The Weekly Summary
Another quiet post-holiday week left the market once again roughly unchanged as investors opted to follow the twists in the trade war instead of the trends the newly concluded earnings season established for the coming month. The S&P 500 gained a bit of ground. Other indices and the BMR universe as a whole stepped back.
We’ve seen this kind of dithering play out in the past. When news flow recedes, investors who have gotten used to the day-by-day rollercoaster get nervous and seek increasingly byzantine headlines to fill the gap. Seasons like this are when everyone turns into a Fed watcher and trade expert, pondering the mysteries of what even the most minor economic data release somehow fails to say.
But from our point of view, it’s all just a distraction from the underlying truth of this season. Earnings weren’t bad and we’re three months closer to the day when tough year-over-year comparisons roll away in the rear view, giving the market a better shot at real growth and a clear reason to rally instead of just drift. For now, of course, the S&P 500 is drifting. Santa came early, largely in the form of Jay Powell at the Fed and the interest rate relief he distributed.
The economy is where the real fireworks are. Depending on your point of view, Friday’s unemployment report either repays investors who refused to lose their nerve or sets up a boom ahead. We suspect it’s just another turn in a virtuous cycle: A confident market gives corporate leadership a foundation to make aggressive moves, which then give the market the numbers that support confidence.
Confidence has been the biggest challenge we’ve faced in recent months, between the trade war, the yield curve and the persistent fretting about a recession on the horizon. Corporate managers spent a lot of time in their quarterly conference calls discussing their customers and suppliers as anxious. But until someone demonstrates leadership, big strategies get delayed and money flows less freely. If it goes on too long, the economy starts to freeze.
The Fed demonstrated that leadership. They’ve done the heavy lifting and are spending the money to repair the yield curve, eliminating a core recession signal and cushioning the impact of the trade war. When we get clarity on tariffs, money will start moving faster again. In the meantime, it’s clear that the job market in particular hasn’t gone over a cliff like we saw in 2008.
There are no mass layoffs. People are still getting hired. Managers remain confident in their own businesses (even if their partners are dragging their feet) to keep making payroll. Talent is worth keeping. And while low interest rates are feeding a new wave of mergers to make workers redundant, so far the laid off are finding work elsewhere. The stock market might not be cheering, but it’s not whimpering either.
There’s always a bull market here at The Bull Market Report! Since we bragged about a few of our biggest successes last week in The High Yield Investor, it’s time to balance the scales with a tough look at a few of our biggest high-yield disappointments. We still love them, but they’ve tested our patience a bit lately. Similarly, The Big Picture examines our sector exposure as 2020 looms. Are we in all the hot spots? Where could we stand to add exposure? As always, reach out with your thoughts and concerns.
Gary Jefferson takes point on the economy, giving us a fresh look at the recession signals that just aren’t flashing red right now no matter how often you hear about them. And then it’s the time in the quarterly cycle when we review our Special Opportunities, which some investors call “value.” We recommended many on a deep dip, but in general we simply think they’ve been misunderstood. Sooner or later, the market always finds its way back to rationality.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: Sweet Spots And Sizzle
With only a handful of days left in the market year, it’s time we stop talking about the heat patterns that dominated 2019 and focus on where we want to be in 2020 and beyond. Right now, we’re what we like to call “guardedly optimistic.” The market has already built just about every wall of worry it can around itself, setting the stage for solid companies to dazzle in the gloom and maybe even surprise us all.
The critical thing is to make sure we hit those high notes. With a portfolio as concentrated as ours, it can be a little challenging to capture every single hot stock without jumping at a lot of head fakes as well. With that in mind, we follow a three-tiered strategic approach.
The foundation is always a strong defense. We want subscribers to park enough money in REITs and other High Yield stocks to keep cash flowing even in the face of a prolonged and profound market downswing. This is our recession hedge. When the economic cycle spins down, you want part of your portfolio to cushion the rest while the healing process plays out. On the whole, even the defense has done well for us, with High Yield up 20% YTD and the REITs at a strong 17%.
But this is an extraordinary year for income stocks as well as the rest of the market. Ordinarily, our defense doesn’t carry the ball far at all; just great dividends. These companies generally don’t rally year after year. They focus instead on squeezing maximum income out of the assets they already have and then distributing that cash back to shareholders. Under normal conditions, our job is to concentrate on the segments of the economy that are actually growing fast.
This year, those hot spots were largely limited to our stocks. The S&P 500 as a whole saw earnings slide every single quarter and is likely to see a similar deterioration when the 4Q19 numbers come out. The trade war was a drag. Even giant companies like Amazon, Alphabet and Apple have felt the chill in various seasons, draining their natural ebullience and forcing our other recommendations to work harder.
But the thing about a trade war or any other chilling effect is that after the first year, the comparisons get easier. When we start seeing 2020 numbers, they’re probably going to look good compared to what Wall Street has been conditioned to expect. They might not be great, but even if the trade talks roll into the new year, steady revenue gains should finally start moving the earnings needle forward. And of course any breakthrough between Beijing and Washington will give the fundamentals all the momentum they lost.
We’re fairly confident that despite all the walls of worry the S&P 500 as a whole can deliver about 10% growth in 2020, which is enough to give investors a decent year and pay back a little of the patience Wall Street demanded since the year-over-year comparisons got tough. However, because we can’t cover all 7,000 stocks with the time we have, we stick to the hot spots. That’s the core of the Stocks for Success portfolio, the front line of our offense.
Stocks for Success and a few other recommendations in the Technology and Healthcare portfolios provide exposure to the market’s main growth engines. You can make money without owning these stocks, but the ride will be volatile and when rotation goes against you, it will really hurt. One constant on Wall Street right now is that the big inexorably get bigger. They hog the hot spots in the economy. In 2020, for example, we suspect that BMR subscribers will be able to capture half of all growth across the entire S&P 500 with about 10 stocks.
That’s all it takes to match the market as a whole. Everything else on Wall Street will perform better or worse, and depending on your side investments you’ll outperform or lag the curve. But as long as you have these stocks, you’re already where the growth is in 2020.
What are they? Start with the most dynamic sectors and drill down. We’re looking for pure Technology to generate about 20% of the market’s growth next year, so if earnings on the S&P 500 climb 10% that means there’s about 2 percentage points to grab here. Microsoft, Apple, Visa (technically classed in this sector) and PayPal give us 60% of that right away. Likewise, simply owning Facebook and Alphabet provide all of the effective growth in Communications . . . everything else is at best dead weight.
Amazon on its own gives us another 6% of the S&P 500’s total earnings upside. That’s huge. The impressive thing is that the rest of the Consumer Discretionary group put together could match the Jeff Bezos behemoth next year. The consumer is simply that strong. There’s growth here for the malls and online retailers to share, and we’ll be watching the mall for opportunities.
Berkshire Hathaway and Johnson & Johnson give us about half the growth emanating out of the Financials and Healthcare next year. And our U.S. Energy fund (IYE) provides exposure to the Energy sector as a whole, capturing all of the likely year-over-year rebound there. That’s our 10 stocks and a full half of the market’s net growth, all in a simple but diversified basket.
These aren’t necessarily the hottest stocks on Wall Street, although most have a growth profile moving faster than the market as a whole in spite of their scale. They’re simply where the center of gravity points, the base around which we layer the real heat. In previous years, that heat came from Technology and the small hypergrowth stocks that dominate the Aggressive portfolio. Each is tiny compared to let’s say PayPal, but they make up for their lack of market heft with a lot of runway left ahead. When we choose the right ones, they’ll grow into giant status and make patient investors extremely happy.
We still like Technology in 2020. It’s still where the growth stories that ultimately drive stocks are concentrated. Overweight the right little names like Roku and Shopify and your personal portfolio gets a boost. We’re always looking for more of those names.
We’re a little underweight Energy because our last Pipeline stock got acquired and then the sector turned into dead money. The giants simply haven’t deserved our attention with Exxon Mobil, ConocoPhillips and Schlumberger down last year while Chevron barely edged up. And those giants have cast a big shadow on the juniors. When we see that pattern shift, we’ll jump. Likewise, we have zero exposure to the Industrials because the trade war gave them a terrible year. There was no point in being in Boeing or Caterpillar or 3M in 2019 so we didn’t even think about recommending those stocks. Maybe in the new year we’ll find the right way to reenter the sector.
And that’s really all the heat we see in the market as 2020 looms. Individual stocks that have the right sizzle are always worth our time, no matter what sector they’re formally classed in . . . we aren’t big believers in rigid top-down allocations and weightings here. But unless the Stocks for Success stumble, small-cap sizzle will remain a sideshow around the main event. While we might shuffle a few portfolios in the new year, on the whole we’re happy to see that we’re still in the right names, with room to add a few more that impress us.
The Carlyle Group (CG: $29, down 1% last week)
Carlyle has performed spectacularly this year, up nearly 100% YTD. The company has been benefitting from the flight of institutional capital away from hedge funds – which are producing low returns and collecting high fees – and into the Private Equity (PE) industry. This influx of institutional capital is leading to record fundraises, and PE companies earn fees on the money they manage. So the larger the funds under management, the more fees – and revenue – a PE company earns.
Carlyle is at the tail end of a $100 billion fundraise – a record for a pure PE fund. Management expects the fundraise to be 20% oversubscribed, which means excess revenue for the company in fee-earning AUM. 3Q19 revenue came in at $770 million, for a 13% YoY gain, and 30% higher than consensus expectations.
With the Fed lowering interest rates, that improves the broader economy and gives a boost to Carlyle’s portfolio companies. As the portfolio companies outperform, Carlyle makes money in management fees and by taking companies public. For example, the company purchased UK-based Addison Lee Minicabs for $400 million in 2013, and now values the company at over $1 billion. Carlyle is looking to take cash out, and to grow the company even further.
BMR Take: Carlyle pays a robust 4.6% dividend and the stock is reaching its mid-2015 level, and with the macro-economic picture looking strong and the industry riding some major tailwinds, we see every reason for the stock to test its all-time high in the mid-$30 range. Carlyle has already blown past our $28 Target Price, so we’re raising it to $34, and our Sell Price to $25.
Dollar Tree (DLTR: $92, up 1%)
Dollar Tree has had a rough year, currently down about 1%. The stock was doing quite well, up 25% YTD, until a bad 3Q19 earnings report sunk the stock. It seems the China trade war is affecting the company more than anticipated, which is why the firm not only came in soft during 3Q19 but also lowered its 4Q19 guidance.
Dollar Tree posted $5.8 billion in revenue for a modest 4% YoY improvement. The Family Dollar brand integration is going well, so revenue is ticking upward. That said, we’d like to see the growth rate accelerate. EPS of $1.08 missed expectations by a nickel, as the company experienced higher maintenance and payroll costs, on top of the additional tariff expenses.
What really dinged the stock was the 4Q19 outlook. Revenue was lowered from $6.41 billion to $6.38 billion, and EPS was lowered from $2.02 to $1.75. Management cited tariff-pressure and additional pressures on merchandise margins for the forecast downgrade. It’s possible they’re being somewhat conservative – we won’t know until we see the 4Q19 numbers. But the lower guidance was enough to send the stock sputtering.
BMR Take: Dollar Tree still has many things going for it, including a strong brand name and defensive position as a discount retailer. That said, the stock drop hurt, and we’re paying close attention to our Sell Price of $82. We do see the stock rebounding, however, and any good news on the 4Q19 earnings front should send the company back towards – or even above – the $100 mark.
Financial Select Sector (XLF: $30, flat)
The Financial sector has performed well this year, and Financial Select is up a strong 25% YTD.
In October, the Fed eased banking regulations and reduced the compliance burden by tailoring the regulations to match the banks’ risk profiles more closely. That freed up funds for banks like Capital One, USB and PNC Financial. What’s more, major banks like Wells Fargo, JPMorgan and Citigroup all posted impressive 3Q19 results (Goldman Sachs was the lone outlier that underwhelmed).
Although the trade war with China does play a role in how US banks perform (any uptick in the trade war negatively impacts banks), China isn’t a big enough threat to what is the fundamental driver of growth for the US economy. Banking stocks take the occasional hit from a flare up, but quickly move past the noise into more positive territory. Expect that trend to continue into next year.
BMR Take: With the Fed lowering interest rates and quietly pumping billions into the economy, it’s clear that the strength of the Financial sector is paramount. In easing regulations on the sector, Fed Chairman Jerome Powell is signaling he wants more growth from banking. Expect continued upside from Finance, and the Financial Select ETF is a great way to invest in the entire sector, without having to choose which banks will be the winners and losers from the moves in regulation and improving economic conditions.
MetLife (MET: $49.50, down 1%)
MetLife has had a strong year, up 20% YTD. The company has been making headlines recently for its strategic M&A activity. Management is purchasing digital estate planning service Bequest, which will improve the company’s existing legal services product line, Hyatt Legal. This is a strong, forward-looking transaction which augments the overall service.
Plus, management is looking at offloading a majority of its European assets, which have been underperforming. The company is in talks with Italian insurer Assicurazioni Generali, Europe’s third-largest insurer. This would reduce the cost burden on the company, and free up operating capital going forward.
Even with the flagging European business, the company posted a stellar 3Q19. Revenue of $18.7 billion was a 15% YoY improvement, and even though earnings ticked down from $1.5 billion last year to $1.4 billion this year, EPS of $1.54 beat consensus expectations by $0.14. Net income surged well over 100%, from $880 million in 3Q18 to $2.2 billion this past quarter. And book value improved 13% to $48.60.
BMR Take: MetLife is a growing company, one that is making strong moves in the M&A space, and is looking to offload underperforming components of the business. An ill-timed management shakeup is what delayed the European asset sale, but now that management is solidified, don’t be surprised by news of a sale next year, which would improve the bottom line. We’re reiterating our $56 Target Price for this rock-solid Insurance giant.
Salesforce (CRM: $158, down 3%)
Salesforce has had an up-and-down year, ranging from the mid-$130s to $167. The stock is currently in the middle of that range, up 11% YTD. Although there have been some slight bumps in the road, this is still a pioneering company that remains an industry leader, and one that is primed for future success.
The Tableau acquisition turns Salesforce into a well-rounded data platform company. Tableau hasn’t been fully-integrated or monetized yet, but the industry-leading data analysis tool will augment Salesforce’s current business model in a variety of ways, most especially by connecting the already robust sales and marketing tools to improved data analytics, which makes the whole platform much more powerful. That’s what makes this company so exciting for next year – there is still room for this $140 billion company to grow.
On the financial front, Salesforce had another strong quarter in 3Q19. The company posted $4.5 billion in revenue, for an impressive 33% YoY gain. The company’s goal is to double its revenue over the next five years – that according to CEO Marc Benioff. EPS of $0.75 beat market expectations by nine cents, and the company generated $300 million in cash during the quarter, for an over 100% YoY improvement.
BMR Take: Salesforce had another strong quarter, but investors have gotten so used to that output that they were expecting some big surprises. In other words, investors wanted a guidance uptick, and didn’t get it. (Why? Because management always under promises and over delivers.) That said, the stock is holding up well, and we expect the fundamentals to win out in the end over market emotion. Once Tableau is fully-integrated, expect revenue growth acceleration to take place, and the stock will achieve liftoff once again.
Twitter (TWTR: $30, down 2%)
No one likes to end on a disappointing note, but our final stock for this week is Twitter, which is only up 5% YTD. That’s more disappointing given the stock cracked the $45 mark earlier in the fall, and we were expecting a breakthrough of our $47 Target Price. However, since then, the stock has shed 1/3 of its value.
The 3Q19 miss was big. Revenue of $824 million was only up 9% YTD, and missed Wall Street expectations by $50 million. EPS of $0.17 missed by three pennies, and shares slid precipitously on the news. Management also lowered 4Q19 guidance from $1.06 billion to $970 million. The data licensing business held up strong, however ad revenue tumbled on weaker than expected customer engagement.
One bright spot is that daily and monthly average users continue to tick upwards, with the former coming in at 145 million, for a 17% YoY gain, and the latter at 30 million, which beat expectations by a cool 4 million.
BMR Take: There’s no soft-pedaling the fact that Twitter’s revenue and EPS miss hurt the stock. That said, even after the selloff, the stock is in positive territory for the year. Management feels the weak ad numbers are seasonal, and expects to be back on track next year. As the platform continues to gain steam with users, we see no reason to disagree. We’re maintaining our $47 Target Price with expectations that the stock will bounce soon. We’re lowering our Sell Price from $34 to $25, because we believe in this company. That said, another bad quarter and we may have to take our licks and go.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
Again, this "trade war" banter is a lot of "noise", and unless there has been a significant change in the fundamentals which would signal an oncoming recession, there is no real reason for the market to collapse. Let's take a look at the updated Recession Risk Dashboard which experienced two changes during November, with Wage Growth turning to red from yellow and Commodities improving to yellow from red.
We reiterate our opinion that the yield curve is not signaling a recession, although it is likely near enough to an inversion such that it may be signaling one for the Dashboard. We actually think the more important signals are all about the consumer. Despite the trade war and tariffs, the consumer sector has been the key driver for our economy.
We're off to a good start this shopping season. Black Friday online sales reached $7.4 billion, the second largest online shopping day ever, behind last year's Cyber Monday. Many are expecting this Cyber Monday to break all records. And, it should be noted that wage gains are great – the fact the recession signal went red is because it is a very long leading indicator, and historically large wage gains eventually lead to inflation, which lead to higher prices, which lead to lower consumer spending.
We don't see a problem in the near or intermediate term because inflation is simply not showing up. Thus, "recession" is not likely to be something to worry about next year or longer, which means that all of the up and down action of the market is more headline driven than not. This usually means that market downturns are swift and shallow rather than deep and long-term.
The High Yield Investor
By John Freund
VP of High Yield
The Bull Market Report
This week we’re going to look at a trio of stocks which haven’t performed as well as we’d hoped this year. We’ll take a look at what went wrong, and why we think these stocks are poised for growth next year.
First up is Service Properties Trust (SVC: $23.55, up 1%, Yield = 9.3%). Service Properties has had an up-and-down year, at one point nearing the $28 mark, but hasn’t been able to maintain its momentum and is currently down 3% YTD.
The company used to be called Hospitality Properties Trust, but changed its name to Service Properties which is more accurate, as the company’s portfolio consists of major hotel brands, plus truck stops and some office space. The company’s bread-and-butter is business-friendly hotels. It licenses and operates brand name properties like Wyndham, Sonesta and Radisson all across the country.
Service Properties has been experiencing a tough year due to some property renovations and slower-than-expected dispositions of its underperforming assets. The company’s 3Q19 came up short, with FFO of $0.95 coming in below last year’s third quarter of $1.06. Total revenue of $600 million also fell nearly 1% from last year, and EBITDA slipped from $225 million in 3Q18 to $210 million this past quarter.
Part of that poor performance had to do with over $80 million in prepayment penalties related to the extinguishment of mortgage debt from the portfolio, a one-time expense. Also, on the bright side, the company completed a $2.4 billion acquisition of nearly 770 retail properties from Spirit MTA. This coincides with the company’s disposition of nearly 130 properties for $500 million. As we stated above, if the disposition were moving faster, we’d see more of an immediate impact on the bottom line. That said, the company’s overall strategy is a sound one and part of the reason we like this company as we move into 2020.
Another reason we like the stock is revenue per available room, or RevPAR. RevPAR is a key indicator of the health of a company in the hotel business. Service Properties RevPAR ticked down 0.3% YoY last quarter – which doesn’t sound good – until you consider that 13 of its hotels are undergoing major renovations, and saw occupancy decreases as a result. If you exclude those 13 hotels under renovation, RevPAR actually increased 1% YoY. That’s a key factor, because those hotels won’t be under renovation forever. And with the rest of the portfolio increasing its RevPAR, the renovated hotels will likely do the same.
So even though it’s been a tough year for Service Properties, the company is looking at a turnaround from renovations and M&A activity. Plus, we expect those dispositions to continue (of the 130 disposed properties, all were either entered into contract, or already disposed of). Additionally, the macro-economic picture is still rosy, despite what some of the more bearish prognosticators have to say. The Fed is continuing to juice the economy by lowering interest rates, and that bodes well for Service Properties because it means more business travel. Based on those tailwinds, we’re expecting the company to have a much better year in 2020. While you wait, you can bank the strong 9.3% dividend.
Next up, let’s take a look at one of our Healthcare REITs, Ventas (VTR: $57.50, down 1%, Yield = 5.5%). Ventas owns and operates actively-managed Healthcare properties, meaning the REIT doesn’t just act like a landlord and book rental income. Management makes CapEx investments and spends on operational and managerial improvements, and as a result achieves greater profit participation. Actively-managing a REIT is obviously more high-risk, as it necessitates spending money and making strategic decisions, however the potential for greater profits is there as well.
Ventas had a mixed 3Q19. The company posted FFO of $0.96 and beat analyst estimates by two pennies, but slipped a nickel from 3Q18. Revenue of $985 million came in at a 5% YoY gain. Management also tightened the full-year FFO guidance a bit. Not a downgrade – just tightened the window of expectation. Yet despite this mild earnings report, the stock tanked as investors ran for the hills. This is a stock that was flirting with the $75 mark prior to the earnings release, and now stands below $60.
The selloff is clearly overdone, as there was nothing in the earnings release to warrant a 20% drop in value. In fact, with the company recently completing its $1.8 billion acquisition of a Canadian senior housing portfolio, management announced expectations of an additional three cents to FFO in 2020. Management has a history of being conservative on its projections. The company also maintains the rights to all development under an exclusive deal with LGM, the company it purchased the portfolio from. That provides a platform for future growth, with Canada now representing 8% of the company’s net operating income going forward.
So there is a lot to get excited about with Ventas. This stock should in no way be down 3% YTD, which is where it currently stands. Does anyone really think Ventas is worth over 20% less than it was pre-earnings release in late October?
Ventas has long been one of the premier actively-managed Healthcare REITs (the other being Welltower, another BMR pick). We are disappointed by the selloff, but sometimes Wall Street just acts irrationally. We’re holding this stock and awaiting the bounce. If you’ve yet to invest in Ventas, now would be a good time.
Our final underperformer of the week is Vornado (VNO: $65.55, up 1.5%, Yield = 4.1%). Vornado is the largest commercial landlord in New York City – perhaps the best Real Estate location in the world. Vornado owns office and retail space throughout Manhattan’s prime locales, including SoHo, the Upper East Side, Time Square and 5th Avenue. The company leases to brand name tenants like Apple, Bloomberg, Google, Cartier, Harry Winston and many others whom you’ve no doubt heard of. This reduces the company’s tenant default risk, and protects its retail business from being negatively impacting by the rise of e-commerce, since many of Vornado’s retail customers own storefronts as mere loss-leaders. A Cartier store on 5th Avenue is less about turning a profit and more about building brand awareness.
That said, the stock is only up 4% on the year, which is a disappointment, especially in this positive year for the broader market. 3Q19 came in strong, with FFO of $1.46 beating expectations by 15 cents, a nearly 50% YoY improvement. Revenue of $465 million beat expectations, this time by $9 million – however on a YoY basis revenue decreased 14%. That decrease was expected, however, as the company has been disposing of underperforming assets all year.
Part of the downward pressure on this stock is concern of an oversupply in office and retail space in New York. Yet these concerns have long-existed in New York, which always finds a way to attract new businesses and retailers. A physical presence in New York City is viewed as a sign of success for many companies and brands, and that’s not changing any time soon. Plus, Vornado is currently completing its long-awaited Penn Plaza development, which will bring even more flagship office and retail space to the heart of New York City, where rents are sky-high on a price-per-square-foot basis.
Yes, the REIT is facing some short-term headwinds given the current oversupply. But that won’t last. The company is the largest Real Estate owner in New York, and as the global economy improves expect more companies and brands to scoop up Vornado’s properties. Additionally, REITs like Vornado represent a strong defensive play against any threat of a continued trade war, or even an economic downturn, given the fixed income component.
So while Vornado didn’t have the best 2019, there’s a lot to get excited about here as 2020 approaches. We’re confident this stock will rebound, as we have faith in the New York Real Estate market.
Todd Shaver, Founder and CEO
The Bull Market Report