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The Weekly Summary

While the week got occasionally tense, volatility has evidently peaked for the time being. Wall Street now accepts that the trade war has escalated and that sweeping tariffs are more likely to take effect before we see signs of a breakthrough on negotiations. Progress simply looks grudging at this point, while the clock keeps ticking to the moment when imports will become more expensive and exports to China will freeze.

Nonetheless, we're satisfied to see the market mood firm up. Even though major indices declined again a bit last week, breadth is no longer overwhelmingly negative. On Monday, 97% of the S&P 500 declined in unnatural unison. A few days later, 45% of the market gained ground for the week as a whole. This is part of the process of recovering from shocking news. We've seen it again and again. Investors who initially panic at the headlines ultimately return to buy back the positions they liquidated, often at a higher price.

It's also nice to see our stocks hold up relatively well. The BMR universe retreated only 0.45% last week, beating all major indices. We had a few natural advantages here. First, our REITs and Healthcare recommendations fared well as safe havens, as well as bond replacements for investors fleeing declining Treasury yields. Our High Yield portfolio was flat. However, while most Technology-driven strategies have been suffering, our High Tech stocks surged an aggregate 4% thanks to huge earnings from Roku and Shopify.

Look behind the market as a whole and money is rotating into Technology as well as High Yield havens. Investors aren't fleeing risk across the board. The mood is less panicked than opportunistic. And in that scenario, we suspect our opportunities will shine brighter than a lot of other stocks. Some are already surging. Others are simply riding the wave.

There’s always a bull market here at The Bull Market Report! The Big Picture weighs the market as a whole to evaluate whether expectations are too high, too low or simply on track. Gary Jefferson is on hand to discuss the broad economic impact of even crippling tariffs and The High Yield Investor analyzes recent earnings from Omega Healthcare Investors, JBG Smith and AGNC Investment.

At least for now, earnings season is over. There are a few companies left to report later in August and early September, but this is a good time to look at a few of our favorite recommendations: Amazon, Microsoft, Visa, Roku, Paycom Software and The Carlyle Group.

Key Market Indicators


BMR Companies and Commentary

The Big Picture: What About The Rest Of The Market?

We’ve talked a lot about the stocks we recommend over the last few weeks. After all, that’s what The Bull Market Report is all about, and since our universe has outperformed the market as a whole this season, it’s been as much a delight as a duty. When investors are back in a buying mood, BMR stocks will top the list of opportunities they just can’t resist.

Of course we’re happier when solid quarterly results are rewarded with rallies instead of retreats, but this is not one of those seasons. Too many investors are obsessing over macroeconomic headlines to digest the way specific companies are rolling with the externals and still generating the kind of cash that rewards shareholders.

As far as these companies are concerned, tariffs aren’t a concern. Many are growing fast enough to weather the policy winds and still achieve management’s long-term objectives. Others are nimble enough to adjust their operations away from trade war threats. And quite a few are insulated from the global market because they still do the bulk of their business in the United States, free from currency concerns and other external headwinds.

The rest of Wall Street isn’t so lucky, but it isn’t as awful as some people want you to think. A year ago, interest rates were exactly where they are now and moving higher as the Fed tightened. People were optimistic, thinking we’d see at least 7% earnings growth continue for the foreseeable future. There wasn’t a cloud in the economic sky.

Back then, the S&P 500 rated a 16.6X earnings multiple, which is a little rich compared to some historical cycles but reasonable in a context of significant earnings growth and low interest rates. Low rates justify higher multiples because bonds just can’t compete as well with stocks for investors’ attention. Growth reduces the amount of patience we need for valuations that may look rich today to become more reasonable as cash flow compounds.

Expectations weren’t unrealistic. People were looking for the index to rise about 10% over the next 12 months, at which point they would have been comfortable seeing stocks command levels of 18.3X next-year earnings. They came awfully close.

Now here we are. Near-term growth expectations have cratered as it becomes clear that U.S. manufacturers and commodity producers can’t fight a strong dollar and rising trade walls overseas. Look out beyond 2019, however, and the outlook is brighter than it was a year ago. These companies have weathered a lot of margin pressure. Now they’re starting to grind efficiencies out of the economic realities they see.

Six months from now, the S&P 500 has a pretty good shot at getting the growth gears moving again. In a year, the market as a whole can easily be back in rally mode. After all, interest rates are dropping, taking financing costs down with them. If the dollar retreats as well, global competition gets a whole lot easier.

And once again, expectations are relatively modest. People are looking for the index to rise about 10% over the next 12 months, buoyed by a little growth on the horizon accelerating into 2020 as the Fed’s relaxed posture takes hold. In that scenario, the market would command a next-year multiple of 18.7X 2020 earnings, which is no steeper than what investors cheerfully accepted last summer and, factoring in likely growth, even a little more attractive.

We know that it can get hard to hear the signal through the day-to-day headlines. But tariffs just aren’t a huge factor in corporate guidance right now. More companies talked about trade threats a year ago than we’ve heard from in the last few weeks. The only difference is the distribution. Manufacturers and Commodity Producers will always feel the heat in a tense global environment, but now Big Tech is worried about losing access to foreign markets as well. As always, we’ll keep you posted when we see tangible impacts.


Amazon (AMZN: $1,808, down 1% -- all returns are for the week) 

After a seesaw week for the market, let’s take a look at some of our stocks that we believe will hold up best post-whiplash. Amazon is up 15% YTD, even after this week’s sell-off. We like this company long-term because of the broad diversification and shift into a cloud computing platform.

Amazon is generally thought of as an online retailer, but its cloud computing services business is actually on pace to outperform its e-commerce operation. Amazon Web Services (AWS), the company’s cloud service, has produced a 45% compounded annual growth rate (CAGR) over the last three years, as well as over 50% margins. That’s simply fantastic, and is the key driver behind the broader company’s 30% CAGR and 10% margins over that time frame. Although Microsoft’s Azure is coming on fast (see last week’s newsletter), AWS still dominates the sector with over 30% market share.

The cloud computing market is expected to grow 15-18% CAGR over the next three years, and we believe Amazon’s market share will increase as well. That’s some serious revenue on the horizon. And oh by the way, Amazon owns 50% of the e-commerce market, which still only accounts for 10% of total retail sales in the U.S. Both of those numbers will surely increase over the coming years.

Amazon is also expanding into other industries (why shouldn’t it?). With Twitch, the company owns the leading e-sports broadcaster. With Whole Foods, the company has a dominant grocery chain. The company is also exploring drone delivery and a burgeoning advertising business, which challenges key rivals Facebook and Alphabet. The company doesn’t know how not to be innovative, and will clearly be dominating industries for decades to come.

BMR Take: Amazon was just below the $1 trillion mark in July, and then the bottom fell out. But the blip is only temporary. Our $2,200 Target Price remains intact, and as long as people are still using the internet, we’re not selling Amazon.


The Carlyle Group (CG: $22.50, up 2%, yield = 6.2%) 

Financials took a big hit this past week, thanks to an escalation of the trade war with China. But that’s all the more reason to love The Carlyle Group, which just paid a $0.43 dividend and maintains a dominant position in a niche sector of Finance: Private Equity.

Carlyle acts independently of the big banks, which have been getting hammered in the market. The entire Private Equity sector is benefitting from a collapse in the hedge fund space, which is sending institutional capital into Private Equity. Carlyle alone is on pace see its aggressive $100 billion fundraise oversubscribed by at least 20% by year-end. That is simply astonishing.

Since Carlyle charges fees on the assets it manages, the more money it raises, the more revenue it takes in. Plus, the company recently made its long-awaited announcement of a transition to C-Corp status. This provides major tax incentives, and also allows the stock to be purchased by investment entities that could not previously own shares due to regulatory issues. This alone will boost liquidity, as we’ve seen with rival KKR which announced C-Corp status a while back.

BMR Take: The stock is up over 40% YTD, which is an enormous upswing for a Financial Services company. The recent fall from the $25 level is a buying opportunity, as the stock got caught up in a bearish moment. (If “a rising tide lifts all boats,” then the opposite is also true.) But the tide – and Carlyle’s boat – won’t stay down for long. All of the positive tailwinds will resume the upward trend, and we would expect the stock to reach our $28 Target Price in a matter of months.


Paycom (PAYC: $241, up 2%) 

Paycom can do no wrong, even in a market downswing. The stock had another phenomenal quarter, and the global growth strategy is playing out exactly as management hoped it would (organically, with very little leverage).

2Q19 revenue rose 31% YoY to $170 million, and EBITDA came in at $70 million, well-ahead of the $64 million consensus expectations. No matter how high the consensus, Paycom always outperforms. Management raised its 2019 EBITDA estimate to $307 million, up from previous guidance of $297 million. That sent the stock soaring, which of course we love.

Some other notable metrics are recurring revenue, which came in at $166 million, or 3% above consensus, and gross margin which topped 85% (consensus was below 84%). These numbers prove Paycom is monetizing its current user base to a greater extent than the market expected, and that they are doing so in a more efficient manner (that gross margin beat is terrific).

BMR Take: Paycom has over 13,000 customers and growing. Continued income growth means management can expand its global footprint without a reliance on debt. How many $15 billion growth-companies can say that? The company has $95 million in cash and only $60 million in debt. If those numbers were reversed, we’d still be comfortable with the liquidity given the margin and income growth. But as is, management has a ton of flexibility should it wish to pursue acquisitions or expand the sales force. We love Paycom’s position as the industry leader in human capital management, and predict continued upside for this shining star of a stock.


Roku (ROKU: $125, up 25%) 

Speaking of companies that can do no wrong, how about this one? The company blew away the Street’s expectations yet again, and the stock is primed to keep its winning streak alive as a result.

Roku hauled in $250 million in revenue for a 60% YoY gain, and produced a loss of $0.08 (the market had been expecting a loss of $0.21). Gross profit rose 50% to $115 million. These are fantastic numbers.

This is a company that’s riding a cord-cutting revolution, as more and more Millennials (everyone actually, but mostly Millennials and Gen-Zers) ditch their expensive cable subscriptions for streaming content capabilities. And since the Roku device allows users to access multiple streaming services, the more entrants the better. With Disney and others chasing Netflix into the space, it only makes Roku’s business model that much more attractive.

BMR Take: Roku was our best-performing stock of the first half of the year, and we have every reason to believe it will finish the year that way. It might sound crazy to expect a stock that’s up nearly 300% YTD to keep soaring, but given the industry tailwinds and revenue and EPS growth rates, we think it’s irrational not to expect that. Our $125 Target Price remains temporary, expect a raise real soon.


Microsoft (MSFT: $138, up 1%) 

This is another stock that’s looking impervious to market conditions (up 40% YTD). There are so many great stories with Microsoft, we hardly know where to start. Azure is a good starting point though, considering that it is rapidly catching up to Amazon’s AWS cloud computing dominance. AWS owns around 1/3 of the market, with Azure nearing the 20% mark. Microsoft is the only company in realistic contention with Amazon in the highly-profitable and growing sector. The company also moved its LinkedIn platform over to Azure (finally).

And speaking of LinkedIn, the business-oriented social media site is looking like a steal at this point. Remember, Microsoft took some serious heat for shelling out $26 billion, but annual revenue for LinkedIn rose nearly 70% in 2018, to over $5 billion, and is expected to reach $10 billion by 2022 and Microsoft hasn’t even fully-monetized the platform yet (they are focused on growing the user base). So far, LinkedIn counts over 600 million users, with more than 70% of them are international. Job listings are also becoming a larger part of the LinkedIn network, with 30 million companies posting 20 million job openings per year. This creates a whole new revenue stream, which Microsoft hasn’t even touched yet.

Microsoft also just purchased PromoteIQ, a retail advertising startup. While this small acquisition (terms undisclosed) may have gone relatively unnoticed, it actually positions the company to take on Amazon in online advertising, an increasingly important space in the digital world.

BMR Take: What’s not to like about Microsoft? The company is firing on all cylinders, and even when the market hits a speed bump the stock stays fairly steady and sits at all-time highs. There is limited exposure to China, so the trade war can’t do much damage. Investors are wise and haven’t been fleeing the stock, which we expect to continue its upward trajectory once the market finds its footing.


Visa (V: $179, up 1%) 

Visa has come down a shade off its all-time high of $184, but the stock remains up over 30% YTD.  The quarter was another strong one, with 2Q19 (technically fiscal 3Q19 for Visa) turning in $5.8 billion of revenue for an 11% YoY change. Net income surged 33% to just over $3 billion. These are very impressive growth numbers for a $400 billion company.

Visa is accomplishing this by focusing on non-card transactions. Visa Direct is the company’s contact-payment system, and Visa is partnering with global brands to embed its pioneering technology into their workflow. The company already counts five of the top-10 Insurance companies in the US as Visa Direct clients. And Insurance isn’t exactly an industry known for innovative partnerships. Visa is making strong headway internationally, partnering with the likes of PayPal for an instant transfer platform launch in Canada.

BMR Take: The more seamless a Visa transaction becomes, the more transactions are initiated by customers. That means more revenue, as the aforementioned financials illustrate. Visa is on the right strategic path here, and it’s good to see a blue chip be so forward-looking. Visa is a lot like Microsoft – easy to confuse for a dinosaur, but in reality the company is on the front-lines of the digital revolution.


A Word From Gary Jefferson

Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.

The number one thing we try to remind ourselves of during these big market selloffs is that the mainstream financial media, with its never-ending barrage of doom and gloom, is really only trying to win ratings. Market psychologists have repeatedly lectured that "fear" is the number one seller when compared to all the other emotions. Therefore, taking a look beyond all the headlines, the University of Michigan Consumer Sentiment index has shown that the consumer has been strong and "continues to gain strength."

Thus, the consumer is strong, has been getting strong for the past two years, and doesn’t show any signs of letting up. The GDP numbers are fine as well, so, if you look at this combination of a strong consumer confidence along with good GDP and use history as a guide, it clearly points to higher stock prices. Another important aspect to keep in consideration is the employment picture, which is better than it has been in decades. The all-important non-farms payroll report only needed to deliver 151,000 new jobs in July to make the economists happy. Instead, we got a better than expected 164,000.

But, if there were still any concerns, the Fed has repeatedly said they were committed to ensuring the economic expansion continues.  Lower rates have almost always pushed investors from fixed income products into the equity markets as yields will move lower.  Rate cuts will also drive mortgage refinances, new home purchases and potentially new car purchases as well. More importantly, the availability of capital will also drive investment by businesses, which had been stagnating once rates went over 2%.

It seems like we keep talking about these same things weekly but, due to the one-two punch of the media and volatility, it is important to always keep them in mind because they bode well for higher stocks. After the most recent 700-point selloff, various firms said they still expected the S&P will gain 30% more by year’s end. We don't predict exact numbers, but we believe the market, notwithstanding the tariff conflict, should be "just fine" and will end higher rather than lower.

Forecasting a higher market is based on consensus numbers used by many experts. It's been estimated that the first round of U.S. tariffs on $200 billion of Chinese goods and the Chinese tariffs on $60 billion of U.S. goods would only shave 0.2-0.3% off of our GDP growth and 0.5% off of China's. That number climbs to 0.4% to 0.5% off of our GDP if/when the U.S. levies tariffs on the additional $300 billion. And that would likely shave more than 1% off of China's GDP, which is enough for Beijing to start worrying about.

But with our GDP growing at a 2.6% rate, we're starting from a great place. And the clear consensus of all the experts we have heard from said it would take a lot more than a half percentage point reduction to hurt this economy. In fact, we'd still be growing at a faster pace than the first 8 years of this recovery, and faster than the average annual GDP of this whole expansion.

Our bottom line: Don't listen to the doomsayers who are reading the worst into this pullback. They have been absurdly wrong in their trade-war and recession predictions and what that would mean for the market for the past two years. When you look past the headlines at the real numbers and use history as a guide, the economy -- and therefore the markets -- should be "just fine."


The High Yield Investor

By John Freund
VP of High Yield
The Bull Market Report 

There are some choppy waters out there for the market as a whole, but that doesn’t mean every stock has to suffer. Take Omega Healthcare Advisors (OHI: $39, up 6%, Yield = 6.9%). Omega announced strong earning this week – nothing mind-blowing – but enough to propel the stock forward amidst otherwise gloomy market conditions.

2Q19 revenue was $225 million, which is a 3% YoY gain. FFO – a key measure of profitability for a REIT – came in at $0.77. That beat 2Q18’s FFO by two cents, and market expectations by a penny. Unfortunately, not all was rosy, as net income slipped from $82 million last year to $76 million this year, for a 7% drop. Management said there was a one-time $15 million reduction in gains due to a sale of assets, coupled with $10 million of impairments financing leases and real estate properties, as well as $4 million of costs related to the recent MedEquities purchase. So based on this, everything appears to be in order with this great firm.

We’ve written in previous newsletters about the benefits of the MedEquities acquisition. The $600 million acquisition adds 34 new properties to the portfolio, and management has stressed the growth opportunities that lies ahead with certain of these properties. This is also one of the best management teams in the REIT universe, having steered this company through thick and thin (The Great Recession, the REIT-apocalypse which wiped out a huge chunk of the industry back in the early 2000s, and the latest restructuring). So when CEO Taylor Pickett gets excited about an acquisition, we get excited.

He also noted during the earnings call that Omega signed a Purchase Agreement to acquire $735 million of skilled nursing and assisted living facilities, as well as the completion of a $25 million acquisition in July. The restructuring is officially complete, and management has turned its focus to growth via M&A and reinvestments into its properties. 2Q19 saw $55 million of capital renovation and construction, a 30% increase from the prior quarter.

One hiccup is that management lowered its full-year 2019 adjusted FFO guidance. Consensus estimates are at $3.08 for the year, and management announced a $3.03-$3.07 range. The company is planning a sale of 10 Diversicare properties, and also plans to continue issuing equity in order to de-lever, both of which are great for the company’s long-term strategy, however each may negatively impact FFO in the near-term.

Omega has long been a conservatively-run REIT, so the de-levering and asset sales don’t come as a shock. It’s management’s conservative nature that enabled the company to secure favorable lending terms which helped it emerge from the restructuring much faster than anticipated. So we like seeing more of the same.

The stock is up 10% YTD, and it still offers a healthy 7% annual yield. The stock briefly touched the $40 mark earlier this year, and we’re looking to get back there by year-end. Omega has one of the best management teams in the business, and is bouncing back from a sharp turnaround, so we expect continued strength and an upward trajectory for the stock.

JBG Smith Properties (JBGS: $38, down 1%, Yield = 2.3%) is another stock doing well this year. Up 10% YTD, the stock was cruising above the $40 mark before tumbling on the latest market downturn. That said, JBG is only impacted by the China trade war indirectly, through its tenants like Amazon.

Yes, Amazon is directly impacted by rising prices out of China, but to say that impact carries over in any measurable way to JBG is a stretch. Amazon’s HQ2 is still being built in Washington, D.C., and JBG is the landlord. None of that is going to change, trade war or no trade war. With the Amazon deal, JBG is on the cusp of transforming from a powerful regional Real Estate player into a nationally-recognized brand. We expect the company to expand out of the D.C. region in the coming years.

The fundamentals are also rock-solid, with 2Q19’s revenue coming in at $160 million for a 1% YoY gain, and FFO reaching $0.41, $0.05 more than consensus expectations on Wall Street. The commercial portfolio remains 90% leased, and the multi-family portfolio is 98% leased. Those numbers have held steady all year long.

JBG executed 1.2 million square feet of new leases during 2Q19, roughly half of which belong to Amazon’s new headquarters at the National Landing site, right next to Reagan National Airport in Virginia, outside of Washington. The good news is all of this new square footage is part of three new leases Amazon signed in current JBG office space. These new leases will operate in conjunction with the headquarters being established nearby. The impact of Amazon’s arrival elevates the value of all nearby office space, a majority of which is owned and operated by JBG. So the company benefits on two fronts here – first by having Amazon establish a headquarters which they will manage, and second by watching the value of their current office space rise as a result.

With 40 projects in the development pipeline totaling 19 million square feet (4 million of which belong to Amazon), there is a lot to get excited about for JBG. Again, we see this company eventually expanding beyond Washington, D.C. But in the meantime, there is plenty of room to grow in one of the nation’s best Real Estate markets. The stock is reflecting that growth potential and will continue to do so as the company expands its portfolio.

Not all of our stocks have been faring well this year, however. AGNC Investment Corp. (AGNC: $17.07, down 1%, Yield = 11.4%) is down 3% YTD after a tough 2Q19. The stock bounced back towards that $18 mark, only to tumble on the latest China trade war fears.

Finance is taking some hits on the trade war escalation, and AGNC is a middle-market lender so they’ve been caught in the tumult. However, the company doesn’t have the exposure to China that banks and major financial institutions do, so any sell-off here is strictly as a result of the broader sector being pressured downward. It’s not like the potential for China’s currency devaluation directly impacts AGNC, as it does the big banks.

Additionally, the China trade war is only temporary (even if it doesn’t seem that way at the moment). Eventually, the trade war will end. Likely either right before or after the 2020 election -- before, to give Trump a boost to the economy going into the election, or after, once China realizes Trump is serious and this could last for years, then they will make a deal with Trump if he is reelected. If the Democrats win, they will definitely make a deal with China and end the trade war. So we don’t see the trade war lasting much longer than another 12-18 months, at the very most.

We here at BMR always invest for the long term. So in addition to having limited exposure to China which mitigates their downside risk during the trade war, AGNC has strong fundamentals which provide the stock every reason to move higher when the trade war finally subsides.

2Q19 net interest income (NII) came in at $123 million, for a 30% YoY increase. At $0.49, EPS missed Wall Street’s expectations by a single penny. Most of the company’s portfolio is agency mortgage-backed securities, and that asset class was adversely impacted thanks to several financial complexities which took place as the market foreshadowed the eventual Fed rate cut (elevated repo funding rates, for example). Suffice it to say, these issues will subside now that we are in a declining rate environment, so AGNC’s earnings outlook is picking up steam going forward, and we don’t expect the EPS miss to be an ongoing problem.

The company offers an 11.4% annual yield (that has kept us in the black this year), and the elevated NII levels keep this hefty payout safe. Plus, now that rates are coming down, we expect NII to pick up even further, thus providing more wiggle room for the company to cover their dividend.

All told, it hasn’t been the best six months for AGNC, but it hasn’t been the worst either, and there have been a lot of headwinds which could have greatly-impacted the stock but didn’t. AGNC has been showing resiliency all year long, which tells us that now that interest rates are coming down, the stock is likely to pop back above that $18 mark. And of course, there’s always the double-digit yield to fall back on.

Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998