The Weekly Summary
Last week was great. Major indices and BMR stocks surged about 2%, bringing the YTD paper return on our active universe to 6% in barely three weeks. The market tone resembles last January as far as the force of the rally goes, but where stocks were simply bouncing back from a steep correction last year, this is more about seeing how far the bulls can run into record territory. The S&P 500 has already cleared a healthy 14% beyond the September 2018 peak and we see no compelling sign that Wall Street will hit a wall here.
The trade war is receding from investors' radar now that the Phase One agreement has eliminated the imminent threat of additional barriers to imports. While we would love a full-fledged return to the old tariff-free status quo, the important thing is that after over a year this is the status quo now . . . and corporate executives have already pivoted to take advantage of the new global landscape or at least minimize the drag from shifting cross-border policies. With that in mind, Phase One doesn't necessarily take us forward so much as it prevents escalation to the downside. The worst scenarios now look vanishingly unlikely.
And with the trade war quieting down, there aren't a lot of risk factors to monitor. The threat of armed conflict in the Persian Gulf has completely evaporated, leaving stocks higher than ever. Likewise, while earnings are not spectacular, a lot of negativity is already factored into asset prices so it would take a lot of disappointment in this quarterly cycle to wreck the market mood. We suspect it's far more likely that the numbers will remain decent and investors will keep looking forward to a return to real growth when the 1Q20 reporting season starts three months from now.
After all, the underlying economy remains robust. Unemployment is extremely low and wages are creeping up despite the occasional wave of worry about a recession on the horizon. This is not how a recession begins. It's not even how a boom fades to a whimper six months before a recession begins. From all the data, this is an old-fashioned expansion cycle supported by the lingering impact of the tax cuts plus a sympathetic Federal Reserve. Maybe we're late in the cycle, but there's a huge difference between "late" and "over."
If anything, the Fed might have given a tired expansion enough fuel to reset to a much more vibrant level, effectively shifting from late autumn to spring without hitting the winter in between. In that scenario, the 2018 correction was really more of a brief "bear market" marking the transition between the 2009-18 recovery and the real boom to come. We'll simply have to see how far the longest bull market in history can go before it finally falters.
Whatever happens, we're ready. Our High Yield positions remain open, generating enough reliable cash flow to buffer the shocks no matter where the market (and the economy) go from here. But in the meantime, our Aggressive and slightly less volatile High Technology portfolios are performing extremely well . . . much better than they would if investors were feeling truly nervous. Last year was the bounce. This is more of a boom.
There’s always a bull market here at The Bull Market Report! This week we're finishing our quarterly review of the Aggressive portfolio with the leader of the group, Zscaler, up 27% YTD. Then it's time to shift to our Special Opportunities ahead of the real crush of earnings season . . . which doesn't start for another couple of weeks as far as we're concerned. We do need to give you our latest thoughts on Johnson & Johnson, however.
The Big Picture explores what everyone else on Wall Street is saying and why their targets are too low to match reality. The High Yield Investor spotlights two of our higher-yielding REITs. Then we welcome Gary Jefferson back for a look at how the "January Effect" has already raised the odds of a bullish 2020 to somewhere between 80% and 90% . . . and that's before we see how the end of the month treats us.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: The Strategists Are Missing The Fun
Here we are, digesting one of the best rallies in generations, and a lot of forecasters say the bulls have run out of room to run. We beg to differ. After all, the Fed remains our friend, with lower interest rates compensating for stalled earnings. The trade war is receding into the background, taking risk aversion with it.
And while stocks are on the rich side now, history proves bubble valuations can stretch a whole lot farther before they finally burst. The bulls will run as long as they can. Telling investors to retreat to the sidelines cheats them out of intervening upside and leaves them vulnerable to worse long-term outcomes.
But that's what most of Wall Street’s biggest banks are doing right now. Go through a list of nearly two dozen numerical targets for the S&P 500 and the vast majority of strategists say the market is going down this year.
Bank of America, Barclays and Jefferies did their math and concluded that we’ve already hit the peak, give or take a few points. Morgan Stanley and UBS are still quoted saying the S&P 500 is headed back to 3,000 in the next 11 months.
That’s effectively calling a correction. Anyone who takes them seriously is already crowded into safe havens waiting to come out and buy that dip. Even the bulls are keeping client expectations under tight control. Credit Suisse, JP Morgan, Citi, Goldman . . . maybe there’s 3% left in the rally. Only Piper Jaffray sees a normal (8%) year ahead.
They’re all working with the same data. They just get widely different results. And of course they’ll recheck the calculations when it becomes clear that something is wrong. UBS, for example, has spread the 3,000 target for normal market conditions while acknowledging that the Fed changes the game. Price multiples can easily swell to 20X earnings they say, in which case their target will be left in the dust mighty fast.
We think that’s the right direction to take right now. When statistically reality snaps back, the math says the market is worth about 10% less than it is now. It’s overvalued. But statistical reality can bend for a long time before it breaks. The only difference between a high-conviction contrarian position and a purely irrational bet is timing.
Even Bob Shiller acknowledges that. Calling the start of a bubble doesn’t take any expertise. There’s always another bubble lurking in the future. Every bull run ends. Calling the burst is the hard part. A lot of people on Wall Street are doing that now, in defiance of all the animal spirits in play.
And in the longer view, fixating on the top hurts everyone. There is no ultimate S&P 500 peak. The long trend still points up at a comfortable slope of 10-11% a year. Remember doing the math in the wake of 2008-9? After we factored in those apocalyptic results, large-cap performance across generations still reflected the same numbers it did in 2006-7.
Average out the booms and busts and stocks have found the fuel to rally 10-11% a year. On that basis, the last five years have been right on track with statistical reality. The last two years have been all over the map but average out to about 9% a year. We’re still working off a little of the burn from the 2018 correction, making up for lost time.
Meanwhile easy liquidity keeps raising the roof. Trades that looked crowded 18 months ago can keep accepting that easy money. Prices climb. We can evaluate the degree to which the market has become “irrational.” We can even shake our heads and roll our eyes.
But this is market reality as long as it lasts. Hoping it will go away it cheats investors out of their most precious commodity: time. People who hedged volatility in 2014-16 learned that betting on disaster was a time bomb. The crash never came and they folded.
We all are. In a world where the Fed is letting inflation nudge above interest rates, betting on bonds or cash is the best way to lock in purchasing power deterioration. You’re locking in at least a little loss there in order to lock out the risk of bigger losses. Effectively, you’re paying the Treasury for peace of mind.
Other investors would rather not lock out the upside, even if it means accepting the prospect that news flow will go against the market this year. If risk is the big question, there’s always our High Yield recommendations.
TPI Composites (TPIC: $21.50, up 10% last week)
TPI Composites has been challenging to own for the last year, falling 40% since reaching an all-time high of $33 last February.
The firm manufactures wind blades that are used to create energy. Management’s growth strategy entails deepening relationships and creating new ones, expand in growing wind markets, and drive down the cost of wind energy.
Investors were not happy with results, though. Their third-quarter bottom line reversed to a $5 million loss versus a $10 million profit a year ago. The company is going through growing pains, facing higher costs as it expands into new geographies.
The company also postponed its Investor Day, citing uncertainty with wind blade model startups, which is clouding 2020.
Still, sales rose 50% in the third quarter, from $255 million to $385 million. While management slightly lowered their guidance for 2019 billings, they still expect the yearly figure to come in at $1.4 billion compared to their previous expectation of $1.5 billion. This is still 40% higher than 2018.
BMR Take: We understand that the market hates uncertainty. In this case, the fundamental story remains sound. So, with TPI at these levels, we believe this has created a buying opportunity Underlying demand remains strong, evidenced by continued solid revenue growth. Once management gets a handle on start-up costs, we expect TPI Composites to regain the wind at its back. Our $35 Target Price reflects plenty of upside potential. We also have an $18 Sell Price.
Zscaler (ZS: $59, up 8%)
Zscaler hit the skids since reaching $90 in July, falling 55% through October. Since then, the stock has recovered nicely, rising 50%, but still well off the record level.
Management provided guidance that disappointed some, but we see nothing wrong with a company that expects to grow revenue by 35% this year, from $305 million to $410 million.
For the first quarter, top line growth was a sky high 50%, increasing from $65 million to $95 million. Investors should expect this to moderate from this unsustainable level.
Expenses are rising at a fast clip, but this is to support higher revenue, with Zscaler’s loss expanding from $8 million to $17 million. Nonetheless, there is a cushion since the company has a clean balance sheet, with $380 million in cash and no debt.
We expect strong growth to continue, too. Zscaler was an early cloud computing company, providing security solutions. The company’s products guard against unwanted access, protect from threats, and watch over data. With all the breaches, these are good areas to operate in.
BMR Take: Those feeling left out can still join the party. We believe the selloff created an opportunity, with these levels representing an attractive jumping off point. Our Target Price is an aggressive $95 while we have a $52 Sell Price.
Carlyle Group (CG: $33, up 6%)
Carlyle Group has handsomely rewarded shareholders, rising 80% over the last year. And we remain optimistic about further gains. After all, this is a top asset management company and management is executing very well.
A large investment firm, with $220 billion in assets under management (up 4% from a year ago), Carlyle has been around for three decades, building up an impressive record in an industry where companies disappear quickly. Management sticks to their knitting, building expertise in areas such as private equity, credit, real estate, and energy.
The proof is in the results. Third-quarter revenue rose 13% versus last year, from $680 million to $770 million. The two biggest drivers were investment income and management fees. Carlyle’s bottom line skyrocketed to $90 million for the period, versus $20 million.
Carlyle’s dividend payout varies, but total distributions were $1.36 in 2019, compared to $1.24 for the past couple of years. The current rate equates to a 4.2% yield.
BMR Take: Carlyle is unique: a company that has built a long-term successful investment track record. Bumping up against our $34 Target Price, we anticipate raising it when the company reports year-end results as we expect revenue and income growth continue. We currently have a $24 Sell Price which we hereby raise to $29.
Dollar Tree (DLTR: $92, flat)
Dollar Tree has been volatile over the last year. Trading near the $88 52-week low reached in early-December, there is a lot we like with about company. This is particularly true since the pullback was not due to any fundamental issues with the company.
Third-quarter sales increased from $5.5 billion to $5.8 billion - 4%. The top-line growth was partly driven by a same store sales increase of 2.8% and 2.3% at Dollar Tree and Family Dollar stores, respectively. There were more customers and they increased spending, both of which are good news.
However, Dollar’s third-quarter income fell $260 million from $280 million a year ago due to higher costs. Investors also got spooked by management lowering fourth-quarter guidance. For the year, they now anticipate earning $4.70 a share compared to their previous $5.00, partly due to higher tariffs. The easing of trade tensions should help the company.
BMR Take: Dollar Tree offers upside potential and it is also a defensive play when the economy softens (not that we’re expecting this anytime soon). When consumer spending is squeezed, dollar stores have appeal. Our $120 Target Price is well above the current price and we have an $82 Sell Price.
Financial Select Sector SPDR Fund (XLF: $31, up 1%)
Since bottoming out at $6 in 2009, Financial Select Sector SPDR has increased 5-fold. Even if you didn’t catch the bottom, the last year was also kind to shareholders, with a 21% price gain, rising from $25. With further gain potential, we remain committed to the Financial Select Sector SPDR.
This Exchange-Traded Fund or "ETF" tracks the performance of the namesake index. This is comprised of stalwart Financial companies, such as Berkshire Hathaway, JPMorgan, Bank of America, and Goldman Sachs. Our economy has recovered from those dark days more than a decade ago. The companies that the ETF owns not only survived but are now thriving.
Owning an ETF, which trades like a stock, allows you to own the largest and best Financial Service companies. This also gives investors diversification benefits.
BMR Take: Financial Select Sector offers capital appreciation potential, and, since these are large, well-established companies, it also provides a 2% dividend yield. Our $35 Target Price indicates further upside, and we have a $28 Sell Price.
MetLife (MET: $53, flat)
MetLife has risen 20% over the last three months, setting a 52-week high this past week. Since we like management’s plan, these levels do not scare us off. In fact, it makes us want to buy more.
Analyzing the results, there is a lot to like. MetLife’s third-quarter revenue jumped 15%, from $16 billion to $19 billion. Net income leaped to $2.2 billion from $900 million. Not content to sit still, management launched their Next Horizon Strategy, with goals to continue delivering a 12%-14% ROE and generate $20 billion in free cash flow to return to shareholders.
MetLife already generates plenty of cash flow, with $9 billion for the first nine months of 2019. We like that the company returns some of this to shareholders with $2 billion in repurchases for the period and a history of increasing dividends for the last couple of years.
BMR Take: Offering life insurance products along with disability and dental insurance, we believe this a strong company that is getting stronger. We have a $56 Target Price and $39 Sell Price.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
In years when we get a Santa Claus Rally and the First Five Days and the January Barometer are both positive, we call it the January Trifecta . . . the best of all possible scenarios for a new year. Santa came at the end of December and the First Five Days closed with a gain of 0.7%. Now all we need is for the S&P 500 to hold onto what's currently a 3.1% gain for January to turn all three statistical lights green.
We want this because in the 31 previous Trifecta occurrences since 1950, the S&P 500 advanced 90% of the time for the full year. We have to get through January, of course, but even if the month turns negative, simply hitting the other two targets is a good thing. Usually it turns into a positive year 80% of the time. So investors are looking at either an 80% or 90% historical chance for a positive year.
However, as you all know, statistics never "guarantee" the year will be free from corrections or even bear market swings. We only have to look at 2018 to see how a positive Trifecta started well only to have external events crush stocks in December. Either way, we like having history on our side any time we can get it. But we also have the facts on our side. The ClearBridge Recession Risk Dashboard had no changes in December:
Thus, no foreshadowing of a looming recession. And historical valuation and asset allocation trends suggest a positive upcoming year in equities. More importantly, because we are coming out of the first decade in history without a recession, if one looks at historical bull market cycles, we are likely only halfway through the current secular bull market and that should give long-term equity investors confidence.
While valuations are above historical averages, with interest rates this low, a fair price-earnings multiple (PE) for the S&P 500 is somewhere around 20X earnings. With 2020 earnings tracking around $174, that produces a price target well above 3,400 for the S&P 500.
Our optimism for 2020 is mainly based on the continued strength of the consumer. The U.S. consumption rate is at its highest share of global GDP in more than a decade. Moreover, wages, employment, individual debt, debt delinquencies, construction, housing, auto sales, etc. all look remarkably healthy. So, what could cause the wall of worry to come tumbling down? A spike in inflation that causes the Fed to change its stance on interest rates, a drastic change in Washington or a major geopolitical event. Barring that, we continue to believe that we are in a bull market until proven otherwise.
Earnings Preview: Johnson & Johnson (JNJ: $149, up 3%)
Earnings Date: Tuesday, 8:00 AM ET
Revenue: $20.8 billion
Net Profit: $4.9 billion
Year Ago Quarter Results
Revenue: $20.4 billion
Net Profit: $5.3 billion
Implied Revenue Growth: 2%
Implied EPS Decline: 5%
Sell Price: We would not sell Johnson & Johnson.
Date Added: July 6, 2018
BMR Performance: 20%
Key Things To Watch For in the Quarter
We abandoned hope for this particular season to translate into positive year-over-year growth for Johnson & Johnson back in June. There simply wasn't enough force driving the company's top line to overcome legal expenses related to ongoing litigation. With that in mind, we're willing to accept a slight decline here as long as management remains upbeat about the future. This needs to be a temporary glitch in the comparisons, not a hint of more prolonged deterioration ahead.
With that in mind, the 4Q19 numbers will be digested and discarded soon. The real excitement around this release revolves around the hints we'll get on 1Q20. From what we've seen since June, there's a real possibility that guidance will be stronger than we currently anticipate. Last quarter was significantly better than management led us to expect and as long as the litigation threats remain subdued, we may need to revise our 1Q20 growth target up. That's extraordinary. We're already looking for confirmation that this gigantic company is tracking earnings of $2.26 or more per share in the current quarter. That represents about $400 million in additional profit that simply wasn't here a year ago . . . a lot of money, but when you're dealing with a global juggernaut like Johnson & Johnson, the numbers get huge fast.
The High Yield Investor
U.S. Treasury yields were flat for the week, stuck at continued low levels. The 10-year yield edged up 1 bp to 1.84%. Last week, the Producer Price Index was released, showing just at 0.1% increase in December and 1.3% for the year, demonstrating that inflation remains contained. A growing economy and low inflation are good news, but it keeps interest rates low, which depresses fixed income yields.
Have no fear since The Bull Market Report is dedicated to finding you attractive income investments. REITs are a natural for this type of investor since it must pay out 90% of taxable income.
Omega Health Investors (OHI: $43, up 2%, Yield=6.2%) raised November’s quarterly dividend by a penny to $0.67. While this was a slight increase, it is nevertheless a positive sign.
Most of Omega’s properties are located in the U.S. These are primarily skilled nursing facilities (SNF) although there are also assisted living and specialty facilities. Since the population is aging, this is a good space to own.
Listed with the NYSE in 1992, Omega was one of the first publicly traded REITs explicitly structured to finance the sale and leaseback, construction, and renovation of Skilled Nursing Facilities. In 2015, Omega merged with Aviv REIT, creating the largest publicly traded REIT in the U.S. dedicated to SNFs.
Their portfolio consists of approximately 83% SNFs and 17% Senior Housing Facilities with gross investments totaling approximately $9.5 billion. The Company has invested over $3.1 billion since the merger with AVIV for reinvestment and new construction.
The company has close to 1000 properties now, located across the United States and the United Kingdom. In October, Omega completed a 60 facility acquisition for $735 million. The 60 facilities, consisting of 58 skilled nursing facilities and two assisted living facilities representing 6,600 operating beds are located mostly in Florida (37), North Carolina (8). These facilities are leased to two operators within three triple net leases providing for approximately $64 million in 2020 annual contractual cash rent.
This was on top of the acquisition by merger of MedEquities Realty Trust in May for approximately $625 million. The investments include 35 properties located in eight states and operated by 12 third-party operators.
While SNFs lean heavily on Medicare and Medicaid programs for reimbursements, Omega has handled it well. Plus, last October, the government approved a 2.4% increase to SNFs, the highest in several years. It has also diversified across 41 states and even has holdings in the U.K. while it is not overly reliant on one company for its revenue.
Turning to financial results, Omega’s third-quarter revenue rose from last year’s $220 million to $235 million. Rental income was the key driver. Funds from operations (FFO), a cash flow metric used by REITs, increased from $160 million to $165 million. It generated operating cash flow of $405 million for the first nine months of 2019, up from $350 million.
Omega (Target Price: $45) specializes in a space that should continue to see increased demand in the coming years, making it an appealing income investment.
Service Properties Trust (SVC: $24, up 3%, Yield=9.0%) has a strong history of steadily increasing dividends, doing it annually since 2012. That’s a nice track record.
It owns a portfolio of hotels across 45 states, providing good geographic diversity, inking long-term leases with well-healed companies such as Marriott and Wyndham. The company owns 330 hotels and owns or leases 950 retail focused net lease properties located throughout the United States, Canada and Puerto Rico. The properties are operated by other companies under long term management or lease agreements.
Service Properties, which was known as Hospitality Properties Trust before it acquired Spirit MTA REIT for $2.4 billion, strengthened its retail portfolio with the deal. The portfolio is now made up of 60% hotels with the remainder Retail.
Revenue dipped to $600 million from $605 million in the year-ago period, but this was largely due to property sales. The combination of lower revenue and higher expenses caused FFO to fall to $155 million from $175 million.
While management took on additional debt to acquire Spirit, we look for the company to pay this down through asset sales. This should allow the company to reap the benefits from a more diversified portfolio. A slow-and-steady dividend grower, Service Properties offers a high yield and could see appreciation (Target Price=$33) once it starts selling properties, repaying debt, and showing revenue growth. While there is some risk involved we like the company’s track record and anticipate a profitable futures for the company.
Todd Shaver, Founder and CEO
The Bull Market Report