The Weekly Summary
As we discussed in the most recent wave of News Flashes, last week was all about a final pre-earnings rush of capital out of defensive sectors like Healthcare and Utilities into areas of the market that can surprise on growth as 1Q19 numbers start coming out.
The Nasdaq gained ground. The blue-chip Dow industrials sagged. The broad S&P 500 edged up a bit, but nowhere near what the growth-heavy BMR universe was able to produce. It never gets old to say that our stocks once again beat the market. On average, our recommendations climbed nearly 1% last week, nearly double the S&P 500 thanks to 2% in the Technology portfolio and more than 1% in the Aggressive, Special Opportunities and core Stocks For Success groups.
Naturally, the pivot to a strong offense left Healthcare, Real Estate and our High Yield recommendations under pressure, but their fleeting pain was barely a divot in our overall results. We’re especially pleased to see money rotated into a few of our growth names that missed last quarter’s rally: Nutanix (NTNX: $41, up 9% last week) and Cloudera (CLDR: $11.55, up 4%) being the obvious ones to note here. As long as their coming earnings reports match our forecasts, we suspect that this is only the first taste of a strong season ahead.
Of course we need to see the numbers first. The next few months will be a busy cycle for us all, with the first of the season’s Earnings Previews coming Tuesday morning to make sure you’re in position for the stocks that report between now and Friday. Look for it in your email and be ready to take advantage of any missteps the market makes.
There’s always a bull market here at The Bull Market Report! The Big Picture opens the earnings season with a look at the numbers the first wave of Banks reported on Friday and the others are likely to give us tomorrow morning. This is also our last pre-earnings chance to catch up on developments from Microsoft, Apple, Eli Lilly, AstraZeneca, Synaptics and Salesforce.com.
Gary Jefferson counters the latest arguments that the economy is in terrible shape – a bullish and contrarian stance that the Banks themselves agree with, by the way – and the High Yield Investor investigates why our Municipal Bond recommendations are soaring to multi-year highs. Evidently the market media is too busy looking for a recession to see the upside in front of our noses
Key Market Measures (Friday’s Close)
BMR Companies and Commentary
The Big Picture: Big Banks Looking Good
Every modern earnings season begins with the big Banks giving us the eye-in-the-sky view of how the business of keeping money moving held up in the previous quarter. This is when we hear about Credit Quality, Loan Delinquencies and other critical economic indicators, as well as how much money the biggest trading desks on Wall Street made or lost on their own market activities.
We got our first taste of 2019 on Friday with J.P. Morgan Chase and Wells Fargo. The former did extremely well last quarter, with nothing but good things to say about its activities despite fears about a slowing global economy and a tangled Treasury yield curve. Earnings jumped 17% on a 5% increase in revenue. Loan activity is up 4% so the Fed’s tightening cycle has helped add a little extra interest income to every dollar the Bank’s underwriters distribute to borrowers, which is exactly what happens in a healthy economy.
CEO Jamie Dimon sees little sign of a slowdown ahead. As he says, “There is no law it has to stop. I wouldn’t count on there having to be a recession in the short run.” He’s in a position to know. As far as he’s concerned, loan volume growth will continue at this rate for the coming year even as the Fed has stopped raising rates for the time being. Again, that’s a signal of health and not a looming economic cliff.
J.P. Morgan bankers aren’t dumb. If they see Credit Quality deteriorating or borrowers defaulting on their obligations, they’ll be the first to close the doors and conserve capital. That’s not happening now.
Wells Fargo told a less cheerful story, but its management team faces much stronger internal challenges from recent scandals and outright fake performance numbers. If we were recommending any big Bank, this would not be the one.
However, Citibank and Bank of America both report tomorrow morning. We’re looking for strong results from both. And since these four institutions together account for 30% of our Financial Select Sector ETF (XLF: $27, up 2%), a strong trend for the biggest Banks as a group is good news for us. We aren’t enormously bullish on the sector, but we recognize that at 13% of the market it’s important to maintain a little exposure to the best and brightest financial institutions on the planet.
Last year wasn’t great for the Banks and even in the best of times these stocks can be a dull ride. This year has given us more of a thrill, with Financial Select Sector rallying 15% YTD. If this is what these companies can do in the face of yield curve concerns, recession fears and the Fed on pause, we can’t wait to see where the stocks end up.
Microsoft (MSFT: $121, flat -- all returns are for the week)
The recent announcement by the Pentagon that only two companies are “in competitive range” for the $10 billion JEDI Cloud contract can only help this giant on its trajectory toward a $1 trillion market capitalization. Here at a record $923 billion, it only takes another 8% rally to cross that line.
JEDI is more prosaically known as the Joint Enterprise Defense Infrastructure initiative, which means working with Silicon Valley to take Defense Department computers into the 21st Century. Since it’s a winner-take-all project, booking that initial $10 billion can actually move the revenue needle for a decade to come even for a giant like Microsoft. Once again, the company’s Windows operating system and Office productivity suite give it the inside track, since the Pentagon is already paying $1 billion to use that software and would appreciate any solution that doesn’t complicate that relationship.
Admittedly, the opportunity is so big that Microsoft’s own consultants have warned the Pentagon that sharing the contract makes more sense. Nonetheless, Alphabet (GOOG: $1,128, up 1%) is already out of the running and Amazon (AMZN: $1,843, flat) is the only serious contender left, with Oracle and IBM having been passed over.
Whatever happens with JEDI, this stock is already up close to 20% this year, sprouting massive revenue opportunities that would make any smaller entity weep with envy. LinkedIn alone has boosted revenue 75% since Microsoft acquired it in 2016 and now contributes over $5 billion annually. And with Retailers shunning Amazon as a partner, Microsoft’s competing Azure computing platform is snagging major wins with store chains – partially because the enemy of my enemy is my friend, but also with Office 365 sweetening every offer.
All in all, revenue here grew 14% last year to $110 billion and we’re expecting 12% growth in 2019. Keep in mind that while the percentages are shrinking a little, it’s only because the comparisons get harder as Microsoft expands. In real cash terms, the company found ways to capture an extra $14 billion last year and will undoubtedly boost sales by the same amount this year. Given its commanding stature already, simply staying on this track is an achievement.
We’re convinced Microsoft can keep bolting about $14 billion a year onto its top line for years to come, keeping its double-digit growth ramp alive. If organic opportunities run dry, there’s always $130 billion in cash to deploy on acquisitions.
BMR Take: Microsoft will top $1 trillion, it’s only a matter of how long the next 8% push takes to play out. An expanded Pentagon relationship accelerates that journey but isn’t essential in itself. After all, if Amazon gets the nod instead, BMR subscribers still win. Look for the announcement by the end of the month.
Synaptics (SYNA: $38, down 3%)
After plunging nearly 30% on the CEO’s “surprise” exit, Synaptics has now recovered 80% of that lost ground and is back in positive territory YTD. This is proof that the market overreacted. Now that calmer heads are reviewing the strategic opportunities that a newly empowered board of directors can exploit, investors are finding a lot of reasons to cheer.
Acquisition offers are back on Wall Street’s radar. Synaptics had been in talks with Dialog Semi about a $59 buyout last summer, but nothing ever came to fruition, apparently because the CEO kept holding out for an even better deal. We were ready to take the premium then and would be happy to lock it in now. Odds are good that at least a few people on the Synaptics board feel the same way.
Of course, the company was still in the throes of a three-quarter earnings decline last summer so the stock was distressed. People were worried about the company’s ability to pivot away from a flagging smartphone market fast enough to remain relevant. Now, after nearly a year of recovery, the fundamentals look a whole lot stronger and earnings are going the right direction again.
Six months ago, this stock had been beaten down to a 7.5X earnings multiple, which in retrospect reflected the absolute disaster-case scenario. With the board reaffirming a more constructive earnings outlook (albeit at the low end of the established guidance range), that scenario is off the table. Even so, here at under 10X earnings, strategic buyers must be circling. Last summer, Dialog was willing to pay at least 12.5X before the CEO smothered the negotiation. He isn’t there now.
BMR Take: Synaptics has been a rough ride but that’s what initially brought it to our attention 16 months ago. Now that the post-CEO swoon is largely behind us, it’s time this stock gets back to work. After all, its core smartphone market has no place to go now but up at this point in the product upgrade cycle, while the most exciting new opportunities in Automotive and Voice-Controlled computing are still in their infancy. Survival is assured. The only question is whether Synaptics will choose to survive on its own or thrive as part of a larger Technology partnership.
Apple (AAPL: $199, up 1%)
With iPhone sales hitting a wall last year, Wall Street’s biggest behemoth has been forced to pick up the slack in other areas. Fortunately, Apple management is always ahead of the curve, building out a robust Service platform around the hardware business we knew would reach a mathematical limit sooner or later.
The company’s devices once again serve as a delivery system for Streaming Content (remember the days of video on the iPod?) as well as News and Video Games. A few weeks ago, we heard that a full 10 billion Apple Pay transactions have been cleared YTD, with over 40% of all iPhone users now on the platform. That’s close to 400 million people around the world ready and willing to replace their physical credit cards with a futuristic phone tap. It’s huge.
There is also the slow-but-steady foray into Healthcare, where the early steps are already in place thanks to the Apple Watch and certain apps on the iPhone that track diet, sleep patterns and exercise. Healthcare provides an enormous total addressable market, large enough to move the needle even for a giant. In the United States alone, capturing just 1% of the $3.5 trillion flowing through the sector every year translates into a 13% revenue bump even for Apple. Again, huge.
Apple has begun partnering with big names like Johnson & Johnson (JNJ: $136, flat) as well as several Health Insurance providers to make storing medical records on the iPhone easier. Given that Apple is sitting on $245 billion in cash and marketable securities, acquisitions could easily accelerate the process.
BMR Take: Once left for dead, Apple has recovered 27% YTD and we see more upside ahead. With a current market cap of $930 billion, Apple is on pace to crack $1 trillion once again. While flagging iPhone sales are an artifact of a slow product cycle, the imminent release of 5G and foldable devices should revive global demand among the Apple faithful. Either way, the future looks bright.
Salesforce.com (CRM: $161, up 1%)
News that Salesforce is doubling its Japanese workforce highlights the way this $120 billion company has barely tapped overseas markets and their endless growth potential. Customer Relationship Management remains a vestigial enterprise outside the United States, where the old-fashioned Rolodex and address book were replaced long ago with spreadsheets and Salesforce apps.
Even without those foreign markets catching up, Salesforce has been a cash machine. Revenue has expanded at an annualized rate of 20% over the last five years and the segment that contributes the most to the company’s overall top line (Cloud-based Sales Support) is also moving the fastest, driving 30% annualized growth over that period. From here, we’re looking for the 20% ramp to extend into the foreseeable future.
As we often say, a ramp like that is practically a rocket launch pad. Here at a $13 billion run rate, Salesforce is still at a point in its corporate evolution where 20% on the top line can translate into better than 100% growth on the bottom. (It happened last year.) Even if margin expansion pauses while the company integrates acquisitions into its platform, there’s a lot of room here for profit. We suspect both sales and earnings can triple over the next five years. We expect the stock to keep up with the fundamentals.
As for acquisitions, the mid-2018 addition of Application Development company Mulesoft will keep the numbers moving once the Salesforce sales team figures out how to bundle it into their existing process. With plans to invest $100 million in Video Communications tool Zoom on the verge of its public offering, a serious move into next-generation professional networking could be coming as well
BMR Take: The stock is up a solid 17% this year so far and our $170 Target is just over the horizon. Salesforce truly is a machine that’s produced plenty of profit for BMR subscribers in its first six months on our Technology list. We love its reliability and growth story, expecting more ahead.
AstraZeneca (AZN: $40, down 3%)
As the 4Q18 dip and 1Q19 recovery both recede into the past, Wall Street is now wavering between the defensive stocks that resisted last year’s selling and the aggressive ones that crumpled in the correction. Last week saw rotation out of the former group into the latter, leaving our Healthcare recommendations temporarily out of favor. Don’t count Big Pharma out yet.
AstraZeneca has more than its share of constructive catalysts to ride when the wind shifts. Last week alone the European Commission approved breast cancer drug Lynparza, while Fasenra, which is currently marketed for asthma, demonstrated its ability to fight autoimmune blood disorders in a recent Phase 2 trial. As these programs advance, this once-stagnant stock can get moving again as a growth play.
Granted, the narrative here remains more about efficiency and cutting costs until new AstraZeneca drugs replace older ones where patent protection has expired or competitors have gained the upper hand. Earnings sank 20% last year. We’re looking for management to make the hard calls this year and boost profit, proving that better days are coming fast. A year from now, we project 20% earnings growth, inaugurating a new golden age for what’s already one of the 20 biggest Drug stocks on the planet.
Revenue is moving forward again after several quarters of contraction. Sales climbed 11% back to $6.4 billion in 4Q18 and while we expect to see that growth rate recede to 3% in 1Q19, any progress at all is a whole lot better than the 5% decline we saw in 1Q18, just 12 months ago.
BMR Take: When defense takes the lead on Wall Street, AstraZeneca is one of our stars. Meanwhile the company’s next wave of products paves the way to a strong offense on the horizon. Last quarter was good. We suspect it’s only a taste of better things to come.
Eli Lilly (LLY: $123, down 3%)
Keeping on the Pharma theme, Eli Lilly hit an all-time high at $132 just three weeks ago, so even though the intervening time has taken it down 7% from that record, the overall trend remains strong here despite the noise. After all, this wasn’t even an $80 stock last May. Now it’s the top-performing Healthcare stock in the S&P 500.
It’s not hard to see why. Even when mid-tier Wall Street firm Guggenheim cut Eli Lilly to “neutral” last week, the firm had to concede that this is the best long-term growth profile in U.S. Pharma. They just think the stock has gotten ahead of that growth story, making near-term upside look precarious in their view.
We disagree. Smart investors always discount where stocks are now to focus on the future, and on those terms Eli Lilly looks like a stronger bet than anything else in Big Pharma much less the S&P 500 as a whole. Growth here over the next nine months may not be fast. That’s all right. We aren’t seriously expecting instant gratification from the market as a whole either, but investors are clearly willing to wait until at least 4Q19 for the fundamental engines to start spinning again.
By then, Eli Lilly will be in a position to run circles around both its immediate peers and the broad market. Nine months from now we’ll be looking at 14% earnings growth feeding into an even better 2020, without banking on any clinical trial success in the intervening time. There’s dramatic upside potential there in the form of outstanding diabetes drugs and a non-opioid painkiller, but if and when those programs become a commercial reality, it only accelerates the company’s glide path to glory.
BMR Take: Lilly has had some recent pipeline wins and acquisitions that raise the odds that 2019 will be a lot more dynamic than our projections suggest. Last quarter’s 4% revenue bump was a pretty good start, even if the comparisons get a lot harder from here. In the long haul, of course, Pharma is all about an aging global population and continued innovation driving growth. Eli Lilly has the best profile in the industry, and we see quality triumphing here in the short term as well.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
Last week we alluded to how "perception" is one of the major factors influencing the market. In fact, if we had to pick one thing that would kill this bull market it would be all the negativity in the media and the resulting disconnect between investor perceptions and the actual state of the economy.
The money media has argued for two years now that the United States is headed towards a recession. This claim is based in large part on the fact that both household and government debt are at all-time highs and the only possible result is doom and gloom. However, the truth behind that fact points in the opposite direction.
Debt is high in absolute dollar terms but as a percentage of household income and the economy as a whole the load is nowhere near record levels. U.S. consumers pay less of their income to manage their obligations now than they did at any point in the last four decades, while the overall impact on household balance sheets is also at its lowest point since the early 1980s. The overall load is high because we have a larger population making more use of available credit, but leverage as a ratio to assets is well within historical parameters.
As for government debt, the percent of debt relative to GDP is still low and more importantly, the Treasury only pays 2.4% a year in interest. Even if bond yields soared to 4%, financing the $21 trillion national debt would only eat up 2.7% of the U.S. economy. Most of that money would flow back to U.S. investors, keeping that economy moving. These are not doom and gloom numbers.
The media also beats the drum on student loan delinquencies, warning that this is the next credit bubble waiting to overwhelm our economy. Yes, student loan delinquencies are at all-time highs, but if you put them in perspective with all delinquencies – mortgages, credit cards, bank loans etc. – the number of consumers in trouble has actually dropped over 50% during the past 10 years. Compared to 2008-9, the pain just isn’t there.
Again and again, we see people use real numbers out of context in order to paint a gloomy picture, but we’re a long way from any kind of catastrophe. Remember, from 2008 through 2016 the U.S. economy plodded along at 2% growth at best. In 2017 we saw an uptick to 2.5% and it felt like a boom. Last year growth hit 3% and is on track to sustain that level of dynamism this year, no matter what happens with corporate earnings. That’s a 50% acceleration from the 2% era.
Meanwhile, even though we believe earnings growth has probably peaked, earnings are nevertheless still growing, so we must bear in mind that while bad news sells newspapers and advertising, relentless negativity can and often does have unintended consequences.
It's best to look beyond the doom and gloom because there is almost always a lot more to see. Our favorite "indicator" is the Non-Farm Payroll number, which not only beat expectations (reversing a steep drop in February) but did so alongside a material decline in wage growth. That’s just what the Fed doctor ordered: full employment and minimal inflation on any front.
Between progress on trade, a better-than-expected jobs report and a healthier slope in the yield curve, we suspect that growth – not recession – should be the natural outcome of today’s economic environment. We see the U.S. economy as the envy of the rest of the world: still vibrant, still growing and still trending upward.
The High Yield Investor
By John Freund
VP of High Yield
The Bull Market Report
The Federal Reserve has paused its recent campaign of tightening interest rates and the longer-term trend still points up as the economy keeps running hotter than it has in over a decade. Between the heat and a Fed on hold, it’s the perfect environment to rekindle your relationship with Municipal Bonds.
Munis generally perform well during times of rising rates for several reasons. First, their real return is a factor of both Fed policy and the tax code. Taxes on the wealthy have hit bottom, which means the odds of a more aggressive IRS taking a bigger bite out of taxable bond income are now almost inevitable. Higher tax rates give Municipal Bonds more space to shine.
Lo and behold, that’s exactly what’s happening today. The asset class is getting a nice bump from investors fleeing Treasury debt and other taxable bonds ahead of the coming electoral cycle. Today 10-year Municipal Bonds pay 1.9% tax free, which translates into 2.9% in taxable interest. With not even 30-year Treasury instruments paying anywhere near that rate, the real winner here is clear.
This dynamic has given our two Muni funds, Nuveen AMT-Free Municipal Credit Income Fund (NVG: $15.27, flat, Yield = 5.2%), and Invesco Municipal Trust (VKQ: $12.01, flat, Yield = 5.2%) what they need to print fresh 52-week highs after spending 2018 spinning their wheels. The Invesco fund is within 1% of its highest level in five years. Its counterpart from Nuveen has already broken through all historical barriers.
Nuveen is a Closed-End Fund, meaning it raised a fixed amount of capital from shareholders in a public offering, unlike mutual funds, which continually sell and redeem shares to meet fluctuations in investor demand. Since its $3 billion portfolio is stocked with Municipal Bonds, its 5.2% yield is tax-free, which means high-tax-bracket investors would need to find an 8% yield elsewhere in order to reap the same real return.
The portfolio is all about quality. Half of the fund’s bonds are rated A and 70% are “investment grade” (BBB+) or better, leaving only 30% of the portfolio invested in below-investment-grade debt from jurisdictions that have a minor chance of defaulting on their obligations. The company mandate allows for up to 55% of its portfolio to be allocated to “junk” in order to chase higher yields, but that’s unlikely to happen here. We’re very comfortable with the current mix.
Furthermore, Nuveen spreads its bets regionally, with only one state – Illinois – comprising more than 10% of the portfolio. California, Texas, Ohio and Colorado round out the top five states for investment. Its top three holdings are the Chicago Board of Education, the California State Communities Development Authority and the San Joaquin Hills Transportation Agency, so there’s a nice mix of industries there.
Instead of chasing higher income through taking on additional risk, the managers here look toward longer maturities. A full 65% of the fund’s bonds won’t be due before 2040, with another 25% maturing between 2029 and 2039. That’s as long as the horizon gets in today’s investment universe, and as a bonus the long view balances out all the short-term fluctuations in interest rates or Fed policy. Whatever happens today or next year will only be a blip when the 2030s roll around.
What we know, of course, is that taxes are more likely to go up than down, raising the effective value of tax-free investments over the intervening decades. In the meantime, Nuveen has also managed to grow the base return on its assets from $0.71 per share in 2014 to $0.81 today. That may not look like much, but remember, $0.80 tax free is the equivalent of $1.25 in taxable interest. It adds up.
Invesco, on the other hand, has a much smaller Muni Fund, with a market cap of around $700 million. The yield is in line with Nuveen’s, even though management has cut the payout $0.01 per share over the last two years in order to free up working capital. We’d rather see the fund maintain a little flexibility even if it means giving up a half penny a year.
Over 80% of the portfolio is investment grade (BBB or better), and over 60% is rated A or better. Quality is the overriding factor here, since management can only attribute 20% of capital to higher-paying and higher-risk “junk” and that allocation is already at maximum.
The top holdings here are the New Jersey Economic Development Authority, the Ohio Tobacco Settlement Financing Authority and the Washington D.C. Airports Authority. All told, Invesco’s top 10 holdings account for just 7% of its portfolio. Nuveen’s top 10 account for 10%.
We’re seeing a bit of a trend here: While Nuveen is diversified and relatively conservative when it comes to the types of bonds it invests in, Invesco is even more heavily diversified with lower overall risk.
Invesco also takes less risk on maturities, with only 45% of the portfolio due beyond 2040, reducing the odds of a catastrophic economic event across those decades forcing defaults along the way. Recall that a full 65% of Nuveen’s bonds mature in a similar period of time and there’s more time there for something to go wrong – even if the odds either way are slim.
The Muni asset class is coming back fast with a rising tide of tax proposals and a sense that IRS loads will never be this light again in our lifetime. Statistically speaking, this is the time to lock in any and all tax breaks while they’re available, and that includes Municipal Bonds and other tax-free investments. However, we never simply let the asset class do all the work. Real investing revolves around picking the best names out of a strong field, which is why we like both of these funds.
The Invesco fund in particular carries an 8% discount to its NAV, meaning it would take an 8% rally just to make the stock worth what its assets would fetch on the open market. There’s really no reason for this beyond its relative lack of sizzle. Investors looking for the hottest exposure to the normally cool Muni universe have ignored it in favor of rival funds like the one from Nuveen. Even so, that fund carries a 7.6% discount, so the mood across Muni Funds is anything but hot or even simmering despite the fact that both of these High Yield selections are at a multi-year peak.
They’ve come a long way but there’s room in the valuations for more. While we may face the future of tax policy with some trepidation, Muni Bonds exist in large part to shield investors from higher IRS obligations ahead. If this is the future, we’re in the right place.
Todd Shaver, Founder and CEO
The Bull Market Report