The Weekly Summary
Wall Street is cooling off a little as the unusually late Thanksgiving feeds into a short holiday season. The Federal Reserve's last policy decision of the year and hints of a trade deal with China moved the market up nicely. As we discussed during the week, the BMR universe is under a bit of pressure from rotation away from Real Estate and Technology, but it isn't anything we haven't seen before. Factor out those portfolios and we continue to beat the S&P 500 as a whole.
Nonetheless, we can't exactly pick our favorite portfolios in any given week and throw away the rest to make our score look better. It was a tough week for Real Estate and Technology. In both cases, the losses don't look like anything more than investors shuffling their holdings ahead of the new year. A few of these stocks made news with their sudden reversals, but we just don't see any sudden material decline in the prospects of companies like Office Properties Income Trust (OPI), Roku (ROKU) or Alteryx (AYX) emerging here.
Consider the fundamentals on these companies. Has some reason emerged in the past week to make you think that their businesses are seriously impaired? We can't find one. Other REITs fell alongside Office Properties, and other Software companies lost ground. They simply didn't fall as far, which means bloggers weren't motivated to concoct a reason for their declines in order to earn a few extra clicks.
What happened to Office Properties? Morgan Stanley cut its target on how much the stock is worth. A few weeks ago, RBC raised its target by roughly the same amount. The net impact on investor sentiment is the same. But on a down day, people chase explanations and so this becomes a downgrade story. The stock will recover.
Then you have Roku and Alteryx, which received no downgrades at all. In our view, their decline is more a matter of happy investors taking a little profit before the 2019 tax year ends. We can't fault them. Roku is up a stunning 330% YTD and Alteryx has given BMR subscribers another 60%. They were champions last year. We can't wait to see where they go in 2020.
Of course our universe is full of champions. Even Office Properties, despite its recent downswing, has delivered a healthy 12% YTD, which is all we really want a yield-driven REIT to do. Forcing a dividend stock to move like a growth stock is a recipe for disappointment. Our universe as a whole is up 38% YTD. It's been a good year so far.
The Fed sees more of the same ahead. They didn't cut interest rates, but they aren't going to raise them in 2020 either. We have an economy that supports something like full employment at minimal inflation. Any concrete progress on trade will accelerate ambient growth and give a lot of people a reason to feel more bullish about the world we live in.
There’s always a bull market here at The Bull Market Report! Gary Jefferson has a lot to say this week about the economy, so we've given him plenty of space. The High Yield Investor deciphers what the Fed statement means for our yield-curve-sensitive stocks and The Big Picture takes a look at trade. For all practical purposes, this is the kind of news that truly lifts all boats on Wall Street. And then it's time to start our quarterly review of our Stocks For Success recommendations. Are they all still companies we love? You bet.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: The Biggest Question On The Planet
Thursday night brought the first hints of a breakthrough on trade with China. Actual details are still scarce, but the markets cheered because this is a step in the right direction. A perfect deal is not the point. What we have been hungry to see for months now is a simple move in the right direction, away from complete disruption back to an emerging status quo. After all, there have been a lot of escalations. Now it's time for the negotiators to start building a new future . . . whatever that entails.
Right now, all we know is that the new tariffs scheduled to take effect today aren't happening. In return, China will start buying U.S. agricultural products again and will consider talking about intellectual property protection, currency manipulation and other topics that matter to Washington. That's it. The Chinese wanted to start buying pork and soybeans anyway because inflation there is getting hotter than the government cares to tolerate. We were probably less than eager to pay higher prices on computers, phones and other gadgets made in China.
Both sides blinked and the status quo resets to where it was in August. That's not bad. The important thing is that corporate executives around the world can see a light at the end of the tunnel. That's part of why progress on a new North American trade agreement is at least as welcome here. Anything that clarifies the operating costs of doing business in one country or another helps planners make choices. You can't allocate resources effectively when everything is under renegotiation at once, or when every assurance that once prevailed is being replaced with new questions.
Sometimes these periods are ultimately constructive, leading to transformation and a stronger future than would have been possible otherwise. But until we get there, the natural impulse that every professional executive feels is to adopt a cautious posture. Plans go on hold. Money flows more slowly to preserve a cushion in case the situation deteriorates or simply doesn't play out as expected. When we don't know which way the wind is blowing, the instinct is to shelter in place.
The Fed sees this. As far as they're concerned, it's been the biggest drag on the local economy:
We've been hearing from our people that we talked to and the many, many people and businesses that we talked to through the Reserve Banks that wind up being written up in the Beige Book, and they've been telling us all year -- for a year and a half really -- that trade policy uncertainty is weighing on the outlook. And I do think that, again, without commenting on it in any way on the process or the content of the agreement, I think that uncertainty removal of uncertainty around that would be a positive for the economy as well.
When the trade war ends, it will feel good. And in the meantime, any progress is a step in the right direction. While that uncertainty has "weighed on the outlook," it has yet to get bad enough to force executives to cut spending proactively because they don't see any good outcomes worth maintaining their overhead where it is. They aren't laying off hundreds of thousands of people. Payroll cuts remain tactical, driven by efficiency instead of existential threats.
That's a good thing. If the only thing Corporate America really has to be afraid of is fear, a little clarity will work wonders. We're looking forward to it.
Alphabet (GOOG: $1,348, up 1% last week)
Alphabet is up nearly 30% YTD, setting all-time high after all-time high. The company is on so many rolls it’s hard to keep up.
Despite that, 3Q19 was a mixed one for the company. On the plus side, revenue of $41 billion came in 20% higher YoY, however EPS of $10.12 was a huge miss, coming in $2.34 less than consensus expectations, and nearly $3 below last year’s $13.06 mark. That was due in part to the operating margin which ticked down 11% YoY to 23%. Net income fell 22% YoY, to $7 billion. A big chunk of that was the effective tax rate of 18% that is double 3Q18’s 9% level.
The good news is on the strategic front – with Alphabet in the process of monetizing YouTube, and with the recent $2.1 billion FitBit acquisition, there are even more revenue streams on the horizon. Expect that revenue number to keep rising, and eventually operating costs will settle down, which will translate into increased earnings. The stock is up 4% since the mixed 3Q19 earnings report, so clearly investors are on the same page as we are regarding this company.
BMR Take: Alphabet is one of the premier companies in the world for a reason. Google continues to dominate search to the point where it qualifies as an actual monopoly (over 90% of search is conducted via Google), and the additional revenue streams like YouTube, FitBit, Waymo and so many others make for a rosy future for this company.
Amazon (AMZN: $1,761, up 1%)
Amazon is still shy of the $2000 mark it broke through earlier this year, however the stock is up a solid 17% YTD, and like Alphabet, there is a lot to get excited about.
AWS just rolled out its Local Zone feature, which provides select services adapted to a given region. The company rolled this feature out on the West Coast, and plans to expand nationally and internationally. This will help maintain AWS’s dominant position as the leading cloud service provider. And recently, Amazon’s latest version of Alexa sold out in Europe, with many countries gobbling up the third generation of Echo speakers. That spells great news for the business line. With automation coming to Whole Foods, and Amazon re-emerging in brick and mortar stores with a plan to differentiate on price, the company has so many bright spots it can be hard to keep track.
Like Alphabet, 3Q19 was mixed. Revenue of $70 billion came in 23% higher YoY, but EPS of $4.23 missed expectations by $0.23. Again, there are some higher operating costs at play here, but with the seemingly-limitless revenue drivers that are in play, we have every reason to believe earnings will pick up steam in the near future.
BMR Take: Despite the loss of the Pentagon’s JEDI contract to Microsoft, Amazon has tons going for it. AWS, Alexa, Whole Foods and many other business lines are poised to continue this company’s increasing revenue generation for some time. Like Alphabet, Amazon is one of the companies of the future.
Apple (AAPL: $275, up 2%)
Speaking of companies of the future, Apple has earned that title for a very long time, and continues to maintain it.
The stock is up over 70% YTD, and we believe there’s more to come. 3Q19 produced $64 billion of revenue for a modest 2% YoY gain. EPS of $3.03 beat market expectations by nearly 20 cents. The company also returned $21 billion to shareholders during the quarter - $18 billion of which came through share repurchases. Management has their eye on both the balance sheet and the stock price.
With new iPhone models due to be released over the coming years, the blip in iPhone sales is widely expected to be in the rearview. Foldable phones and 5G will make the next iterations must-haves, and bring Apple’s core product line back to the record-breaking territory we’ve all grown used to. The company has also been diversifying heavily into credit cards, content production, gaming, and other revenue drivers.
BMR Take: Apple is one of the cornerstones of corporate America. The company’s stellar earnings report, plus the bright outlook for both the iPhone and its other business lines make this stock a must-own. The stock has settled well above the $1 trillion mark at $1.21 trillion, and don’t be surprised if it keeps growing from here.
Microsoft (MSFT: $154.50, up 2%)
The winner of the Pentagon’s JEDI contract has been on a tear all year. Microsoft is up 50% YTD, and this $1.17 trillion company is sitting at its all-time high, with good reason.
Microsoft had yet another strong quarter. Revenue of $33 billion grew 14% YoY, while EPS of $1.38 beat market estimates by $0.14. The company made some strong strategic partnerships, including with major pharmaceutical retailers where it will implement its Azure cloud service and 365 as a bundled package. This is a direct shot across the bow at the cloud industry leader, Amazon, which many retailers want to avoid working with given the threat that Amazon poses in the retail space.
Of course, the big story of 4Q19 is the JEDI win, which analyst Wedbush says should add $10 of value to the stock. Wall Street will also be factoring in the potential impact on additional revenue streams going forward, so expect this stock to continue to remain a Wall Street darling for some time.
BMR Take: Like the aforementioned stocks, Microsoft has too many strong business lines to mention here. Azure, 365, its core software products and now the new JEDI contract all spell a revenue deluge for this timeless company. Microsoft is a blue chip that acts like a startup, and we’re loving the results.
PayPal (PYPL: $108, up 3%)
PayPal is up a very solid 25% YTD, and we’re excited about the continued expansion through M&A.
M&A expansion has been a staple of PayPal’s growth model for years, and this year is no exception. Management just announced the $4 billion purchase of Honey Science, a technology platform for shopping and retail rewards. Honey already has 17 million subscribers, and is currently profitable, so the deal will be immediately accretive to earnings. And that’s before any synergies or strategic expansions are implemented.
The company had an excellent third quarter of 2-019. Revenue of $4.4 billion rose 19% YoY, while EPS of $0.61 came in a penny higher than expectations. But the real star of the earnings report was the guidance. Management raised its full-year EPS guidance to $3.07, when the market was expecting $3.02. And revenue guidance of $17.7 billion rose $10 million higher than expectations.
BMR Take: The guidance raise was enough to send the stock soaring 8% on the news, and the stock has remained at roughly the new level since. We’re hoping for still another breakout before year’s end. That said we’re content where we are, and confident the future will be even brighter than the past. With the core products of PayPal and Venmo gaining users every month, and strategic acquisitions helping diversify the business, PayPal has plenty more revenue and EPS growth on the horizon.
Visa (V: $185, up 2%)
Visa is up an impressive 38% YTD; not bad for a company worth $410 billion. The company has been innovating its product and focusing on global expansion – two very rewarding strategies.
Visa is proving its innovative prowess by partnering with Chinese behemoth Tencent. Tencent’s current mobile wallet, WeChat Pay, will soon allow Visa cardholders to use their Visa card at retailers across China that accept WeChat (which is many). This helps embed the company in the daily life of customers in the world’s largest market. Additionally, the company has introduced Visa Infinite Business, a new card portfolio designed for small businesses. Higher credit lines, travel protection, and extended warranties all target this fast-growing segment of the US credit industry.
On the global growth front, the company recently announced a partnership with MFS Africa – the continent’s largest digital payments hub – which will help grow the digital payments ecosystem there. And the company is partnering with TransferWise to provide customers additional capabilities to move money to debit cards worldwide. There’s already been a successful rollout in Europe which is expected to continue with a further global rollout in 2020.
BMR Take: Like Microsoft, Visa is a shining example of a blue chip that acts like an innovative startup. The company is growing on all fronts, and its global expansion efforts and innovative technological offerings display a forward-looking growth strategy that we’re confident investing in. The stock is at its all-time high for a reason, but don’t be scared off. There is more room for growth on the horizon.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
The media was prepared to start talking up a forthcoming and allegedly inevitable recession but the November employment report blew them out of the water with a staggering 266,000 new jobs. That was a huge beat. In addition, the previous month's report was upwardly revised from 128K to 156K, showing another 28,000 more jobs were created than previously thought. And as if that wasn't enough, the unemployment rate receded from 3.6% (near a 50-year low) to 3.5% (an actual 50-year low). What we really like the most is that the biggest job gains came from Manufacturing (with 54,000 new jobs), Healthcare (45,000), Leisure and Hospitality (45,000), Professional and Technical Services (31,000), Transportation and Warehousing (16,000) and Financial Activities.
And, the good news kept coming with the Consumer Sentiment report jumping up from 96.8 to 99.2. That's not surprising when you look at the "rest of the story," which includes not only the record employment, but also rising wages and household income at the highest level in 20 years. We've said it before: these are historic times for the economy, and historic times for the market. Most reports reflect these are the best numbers in 50 or more years. And this was, in essence, a “perfect” report, because it shows that U.S. employers are adding employees much faster than they are letting workers go, and, importantly, that wages are not increasing quickly enough to spur fears of inflation. This in turn equates, in our mind, to lower interest rates for longer periods.
Basically, we are watching an economy that continues to be just humming along with few signs of significantly slowing any time soon. The widest possible measure of economic activity (Gross Domestic Product) seems to be staying around the "magic" 2% growth figure that most economists consider to be the “sweet spot” for healthy, sustainable growth without the threat of overheating into inflationary conditions.
Now that everyone feels better, we have to remind investors that the media is working hard to derail the economy by talking down the facts and talking up recession fears. That is where the bigger risk may lie, and it has nothing to do with economics, earnings, interest rates, trade wars, or market fundamentals. The biggest risk may end up being an investor’s attempt to time the bull market’s peak. As we have repeatedly said, being a long-term investor is the key to financial success. And it's all about earnings, earnings and more earnings. Stock prices eventually align with fundamentals, which are essentially governed by earnings.
Over the short term, stock prices will fluctuate far more often than a company’s fundamentals will. There will be times when a stock’s price trades far above its actual value, and times when a stock’s price trades far below where it should. But over the long term, the stock market is a weighing machine, reflecting the value being created by those earnings.
We think there will be a 100% chance that recession talk increases in the months and quarters heading into the election, regardless of how good the real news may be. And, we also understand that nothing ever remains the same, so as economic conditions seemingly become more uncertain, the temptation to try and time the bull market’s peak is likely to rise as well. Any downside volatility will be hard to ignore and investors may misconstrue normal selling pressure for a full-blown bear market. We expect the media will certainly claim it is so. We want to avoid getting caught in this trap. That's because, again, we have history on our side.
If we look at S&P 500 returns in rolling 1-, 3-, 5- and 10-year periods from 1871 through September 2019, it shows that volatility and the possibility of negative returns are more prevalent over short time frames. In one-year periods, volatility registered at 19% and the possibility of a negative return was 28%. But as you zoom out and look at longer time frames, volatility decreases as does the probability of a negative return:
- 1-year rolling period: volatility 19%, possibility of negative return 28%
- 3-year rolling period: volatility 10%, possibility of negative return 16%
- 5-year rolling period: volatility 8%, possibility of negative return 11%
- 10-year rolling period: volatility 5%, possibility of negative return 3%
That last data point deserves another look. If you held onto equities in any 10-year period from 1871 to September 2019, you had a 97% chance of achieving a positive return (100% in most of our lifetimes). It’s crucial to note, however, that these odds do not exist for the investor who tries to ‘time’ market peaks and troughs. Market timing returns pale in comparison to long-term ones. These odds only apply to the patient, long-term focused investor who sticks to the plan and dodges emotional reactions. Again, we're big fans of having history on our side.
The High Yield Investor
By John Freund
VP of High Yield
The Bull Market Report
The big news from the Fed this week was that Jay Powell and company decided to leave the overnight Fed Funds rate unchanged. The Fed also signaled that interest rates will remain at their current levels for the entirety of next year, as the Fed all but declared its intention not to raise or lower rates for the next 12 months.
This move makes sense given the current macroeconomic climate. At roughly 3.5%, unemployment is historically low, and we can arguably be said to be at ‘full employment’ given that an economy will never achieve a state where 100% of the people who can theoretically work are actually working. So with the fundamental engine of the economy humming along smoothly, the Fed has no incentive to continue its rate reduction policies. That said, with inflation currently below 2%, and with many predicting it will stay that way throughout 2020, there is no need for the Fed to raise interest rates. After all, there is no inflation for them to combat.
That leaves us with a climate of stable interest rates, which means companies that earn income by ‘buying low and selling high’ when it comes to interest rates are poised to benefit. These companies now have a dependable macroeconomic climate to rely upon, which isn’t something they have had for quite some time.
Let’s take Annaly Capital Management (NLY: $9.49, up 1%, Yield = 10.7%) as an example. Annaly is by far the largest Mortgage REIT in the world, so much so that an investment in Annaly is often said to be an investment in the Mortgage REIT sector. The company makes money by borrowing short and purchasing notes with longer durations, and the associated higher interest rates. In other words, Annaly earns income on the spread between short and long-term interest rates. When long-term rates tick downward – as they did earlier this year when the yield curve inverted – that spells bad news for Annaly, which now has to borrow at higher short-term rates. However, when short-term rates are dependably lower than long-term rates, Annaly can reliably earn income. Thanks to the Fed’s decision to keep rates steady for the time being, this is exactly the type of climate Annaly relishes.
Investors realize this, which is why the stock has been on a tear since early September, when the Fed last lowered short-term rates. The stock is up over 16% since. Annaly still has some way to go before reaching its early-2019 trading level, but we believe the stock will continue to rise over the coming months based on the aforementioned macroeconomic outlook. And with that hefty 10.7% annual yield in place, Annaly is primed to deliver high returns in 2020, especially for a REIT that is usually considered a ‘defensive investment.
And speaking of its defensive posture, Annaly is a terrific stock to own if you’re at all concerned about an impending recession. We believe fears of one are overblown, but it’s nice to be diversified just in case. It just so happens Annaly outperforms during a recession, because when the Fed lowers interest rates, the company’s cost of funds falls more than the yield on the assets it owns. In other words, Annaly can cover its costs of owning mortgage-backed securities through the yield of its entire portfolio. That’s why, during The Great Recession, Annaly’s margin expanded, and its dividend more than doubled from 2006 to 2009. Those are some impressive numbers for a company operating during a major recession.
Also, let’s not forget the share repurchase program management authorized earlier this year. The company has plans to buy back $1.5 billion of shares through the end of 2020. That accounts for over 12% of the company’s market cap. Yet another reason to like this company – management has their eyes on the fundamentals, as well as on buffering the stock price.
One other stock we’ll take a look at this week in light of the Fed’s recent moves is Ares Capital (ARCC: $18.50, down 1%, Yield = 8.4%). Ares is the largest middle-market lender in the world – so large, in fact, that the company occasionally does deals that qualify as large-cap ($500 million and above).
In light of the Fed’s recent moves, Ares is poised to benefit for a different reason than Annaly. As a middle-market lender, the company invests in private portfolio companies. As the broader market improves and achieves some measure of stability, private companies earn enough breathing room to make strategic and operational decisions that enable them to grow, which means Ares benefits as their lender. In other words, what’s good for the broader economy is good for Ares. And stable interest rates are good for the broader economy.
Ares is also benefitting from the flight of institutional capital to the private equity sector. If you’ve been following BMR, you know we’ve written about this several times in our coverage of PE titans Blackstone and Carlyle. The two are raising record amounts of capital at the moment. This impacts Ares because with the big boys in the space focused on multibillion-dollar deals, there is less competition for Ares to worry about. Suddenly, management doesn’t have to be concerned that Blackstone, Carlyle or KKR will swoop in and eat their lunch by doing a nine-figure deal. Those firms are focused on much bigger fish, which leaves Ares – as the largest middle-market lender in existence – in a dominant position.
The 3Q19 financials bear this out. Total investment income of $400 million is a 13% YoY improvement, and EPS of $0.48 beat market expectations by two pennies. The company also made $2.4 billion of new investments during the quarter, 90% of which were in reliable, first-lien senior secured loans. Ares doesn’t take a lot of chances – it doesn’t need to. The company is the clear market leader in its specific niche sector.
The stock is up nearly 20% on the year, and is hovering just beneath its all-time high of $19.90. When you look at the meteoric growth that both Blackstone and Carlyle have achieved this year (both BMR picks), you can see how strong the overall PE sector has been in 2019. That strength will trickle down to Ares and the middle-market sector. Sort of like how when the prices of multimillion-dollar homes increase, it brings up the price of all local real estate. The same is true here: With large, global PE shops outperforming, expect to see ‘a rising tide lift all boats.’ Ares’ boat is already on the upswing, but we expect it to achieve new heights and break through the $20 mark next year.
All told, in a climate of low interest rates and expected inflation under 2%, investors need a place to safely park their money – investments that will deliver stable, dependable fixed incomes. Both Annaly and Ares are poised to appreciate in value over the coming year, and both offer impressive dividends that investors can count on.
Todd Shaver, Founder and CEO
The Bull Market Report