The Weekly Summary
The Fed has spoken and, just as we expected, once again interest rates have come down. If you're counting on additional rate cuts, Jay Powell explicitly left the door open. However, it all depends on inflation edging above 2% for an extended period, so we'll simply have to see. We think that the cuts are just about done.
From our perspective, the important thing is that the market now has a little extra stimulus on its side to make sure stocks remain a more compelling proposition than bonds. Treasury yields have dropped a lot over the past year, pushing income-oriented investors out of the bond market into dividend-paying stocks like our REIT and High Yield recommendations. Meanwhile, with the Fed pushing downwards on the short end of the scale, the yield curve is healing, eliminating the psychological pressure on investors schooled to equate an inverted curve with a recession on the horizon.
From the employment and GDP numbers we saw last week, there's no recession coming in the immediate future. The job market remains robust. We're not seeing mass layoffs. All we see is steady hiring despite all the uncertainty that corporate executives have weathered in recent months. Furthermore, the economy is still growing at a 1.9% annualized rate . . . not a boom, but enough of an expansion to drive stocks higher under the right conditions.
Earnings are decent, again reflecting an economy that is slow but not stagnant. While the year-over-year comparisons for the market as a whole are not good, the 3Q19 numbers have been a little better than we initially thought. At this rate, we could see real growth return to the market early next year, which is not long to wait. And of course BMR stocks are still delivering some nice year-over-year growth, so we're ahead of the game either way.
There’s always a bull market here at The Bull Market Report! After last week's overstuffed Earnings Previews, the schedule relaxes a little with only one BMR company (Shutterstock) reporting its numbers before Tuesday night. We also have updates on the numbers from Alteryx, Berkshire Hathaway and, in the High Yield Investor, Office Properties Income Trust as well as newly restored recommendations Annaly Capital Management and New Residential.
Beyond that, Gary Jefferson ponders how long the bull market can continue. In his as well as our view, the answer is "a long time," especially after the year that the S&P 500 has survived. The road from November 2018 to now is the topic of this week's Big Picture. Add updates on CyberArk, Dropbox, Johnson & Johnson and TPI Composites (which you'll see in upcoming Earnings Previews as well), and we have a lot to cover. Let's get started.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: What A Difference A Year Makes
Here we are with the days once again ticking away on another market year. Twelve months ago, Apple (AAPL: $256, up 4% this week) was in the early stages of warning investors that global demand for new iPhones had hit a wall and overall revenue was going over a 5% cliff. The stock dropped 36% from what was then a record peak, taking the rest of the S&P 500 with it.
Now their business is back on the rise. New products and especially Services are stepping up to fill the gap a mature iPhone market left in the quarterly results. Expectations have receded to more realistic levels. The stock has rallied 11% beyond last year's high and there's no ceiling in sight. And again, as Apple goes, the market follows.
The economy hasn't deteriorated over the past year. The trade war hasn't gotten resolved, but it hasn't gotten much worse either when you cut through the rhetoric. Corporate guidance has receded a little, but profit targets haven't budged. A year ago, Wall Street was looking for 9.4% earnings growth. Now the projections point to a 9.8% higher bottom line by the time 2020 is over. That's significant. All the best math in the market signals that the future looks as good as it ever did.
Of course investors didn't get that growth, and as a result the S&P 500 had trouble making real progress. Cut off from fundamental fuel, the market as a whole is up 5% over the past year . . . and close to half of that return is from dividends. Those who decided to hold their stocks waiting for earnings to recover are a year older and don't have a lot to show for their patience. End to end, their portfolios haven't lost ground. They just haven't made big gains either.
Of course investing isn't always about instant gratification. Sometimes it can take a year or longer for conviction to pay off, and if growth comes back in 2020, the S&P 500 will have what it takes to return to its normal bullish performance. Remember, the index usually moves about 10% in a typical year, so in the long haul it will make up for what is currently lost time. Meanwhile, however, patience needs occasional incentives to keep from deteriorating, and we aren't convinced 5% a year is what it takes to compensate investors for putting up with last year's 20% downswing along with months of trade-related volatility more recently.
Furthermore, the market as a whole looked a little rich (but far from "bubble" territory) a year ago and now presents even less of a bargain. Every bit of progress the S&P 500 made last year only pushed price-per-earnings calculations higher in the absence of real earnings progress. A year ago, someone could pay a 15.6X multiple for the market as a whole. Now those same stocks carry a 17.2X multiple. That's not a deep discount, but as long as growth prospects remain alive, it's clear that that's what people will pay.
After all, the Fed has changed direction over the past year. Even if earnings and growth targets are exactly where they were last November, rising interest rates were a drag on the mood a year ago. With rates more likely to keep dropping in the foreseeable future, stocks can justify higher multiples because there's more easy money to float the market. This is how stocks rally in the absence of real earnings growth. We saw something similar in 2015-16 and know it can happen here.
But it's not like we need to deviate from what we're doing, either. The S&P 500 has delivered a grudging 5% from last year's peak. BMR stocks are up 20% over the same period. We always had growth on our side and that situation hasn't changed. Since the Fed lifts all boats, we've enjoyed the benefit of more relaxed rate policy as well as the ambient dynamism driving our recommendations.
We hope 20% has been enough to compensate you for a volatile year. We admit that our patience has frayed from time to time, but on the whole it's been worth it. Compared to just about everything else, from bonds to foreign stocks, the BMR universe has been one of the best places for money to work. And if the market as a whole has a better 2020, we see no reason for that story to change. Earnings growth for our stocks has slowed thanks to the same forces that held the rest of the market back over the past year. The more acceleration we see, the faster they'll keep moving to the upside.
Johnson & Johnson (JNJ: $131, up 2% last week)
After Johnson & Johnson agreed to pay just over $100 million to resolve the transvaginal mesh claim, it appears the worst of the company’s legal troubles are now behind it. There will likely be more settlements, as several states from the multi-district litigation were not included in the settlement announcement. That said, $100 million-plus is a pittance for this $350 billion company.
There was some concern that Johnson & Johnson would take a serious hit from the litigation, and face a payout that would materially affect its bottom line. But that concern has now abated, and it’s all-systems-go from this point on. The stock is up 2% YTD, and has risen on news of the settlement. We expect further increases, as this is a fundamentally sound Pharma company, and one of the best defensive plays in the market.
BMR Take: Johnson & Johnson is one of only two companies to be rated AAA (the other is Microsoft). That makes the company more dependable than the federal government, which has a AA+ rating. And why shouldn’t it be? The company has raised its dividend in each of the last 56 years. The company has $18 billion in cash and only $30 billion in debt. We’re in Johnson and Johnson for the safety and security of the dividend, and the minimal downside risk to the stock. In times of market volatility, every portfolio should be diversified with Johnson & Johnson.
Alteryx (AYX: $99, up 6%)
Alteryx is a data science and analytics company that seeks to empower ‘data citizens.’ The company’s software allows non-tech users to easily and efficiently analyze data. With data becoming more and more integral to all business operations, Alteryx’s data citizen strategy is endearing the company to customers across the globe.
The company’s 3Q19 was strong. Revenue of $103 million increased 65% YoY, and EPS of $0.24 beat consensus estimates by $0.15. The company posted a loss of $6.2 million, compared with a loss of $11 million the year prior. Alteryx is a growing mid-cap Tech company, so profit isn’t on the menu at the moment, the key here is growth – specifically revenue growth. And Alteryx is posting plenty of that.
The current data science market is $50 billion, and Alteryx owns around 1% of it. So the company has plenty of growth potential in front of it. With the unique data citizen approach, Alteryx is bound to keep growing for some time, and that should bode well for the stock.
BMR Take: The stock is up over 50% YTD, and had been much higher – having crossed the $140 mark in September. The SaaS market sold off recently, but with the latest strong earnings from the company, expect a serious bounce for the stock through the rest of the year.
CyberArk (CYBR: $106, up 6%)
CyberArk is another example of an SaaS company that was oversold during the past two months, and is now on the verge of an upswing. The company just reported strong 3Q19 numbers, with revenue of $100 million rising 29% YoY, and EPS of $0.59 beating market estimates by $0.12. Management raised its full-year revenue target to $421 million (consensus is $418 million), and EPS to $2.27 (consensus was $2.16).
CyberArk is a leader in privileged account management (PAM) security, a niche sector of the Cybersecurity market. Cybersecurity is a booming industry at the moment, full of excellent companies that focus on personalized aspects of digital security, CyberArk being one of them. Analyst Cowen recently named CyberArk the leader in PAM security, noting PAM is the one of the fastest-growing areas in the space, and raised the stock to ‘Outperform.’
BMR Take: After the tumble from its 52-week high of $147, CyberArk is still up 36% YTD. We see the entire SaaS sector bouncing after a rough couple of months, and while a rising tide lifts all boats, the best boats will bounce the highest. CyberArk is one of the best Cybersecurity companies out there, so if the market holds we’re eyeing a climb back towards $140 as the year ends.
Dropbox (DBX: $20, up 3%)
Dropbox has over 500 million customers. The only problem is, around 485 million of them are non-paying. But that’s a good problem to have, however, as the company has been accelerating its transition of free customers to paying ones. And convincing people to purchase once they already have an account is much easier than doing so when they’ve never used your product before.
Part of the company’s strategy is to upgrade its core service of document storage. Management has formed strategic partnerships to integrate the product with popular tools like Zoom, Slack and Atlassian. Dropbox has so far converted less than 3% of its total user base. Average freemium conversion rates are 2-6%, so if Dropbox can reach the higher end of that spectrum, that would double the entire paid user base. But the company doesn’t have to get there. Just another 1% conversion adds 5 million more paid users, and revenue and EPS will shoot through the roof (as well as the stock).
Some are concerned about competition from the likes of Box, but Box is enterprise-focused. Dropbox is focused on the individual user. The company has a first-mover advantage, having pioneered the document storage space. With the product upgrades, we expect at least 1% conversion if not more on the way.
BMR Take: The stock is down 3% this year, so we’re not happy. That said, we understand the market’s hesitation here, as they’re in a wait-and-see mode to see if the new product integrations will translate into new paying customers. We’re optimistic, but will be keeping a close eye on customer acquisition numbers as we turn the corner into 2020. The stock is up 11% since the start of September, so we could be in the midst of a nice bounce here. All of the risk is already baked into the stock, so any positive news regarding customer acquisition will send Dropbox back into the mid-$20 range, where it spent most of the year.
Berkshire Hathaway (BRK-B: $43, flat last week)
Warren Buffett turned his massive portfolio around last quarter, generating 14% more profit than it did a year ago as the impact of faltering bets on companies like Kraft Heinz recedes from the trailing comparisons. Two things really stood out in yesterday's earnings report. First, Berkshire Hathaway only bought $700 million of its own stock in the quarter, indicating that Buffett is getting more eager to put his cash to work on acquisitions. Second, that cash hoard has expanded to $128 billion, which means there are only a few dozen stocks big enough to support the kind of strategic position Buffett prefers.
What we know is that Buffett is open to raising his stake in the biggest Banks. He likes Railroads. He's intrigued with the value and cash flow lurking in Energy Infrastructure . . . pipelines, refineries, any company that generates incremental income without taking on huge amounts of risk from the twists in the global Oil market. He likes companies that keep America and the rest of the world humming along at a Main Street level.
BMR Take: While Berkshire Hathaway has lagged the S&P 500 this year, we're up 4% since July and odds are good this earnings report will give the stock move space to catch up to the broad market. After all, we knew this wouldn't be an instant success. Nothing associated with Buffett moves fast. He's about the marathon win and as long as BMR subscribers can nibble on the stock, you're in it with him. Our $230 Target on Berkshire Hathaway will one day be a fond memory. For now, this stock has what it takes to get there, no matter where the broad economy goes.
TPI Composites (TPIC: $21, up 3%)
TPI Composites is our renewable energy investment. There are a lot of tailwinds for the industry (pun intended), as renewables are gaining steam as a mainstream political cause, and the cost of production continues to decrease, making renewable energy a more viable option for the economy.
The company has suffered from the China trade war (there is a lot of exposure to China), yet sales of wind blades increased during 2Q19, producing $300 million in revenue for a 46% YoY gain. The company improved its margin by 20%, now up to 6%. That led to an EBITDA of $20 million, for a 45% YoY gain. Yet the stock was hammered on lower full-year guidance, which came after a series of unlucky one-time events (a labor shortage in Mexico and a client bankruptcy), which happened during the trade war.
The stock is up 20% since the drop in August, but we still feel it has been oversold. This is a fundamentally sound company in a booming industry. There are bound to be hiccups along the way, as this brand new energy source gets integrated into the global market. That said, TPI is leading the renewable energy revolution, and an investment in this company now gives you a position in that revolution that will continue to pick up steam. We believe it will.
BMR Take: The past few months haven’t been good to TPI. However, the worst is behind this company. The only major concern is the trade war, and there is a possibility of a deal getting done before the 2020 election (we think this scenario likely). We’re hopeful the stock can get back to the mid-$20s range and finish the year flat. Earnings are only days away. Look for the Preview in your email with our thoughts on the fundamentals.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
The bull market for stocks may be old but it’s not dead yet, according to one of Wall Street's biggest bankers. Strategists at Citi said last week that while clouds are gathering over the global economy, it’s not time to sell in this market yet. We agree, mainly because the U.S. is still a better-looking economy than what we see in Europe or Asia or anywhere else. It seems to us that every time any important data has a miss here or there, the media whips up the markets and recession fears begin anew. What this has done is fuel a rotation away from cyclical sectors and towards defensive sectors . . . and there is no real threat of a recession on the horizon.
The top performing sector last quarter was Utilities (+9.3%), followed by Consumer Staples (+6.1%). For the past year these have been the top performers, with Staples beating Tech by a margin of 2-to-1 and Utilities outperforming by a margin of 3-to-1. The result is that now the Utilities sector's P/E ratio is at an all-time high, possibly making it the most overvalued sector with Consumer Staples not far behind.
Investors are overplaying the defensive hand and paying dearly for it. This is all because the media has convinced investors that the recession is nearly upon us. This is simply not the case. If the economy was on the brink of a recession, we would not be seeing the financial, semiconductor and U.S. home construction sectors breaking out to the upside. Ask yourself a simple question: "Who has the most growth potential, utilities and grocery stores, or the semiconductor sector on the verge of 5G, Internet of Things (IoT), big data, artificial intelligence (AI), analytics, augmented reality (AR), computer vision, robotics, smart homes, digital ecosystems and autonomous driving?"
Meanwhile, a robust labor market, steady wage gains coupled with low inventory and low mortgage rates are fueling the fastest growth rate in new home starts in over a decade. And in the Financial area, Jamie Dimon at JP Morgan recently attributes the strength of operations to "consumer spending, credit trends staying solid and a very healthy business activity." We view the strength being exhibited by these sectors (along with others) as a signal that economic activity is not slowing down and headed for a recession, but rather as activity that should extend this bull market for at least another couple of years if not longer.
Bottom Line: being diversified is extremely important, but piling into utilities which now trade at an all-time high because of recession fears may be premature based on economic data that still points towards further growth. In other words, the investor who remains patient and engaged in a long-term horizon will do better than those who are beholden to headline news cycles and try to "time the markets."
Earnings Preview: Shutterstock (SSTK: $41, up 14%)
Earnings Date: Tuesday, 8:00 AM ET
Revenue: $161 million
Net Profit: $6 million
Year Ago Quarter Results
Revenue: $151 million
Net Profit: $13 million
Implied Revenue Growth: 6%
Implied EPS Decline: 50%
Sell Price: $35
Date Added: January 16, 2018
BMR Performance: -6%
Key Things To Watch For in the Quarter
Shutterstock is up a solid 13% YTD, even though the company was written off by many analysts who didn’t foresee it meeting growth expectations. While 2Q19’s revenue of $160 million did miss expectations by $10 million, it was a 3% YoY gainer, and proved that the company isn’t in as bad a shape as many predicted. EPS of $0.33 also beat expectations by two pennies.
This time around, slow revenue growth has already been baked into the cake. Imagine what would happen if Shutterstock produces a better-than-expected quarter in terms of revenue growth? That’s entirely possible, given the way management has been upgrading the company's Media Licensing operations, with technology upgrades that improved page load times and mobile device functionality.
That has led to an uptick in revenue growth for Shutterstock's core online business, which represents 60% of the company's overall revenue profile. On that respect, we're looking for a decent top-line number Tuesday morning. It's expensive to keep the technology fresh, so profit probably took a hit.
However, we're just here for the sales trend. As tiny as this company is, even $10 million improvement a year can ultimately push the stock a long way. We've already seen Shutterstock soar 14% in the last five days, purely on anticipation that this quarterly report will be even a little bigger than expected.
The High Yield Investor
By John Freund
VP of High Yield
The Bull Market Report
It seems that the worst is over for Annaly Capital Management (NLY: $9.10, up 3.5%, Yield = 11.1%). The company reported earnings this past week and although numbers fell short of expectations, the stock rose as the forward-looking guidance is strong.
3Q19 book value fell by 1% YoY to $9.20, and EPS fell 16% to $0.21. Net interest income actually rose 12% to $920 million, so not all of the numbers were bad. That said, this earnings call was more about the future than the present. With the Fed lowering interest rates, the yield curve normalizing, and the cost of financing continuing to decline, Annaly is in good shape as we head into 2020. The company earns money off of the spread between short-term and long-term interest rates, and with that spread widening, Annaly is positioned to continue growing income. The company has also been diversifying its product base, and the low cost of capital will factor into that expansion as well.
Management made the fiscally conservative decision to slash its dividend by 17% earlier this year, anticipating the worst regarding the inverted yield curve and the China trade war. Turns out the yield curve inversion was only temporary, and doesn’t appear to be presaging the onset of a recession, as previous inversions have. And the trade war is tapering down – potentially even ending altogether. President Trump has too many other problems to worry about, so it’s unlikely he spikes the trade war pressure. If anything, a negotiated deal with China before the 2020 election is the most likely outcome here.
As we pointed out last week, Annaly’s stock had already been beaten down to historic-lows, so it really has nowhere to go but up. This earnings call wasn’t great, but all of that bad news was already baked into the stock, and the forward-looking indicators are good, so the market rejoiced and sent the stock higher 3%. Even after the dividend cut, Annaly is still paying over 11% per year in the form of a fixed income yield. So there’s a lot to get excited about with Annaly over the coming 12 months.
We re-inserted Annaly into the portfolio last week, predicting that the stock would begin its bull run now that the yield curve inversion is in the rearview mirror and lower interest rates are the new normal. With the latest pop, it seems we got in at the exact right time. Remember, Annaly is the largest Mortgage REIT in the world, and its sheer size means that the stock doesn’t swing a whole lot in either direction. But that’s okay. We’re happy to accept modest gains while we continue to bank that 11+% yield year-in and year-out.
With Annaly on the upswing due to improving macro-economic conditions, let’s take a look at how these conditions will impact a couple of our other HYI investments. New Residential Investment (NRZ: $15.98, up 2%, Yield = 12.6%) is the other HYI stock we added back into the portfolio last week. As we mentioned last week, the normalization of the yield curve is good news for New Residential, since the company relies on servicing mortgages. When long-term interest rates go up, people don’t refinance as often, which means the life-cycles of the mortgages they service last longer, which in turn translates to more revenue. The Fed lowering rates may negatively impact New Residential, which performs better during times of higher interest rates. That said, the yield curve is the key factor here, and as long as long-term rates are ticking back up, that’s what’s most important for New Residential’s go-forward strategy.
And the stock has reflected yield curve’s progress. Now trading back at $16, we believe the stock can easily pop back into the $17+ range, where it traded for most of the year. The current book value of the stock is just above $16, and the stock rarely trades below its book value. Now creeping up to book value, we feel confident it will break through and get back to over $17.
While that’s not a big move, remember that the stock is currently offering 12.6% in annual yield. Plus, the company has covered its dividend with earnings by 114% over the past year. So even though that dividend is massive, it is very safe. This is a fabulous investment opportunity for anyone looking to park some money in a high-yield REIT.
One other stock we’ll look at this week is Office Properties Income Trust (OPI: $32, up 2%, Yield = 6.8%). Office Properties just reported its 3Q19 numbers, and revenue of $167 million came in 58% higher YoY. FFO of $1.45 beat consensus expectations by a nickel. Total occupancy reached 93%, for a 1.7% increase from the prior quarter. And management is making progress on its plan to sell underperforming properties, having offloaded a dozen such assets last quarter for a total of $300 million. The company is offloading product to reduce its leverage, and that plan is working.
The company is already more diversified than it was before the Select Income REIT merger, when all assets were leased to federal, state and local governments. Now Office Properties has plenty of Industrial space in its portfolio, and the sector is a fast-growing segment of the Real Estate market. Industrial space isn’t prone to the kinds of setbacks that retail space is, with Amazon rapidly capturing market share and sending traditional brick-and-mortar retailers out of business. And with companies’ Tech needs growing, many are leasing out industrial space to house data centers and other large-scale technology operations. So this is a booming part of the overall Real Estate industry.
Office Properties leased 800,000 square feet of Real Estate last quarter alone, and with the total occupancy rate ticking upwards, the company is having no problem keeping tenants in place. All of this is good news, especially as management continues to offload underperforming assets (average occupancy for the offloaded properties was just 71%). In addition to gaining cash on the balance sheet, the company is ridding itself of numerous headaches caused by these slow-growth entities.
Lower interest rates and a stronger overall economy are good harbingers for Office Properties, which thrives on rental rates increasing over time. With the economy booming, more businesses and government entities will be leasing out office space, and that helps increase both the rent and the occupancy rate in the long run.
So Office Properties is likely to have continued success for the rest of this year and into next. The stock is up nearly 20% YTD, and we foresee continued growth on the horizon. The stock spent most of 4Q18 in the $30-$40 range, and with the macro-economic tailwinds in place, Office Properties should have no trouble getting back there. And meanwhile, the stock pays out 7% annually, which is better than you can do in most bonds that aren’t junk-rated.
Annaly, New Residential and Office Properties are three stocks we believe will continue to shine, given the improving economic conditions, and the normalizing yield curve. All three provide stable, dependable fixed income, and all are likely to move higher in the near future.
Todd Shaver, Founder and CEO
The Bull Market Report