it. This thinking is underpinned by what's called “value-based care,” a way of paying for healthcare that aims to improve the quality of care and cut costs. He said, "If you make a 99% profit on a $80,000 drug, and you take $120,000 of 2% profit margin hospital cost out of the system, God bless you, you just took $40,000 of cost out of the Healthcare system." It’s a very insightful perspective, we believe.
Second, Athena is the leading cloud IT company in the Healthcare market and they aren’t holding back. This week Athena announced a deal with Automatic Data Processing (ADP) to offer payroll, and time and attendance software to the small hospital market. This is great news as ADP is a wonderful partner for Athena. We hope to see more products offerings like this.
BMR Take: Sentiment remains weak for Healthcare stocks including Athena but the company is fighting back. The core business is doing well with new product offerings cementing the company’s leadership as the top cloud IT company. We think shares are a compelling value on this recent pullback.
Blackstone (BX: $30, +14%) The sails of Blackstone are catching wind causing momentum for the shares to acceleration. We’ve been saying this for months now, and are almost blue in the face. But this week the market finally took notice. Beyond the broader market rally, there is a particular force at play garnering more attention from the investment community for Blackstone.
Recall, this past quarter management reiterated the “huge” opportunity within the Retail channel (retail in reference to products sold with little to no minimum requirements, as opposed to institutional products that require at least a $1 million minimum purchase). All of Blackstone's products fully comply with the new Department of Labor (DOL) Fiduciary rule, which will do away with more aggressive products being sold. Basically, the new rule expands the standard of fiduciary obligation to apply to more brokers in more circumstances. Accordingly, many corners of the market, like non-traded REITs in particular, are not going to be able to be sold like they used to.
What does all this mean for Blackstone? Blackstone offers a world class investment product line-up, which should benefit as the new DOL rule cleans up some of the bad behavior in the industry and pushes the investment community toward Blackstone's products.
Demonstrating early favorable indicators of the trend, retail fundraising historically represented about 10% of firm-wide capital raised, but accounted for a higher 15-20% over the past three years, a trend we anticipate will persist.
BMR Take: Given the elevated growth trajectory at Blackstone, we view shares to be a compelling risk/reward. We think the stock is still cheap trading at under 10x the 2017 EPS outlook, and you get a huge 5.6% dividend yield along the way.
Aetna (AET: $129, -3%) The Justice Department hammered away in court Thursday at the viability of a plan by Aetna and Humana to sell off assets to alleviate antitrust concerns about their proposed $34 billion merger. The department, which is suing to block the merger, questioned the ability of the proposed asset buyer, California-based Molina Healthcare, to keep the market competitive for private Medicare plans for senior citizens if Aetna and Humana combine. Currently the two large health insurers compete head-to-head in hundreds of counties for the sale of Medicare Advantage plans, which are government-backed alternatives to traditional Medicare.
BMR Take: With the big recent run-up in the stock, the valuation is looking pretty reasonable on earnings assumptions that account for the merger happening. If the merger were to be blocked and were to fall apart, there could be severe damage ahead for the stock. We added the stock at $105 in February and currently at $129 the stock is up 25%. We hereby exit our position considering the unfavorable risk/reward.
But stay tuned for a substitute that we will issue a News Flash about on Tuesday morning.
Upcoming Economic News
TUESDAY, DECEMBER 13
Import Price Index – November
Time: 8:30 am
Forecast: -0.4%
The Import Price Index is projected to fall in November after two straight monthly advances. Even after expanding in seven out of eight months through October, the Import Index only managed a piddling 0.5% annual advance. Uplift in oil prices can boost the index in the near-term, yet dollar strength is likely to limit gains in the year ahead.
WEDNESDAY, DECEMBER 14
Retail Sales – November
Time: 8:30 am
Forecast: 0.4% overall, 0.5% ex auto
Retail sales look to grow strongly for the third consecutive month in November, bolstered by steady job and income gains. Disposable personal income grew 4.1% year-over-year in October, the fastest such pace since January. That acceleration in income growth suggests strongly positive, but not overly robust results for holiday retail sales.
Producer Price Index – November
Time: 8:30 am
Forecast: 0.1% overall, 0.2% core
The Producer Price Index is forecast to edge higher in November after holding flat in the previous month. Although the 0.8% annualized increase in the PPI in October is the highest in almost two years, that pace points to very modest pressure on business costs. The core PPI presents a similarly subdued trend, rising no more than 1.3% annually at any point over the past 21 months.
Industrial Production & Capacity Utilization – November
Time: 9:15 am
Forecast: -0.2% industrial production, 75.1% capacity utilization
Industrial production is expected to decline for the third time in four months in November, with warm weather greatly limiting utility sector output. Manufacturing sector production has been lackluster over the long-term, falling 0.2% yearly as of October. Positive industrial orders data in recent months and auto sales volume that has beat expectations of late can help turn around overall output trends.
Business Inventories – October
Time: 10:00 am
Forecast: -0.1%
Business inventories are projected to fall slightly in October after expanding in the two previous months. After long being a drag on overall output, businesses have a better handle on their stockpiling needs. Inventories added 0.5% to third quarter GDP growth, the first such positive contribution of the past six quarters.
FOMC Rate Decision
Time: 2:00 pm
Forecast: 0.5%-0.75% fed funds target range
The first and only fed funds hike of 2016 is all but certain to occur at the December 2016 FOMC meeting. The more interesting question revolves around policymaker projections for the fed funds rate in 2017. Consistent uplift in inflation and wage growth will be needed to increase the pace of policy tightening. Until the data for inflation and wage growth comes in consistently strong, we don't see Yellen quickly moving up the Fed Funds rate. It will be slow and steady, unless the numbers portend an overall economic slowdown.
THURSDAY, DECEMBER 15
Consumer Price Index – November
Time: 8:30 am
Forecast: 0.2% overall, 0.2% core
The Consumer Price Index is in line to increase steadily in November, keeping the annual core price trend north of 2%. Housing costs are keeping the core price growth elevated, with the cost of shelter rising 3.5% year-over-year in October.
FRIDAY, DECEMBER 16
Housing Starts & Building Permits – November
Time: 8:30 am
Forecast: 1.23 million starts, 1.23 million permits
After jumping to the 9-year high in October, housing starts are likely to step backwards in November. Yet an improving permits trend will continue to guide starts higher over the long-term. Permits rose 4% year-over-year in the three months ending October, greatly improving on the 10% yearly decline recorded in the second quarter.
Ferrellgas Partners (FGP: $6.65, up 19% after paying a 10 cent dividend) has been hit hard as you know. What do some of the big Street research firms have to say about the company? Barclay’s is looking for $15. Janney Montgomery Scott has a $20 price target. Royal Bank of Canada - $11. Citigroup - $21. Wow.
BMR Take: We think the selloff is way over done. This is a franchise that has been making money for decades. They made a bad mistake by buying into a new business they knew little about. And now they are paying for it with increased debt service and much lower profits. For the patient investor hopefully the bottom has been reached and we can see $10 in the first half of 2017.
The Google Amazon Apple Race
Google (GOOG: $789, up $40, 5%)
Amazon (AMZN: $769, up $29, 4%)
Apple (AAPL: $114, up $4, 4%) - $798 equivalent, reversing out the 7-1 split in 2014.
Apple leads the race!
Tesla On Track to Ship 80,000 Cars This Year
Tesla (TSLA: $192, up 6%) has stated numerous times that it will produce the first Model 3 by late 2017. This is the car that almost 400,000 people gave the company $1000 as a down payment earlier this year when it was announced. (That’s $400 million in cash that the company gets to use.) Other pundits state it will be late 2018 before the first unit roles off the assembly line. And remember, the company has said they will produce 500,000 cars by 2018. So there is conjecture in the air. This is why we have always said the stock could be so volatile, perhaps hitting $150 before it hits $300. And some skeptics think there is no chance that Tesla will ever survive. But Tesla has hired an expert production executive from Audi to help make this transition from assembling around 100,000 vehicles annually to 500,000 by 2018. All this appears completely doable to us and we continue to be believers in the company.
OPEC CUTS
OPEC has persuaded 11 non-members to cut oil production. Non-members agreed to cut almost 600,000 barrels per day for six months starting Jan. 1st, renewable for another six months after that. These non-member cuts come on top of an OPEC decision in late November to reduce their own output by 1.2 million barrels a day. We personally feel this is a drop in the bucket, as the world burns 95 million barrels of oil a day, but sentiment is important here. The thinking is that if OPEC can cut here, they may just cut more in order to prop up the price of crude which hovers around the $50 mark. The 11 non-OPEC countries taking part in the agreement are: Azerbaijan, Bahrain, Brunei, Equatorial Guinea, Kazakhstan, Malaysia, Mexico, Oman, Russia, Sudan and South Sudan. Most of the cuts would come from Russia.
High Yield Corner
It’s been something of a quiet week for high yield after weeks of volatility and uncertainty. This is ironic, since we’re a week away from the Fed’s expected rate hike announcement, but that is already priced in to just about every asset class, and the market seems to be accepting higher interest rates. Some believe that high yield bonds are not pricing this rate hike in well enough, which is why we have diversified our high yield portfolio with stocks, REITs, and other asset classes that are pricing in the rate hike more clearly. That said, we are confident that bond markets will not collapse after the Fed makes its move, and we believe the response is going to be quite muted. Remember, last year the rate hike was relatively unprecedented and unexpected; this year it’s widely expected and we have recent history to guide us in how high yield assets will respond. High yield assets are all up strongly before the rate hike, which suggests the risks aren’t really that great. The lack of a sell-off right now makes a lot of sense in that context.
So let’s take a look at individual asset classes. The SPDR High Yield Bond ETF (JNK: $36) and the iShares AMT-Free Municipal Bond ETF (MUB: $108) rose over 1% this week. The market seems to have accepted that the rate hike is coming and is already well priced in. Some high yield asset classes acted as if the market has over-priced the rate hike in. The SPDR Dow Jones REIT ETF (RWR: $94) surged over 3% this week, and many of our REIT picks performed even better. REITs were theoretically going to be hard hit by rate hikes with higher borrowing costs and less investor demand. While that’s true, the downside was clearly overstated in the recent sell-off. The market now realizes this, and REITs are climbing upwards.
AstraZeneca (AZN: $27) got a huge bump this week after durvalumab, a new cancer drug being developed by the company, got priority review status by the FDA. When we first recommended AstraZeneca, we liked the drug pipeline of this company, and we’re happy to see the pipeline perform strongly. The company still has a long way to go; the stock is down 20% year-to-date and down 4% from when we recommended it. Still, we fully expect investors to realize this company has many tricks up its sleeve, and we’re confident that the company will outperform the Biopharma industry even as it appears to be under attack by newly elected Donald Trump, who has targeted high drug costs as one focus of his upcoming presidency.
On the issue of government intervention in capitalism, Government Properties Income Trust (GOV: $19.70) surged over 6% this week and is up 24% year-to-date. The REIT rout that we’ve suffered since summer is waning and the market finally realizes it has oversold many great companies. We’re not surprised to see this REIT return to a more appropriate valuation, although we are getting close to our price target. When we recommended this company, it was yielding 11%. Don’t expect that yield to return anytime soon. FFO over the last 12 months is 142% of the dividend, meaning the company will have no problem paying out distributions in the short term. This dividend coverage is also higher than many other REITs, meaning its high yield implies more risk than is really there.
What about our other REIT picks? Starting with Kimco Realty (KIM: $26), up over 3% for the week. Yet Kimco is still down slightly year-to-date, meaning more upside is available very soon. The company’s FFO has gone up since we started the year, and the dividend went up 6% in October while FFO also went up 6%. This all demonstrates the durability of this high-yielding REIT and makes it a hard hold. Ignore analysts at Goldman Sachs who downgraded the REIT to Sell at the end of November. The stock is flat since they made that call, and the argument that rising rates will hit REITs is getting weaker - the market has clearly already priced that risk in.
Digital Realty Trust (DLR: $94) is one of the most exciting REITs in our portfolio because it benefits with the growth of cloud computing yet has little volatility relative to tech stocks. We’re up 6% last week, bringing DLR’s year-to-date performance to 24%. FFO is still far above the payout and 25% year-over-year revenue growth last quarter shows just how much growth is in this stock. At a 3.7% yield, the market has realized there’s limited risk in this stock, but that also means we’re reaching a sell point. We aren’t there yet, however, so we recommend holding this stock for now.
Finally, we have two Healthcare REIT picks to go over. Omega Healthcare Investors (OHI: $31) and Care Capital Properties (CCP: $25) rose nearly 5% each this week on fundamental optimism in the Healthcare REIT sector. With this entire sector down double digits year-to-date and many Healthcare REITs near 52-week lows, it seems clear that investors realize we’re at a bottom for this asset class. That’s why we recommend holding and enjoying the 8% to 9% yields these REITs offer.
Now let’s turn to the more diversified funds, which had a subdued week. AllianzGI Equity and Convertible Income Fund (NIE: $18.80) rose over 2% thanks to steady NAV appreciation in its equity holdings. This fund holds great companies like Amazon and Google, but it trades at a 14% discount. This means for every $1 you spend on NIE shares, you’re getting $1.14 in assets. Unfortunately, this fund has traded at a discount to NAV since 2009, and it hasn’t traded at a discount larger than 10% since early 2015. We feel this price pressure is due to the smallish size of the fund and concerns that rising interest rates (which have been an ongoing drama for years now) will hurt the value of the convertible bonds in the fund. Ironically, rising rates will help the covered call side of the fund, meaning the downside is hedged internally in the fund. The market doesn’t really care about this, though, so its discount is still large. But markets don’t stay inefficient forever, and we’re fairly confident the market will realize it has underpriced this fund for years. That’s why we recommend holding it and enjoying the NAV appreciation and the 8% income stream.
Our other big fund pick is Pimco Dynamic Income Fund (PDI: $29) which was flat this week and paid out another 22 cent dividend. There’s nothing to report on the Pimco fund from a price or performance standpoint, but the real frustration is that Pimco still hasn’t released its special dividends for this fund or any other fund. This fund traditionally pays a very large special dividend, and there is a lot of undistributed net investment income that is likely to be paid out by the end of the year. Last year, Pimco announced its special payouts on December 11th; since the 11th is a Sunday this year, we were expecting Pimco to announce earlier. The announcement is coming later, however, and we wouldn’t be surprised if was made on Monday. It could be as late as Friday, however. This means sit tight and wait one more week to see just how much extra income we’re going to get. It seems there is a high probability that the extra income will be over $1.00 and could be even as high as $1.40. We just need to be patient and see.
Good Investing,
Todd Shaver
Founder and Editor
The Bull Market Report