“Let’s get ready to rumble!”
On Thursday the Dow, S&P and Nasdaq all closed at records on the same day for the first time since 1999. Last time around this historic trifecta meant a fantastic year for stocks. Many on Wall Street are now hollering for a repeat. Some say the money flows are pointing to “the final melt up” and “a blow off top”. We don’t buy that. Everybody from pension funds to retirees are desperately searching for yield in a world of historically low bond returns. The new mentality that prevails is being called “TINA” investing, which stands for “there is no alternative”. If you are looking for new ideas in a market that may approach continued new highs, we highlight Mazor, Twitter, Netflix, and Splunk as places to find value. Have a great week!
Here is How The Major Indices Performed Last Week
Here is How Last Week Progressed
Monday (8/8) - S&P 500 -0.1%
The markets opened at fresh all-time highs only to drift toward an end result that was about flat for the day. China reported July trade data that confirmed a global slowdown. Specifically exports were down 4.4% versus the -3.5% consensus, and imports were down 12.5% versus the -7.0% consensus. The hoped-for moderation that would signal gearing up for orders heading into peak shopping season at year end did not come. Oil prices rose despite the glut of crude supply. Data revealed that corporate bond issuance totaled $88 billion worldwide in the first week of August, the most since 1999, which clearly highlights the amazing strength of the bond market, despite historic low yields.
Tuesday (8/9) - S&P 500 +0.1%
It was a very tepid day. The VIX nearly touched 11, which was last seen in July 2014. The 10-year US Treasury Note closed at 1.55%, which compares to the consensus forecast 8 months ago for the level to be 2.80%. Some savvy market participants are pointing to a 10-year of 0.80% in the intermediate term due to global spreads that face a widespread negative yield curve. (Of course, given consensus results as noted just above, it is obvious that no one has any idea.) Wholesale inventories rose mildly and sales surged to 4-year highs. The interpretation is that the inventory-to-sales ratio of 1.3x is in recession territory. Analysis from Morgan Stanley shined light on trailing 12 month profit margin now at the lowest levels since before the global financial crisis back in 2006 when the S&P was trading 700 points lower.
Wednesday (8/10) - S&P 500 -0.3%
The market continued grinding sideways. The BOJ disclosed in a policy report that tapering of its stimulus program in September is unlikely. The JOLTS data for job openings showed 5.62 million new jobs versus the expectation for 5.68 million. While the pace of hiring rebounded to 5.13 million from 5.05 million a month ago, the annual growth rate for hiring decelerated, which some pointed to as a key indicator that the US jobs market has peaked. Crude fell due to surprising builds despite gasoline drawdowns and production cuts. DOE data confirmed the build in crude of +1.05 million marked the third weekly rise. A rare event was seen in global treasury markets. The spread of the 10-year US Treasury Note to the 10-year GILT (UK bonds) exceeded 100bps, the widest spread seen since 2000.
Thursday (8/11) - S&P 500 +0.5%
The best day of the week so far. The Europe Stoxx 600 Index officially fully recovered from the Brexit decision. Oil prices rose 4% on the Saudi Minister’s OPEC remarks, saying that there is now a meeting scheduled for late September to discuss stabilizing prices, though is past times this rhetoric has led to little. The aforementioned good news overlooked lingering concern of the BLS massive downward revision of the 1Q16 annual growth rate for real wages to -0.4% from +4.2%. US federal tax receipts increased a modest +1% from last year slowing dramatically from the +13% pace of growth recorded just last summer.
Friday (8/12) - S&P 500 -0.1%
Word started circulating calling for a major melt-up in equity price indices. The upcoming Jackson Hole meeting with the leading economists in the US including Fed officials is anticipated to kick-start a discussion about the health of the US economy and a slow rate-hike cycle. At the same time, institutional investors will be returning from summer vacations needing to put money to work, where low interest rates is likely to force money flows into risk assets. St. Louis Fed President James Bullard was already on a radio show today talking about how the Fed sees no recession risk in the near term. A big firm in Europe sold $5 billion of gold futures right before the close perhaps bracing for a sell off on Monday.
Bull Market Report Companies and Commentary
Splunk (SPLK: $64, +5%) Splunk caught a bid early in the week when Morgan Stanley raised its price target to $74 from $58 while reiterating an Overweight rating. What is there to like? The company is the leader in operational intelligence software that helps enterprises make sense of machine data. This end market is large and expanding, which offers a runway for sustainable 30% revenue growth. The business model is increasingly more predictable as the revenue base grows. In the most recent quarter, Splunk’s bookings accelerated to 48% annual growth, which was the highest pace recorded in six quarters. Moreover, the company guided well for the full year raising revenue guidance from $880 million to a new level of $895 million. We should also note that Splunk added 450 new customers and completed 320 deals over $100,000, up 40% from a year ago, which highlights very healthy demand. And this: The Splunk Cloud business doubled from last year, as well!
BMR Take: We see momentum carrying the shares to the $70+ level. This valuation assumes a premium to the peer group justified by the company’s leadership position.
Netflix (NFLX: $97, +1%) Shares started the week off wobbly on news that Alibaba would not be making an investment in Netflix. However, by the end of the week, investor focus returned to the fundamentals, where there is a lot to like. A comparison of Google search volume suggests that "Stranger Things" has had the biggest debut of any new series in 2016 on traditional cable or online, and there is not even a close second place. The extraordinary consumer interest in this science fiction TV show is particularly notable given the lack of a large marketing budget and high profile talent on the show. We believe this demonstrates the power of scaled distribution online, as well as the benefits of full season releases, which allow for instant immersion in a series.
At this point, we do not believe any cable network could replicate this type of performance with a new series. Looking ahead, the release schedule includes Narcos 2 and Disney’s The Crown. While there was concern in the recent quarter over lighter than expected US and International subscribers, it was all driven by elevated churn, which is mostly believed to be the result of price increases in contrast to something more concerning like competition or saturation. Historically, 40% of churning subscribers ultimately return considering the content is increasingly irresistible as we just discussed, which means the recent softness may very well ease.
BMR Take: We remain positive on the long term outlook and expect shares to recover their footing to test 52-week highs of $133.
Mazor (MZOR: $24, +3%). We saw impressive gains in Mazor last week. The focus remains on continued performance improvement building off of the recent solid quarter result. Mazor recently received orders for 11 new Renaissance systems, six in the US, and five internationally. Importantly, there were 16 orders in 1H16, which marked the best six month period in company history. Sales in 2Q16 were up an impressive 30% sequentially. The outlook for the US pipeline in the second half of the year was strong. Utilization continues to increase as recurring revenue growth is running above 30% with increasing system usage cited by management as a key driver. Management has indicated confidence that 2016 will be a record year for both systems sales and procedure volumes. Lastly, the headcount of sales professionals during the quarter increased by one to 17. This compares to plans to reach hundreds of sales reps, which will be transformational.
BMR Take: We see strong fundamentals for long term growth. That said, the stock has appreciated significantly in a short period, so watch it closely.
Twitter (TWTR: $20, +7%). The company had a great week as it was in the headlines this week for a few whacky storylines, plus the prospects for an acquisition, the latest mentioned buyer being Alphabet. The core fundamentals have been steady in terms of revenue deceleration and slowing engagement growth. In fact, management’s latest 3Q revenue guidance of $600 million came in well below the consensus of $680 million. However, there are encouraging signs. In particular, there is much discussion over the new product pipeline. Growth in engagement is now being driven by product changes and marketing efforts, versus previously what were only marketing efforts. The fact that engagement growth is now coming from product changes is a clear sign of increased business momentum. We believe engagement growth coming from product changes is positive, and we would like to see this continue.
Additionally, there is opportunity in video. The company notes that video is one of the two big opportunities for growth, as online video ad budgets for clients across the marketing ecosystem have only recently been revised to permit allocations to Twitter. Note that video is the number one ad format in terms of revenue on Twitter. We likely will not see an impact from live video until 4Q16 since only three events were live on Twitter thus far and just two NFL games will be on Twitter in 3Q16.
BMR Take: Good things will happen here.
Apple Corner
Nothing much new with Apple (AAPL: $108) except another $800 million in cash in the bank this past week. Ha. Nothing new. Right. And the stock TRICKLED UP another 1%. This week? Well if the market moves higher, then Apple is going to add another few dollars. We really do believe we will see new highs in Apple down the road. This year? Maybe. But certainly next year. Can you wait for a year for the stock to move from $108 to $134? Well, let’s see. That’s a 24% return in a year if it happens. I guess we can wait for that!
We hope it happens.
Upcoming Economic News
It is a very quiet upcoming week for the economic data release schedule. The highlight will be housing starts, out Tuesday. A month ago, we observed the US Census released June housing start data that supported the long-term outlook for a slow-paced recovery to normalized levels. We believe the industry is benefitting from a return of the first-time homebuyer which has accelerated as 3% FHA loans have become more commonplace. We also see the recent decline in interest rates as a potential catalyst in the second half of the year as homebuyers look to take advantage of incrementally attractive financing opportunities. However, we note that permits are now lagging starts by over 5%, which is a relatively large margin from historical standards and does not verify future acceleration to be a given.
High Yield Corner
High yield assets continue to see strong performance throughout 2016, again confirming The Bull Market Report’s recommendation to go heavy into these sectors earlier this year. However, new warning signs suggest more caution is necessary as we plow through the second half of the year.
Junk bonds had another strong week, with the SPDR Barclays Capital High Yield Bond ETF (JNK: $36) up over 1% for the week. That means high yield is now up over 7% for 2016, and up 15% from the lowest point in February.
That’s all great news, but fundamentals urge greater caution right now. The junk bond default rate rose to 5.5% by the end of July, according to a new report by Moody’s, and the number of defaults in July rose by 11, meaning 102 defaults in total for 2016. That’s the highest amount of defaults since 2009. What’s causing the defaults? Oil, of course. Moody’s expects a shocking 10% default rate for metals and mining sectors and 7% for oil and gas. Defaults are also expected to continue to climb for the year, peaking at 6% by the end of the year.
Is the corporate bond market pricing these defaults in and offering creditors a higher yield on bonds to compensate for the risk? Simply put: no, it is not. The average yield on junk bonds fell again this week by nearly 2%, and yields have fallen over 30% from their highest point during the great risk-off moment in February. Right now the market seems to have an insatiable appetite for risk, meaning that investors are willing to buy high risk bonds even if the interest rate they are getting is lower than it was when the bond market was less risky. Why? Simple: there are few alternatives. U.S. Treasury yields continue to stay around all-time lows, meaning there are less places to get income than ever before without taking on more risk. Income-hungry investors are willing to accept the higher risks in the corporate bond world because there are few options out there.
This trend has also driven money into REITs, with the SPDR Dow Jones REIT ETF (RWR: $101) up over 10% year-to-date and up over 23% from the lowest point in February. The REIT world’s strength in 2016 has astounded us, even though we were bullish on REITs earlier this year.
Our favorite REITs continue to be strong performers and continue to cover dividends with funds from operations (FFO). Omega Healthcare Investors (OHI: $37) rose 5% this week, although the SPDR Dow Jones REIT ETF actually fell slightly, due largely to underperformance from large and low-yielding REITs that make up that index.
Our other favorite REIT, Digital Realty Trust (DLR: $103) is up another 2% for the week, and is up over 36% year-to-date. Digital Realty Trust has been one of our best picks this year, and the strong recent performance makes it tempting to sell the REIT and go elsewhere, but this temptation needs to be resisted. Why? Digital Realty Trust is optimally positioned to benefit from the continued explosive growth in cloud computing and companies’ and governments’ need for server space. As a competitive, attractively priced, and highly reliable lessor of server space, Digital Realty Trust has gained the respect and business of Amazon, AT&T, and the U.S. Federal Government - and each of these entities is not only renewing leases but demanding more. We want to profit from that continued high demand.
Another place where we have seen cautious growth is the BDC sector. The UBS Etracs BDC ETF (BDCS: $22) rose less than 1% this week and is up 7% year-to-date. That’s good, but our super pick Main Street Capital (MAIN: $34) is up over 1% for the week and a shocking 18% year-to-date. Plus, dividend coverage remains well over 100% and the company’s recent special dividend payout - and expected December payout - means this stock is yielding nearly 8% on an annualized basis. Such a high yield from a company that can cover payouts so well is unprecedented both inside and outside of the BDC world. Thus it’s no surprise that investors have been flocking to this stock in recent months, and that capital flow is likely to continue. Main Street’s management is just too good, and the company is too well positioned in the BDC world to attract the best quality debtors in need of cash. Thus the increased corporate default rate - which of course means higher defaults among smaller businesses - is not a concern for Main Street, while it dos remain a concern for smaller and less competent BDCs.
In summary, there are growing signs that investors need to be more cautious now that high yield defaults are up but yields are down. This means that a more careful and diligent allocation of capital to the best funds and companies is essential. The lower-quality companies are going to suffer, and that is going to impact indexes and the more risky funds. Sadly, this means investors cannot simply index the market and ride the valleys and troughs. It means investors need to be very careful, pick the best high yielding assets out there, and hold them in thick times and thin.
Notes on the market from Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
Investor: "Mr. Market……I'm a little worried about you. You've been a manic depressive so far this year – super lows followed by super highs. Can you give me an idea about how you feel now and maybe tell me what you see going on?"
Mr. Market: "I feel pretty good. I can tell you that I only care about two things today – bond yields and oil. (We have always considered oil as a 'wild card') So, whether you agree or not, I feel fairly confident that investors will pay me historically high valuations for stocks because interest rates are so low – and I believe they are going to stay low for as long as the central bankers remain 'uncertain' about what rate hikes would do to the global economy. That said, I have to caution you that bond yields staying low are critical to the ability of stocks to keep rising…."
Well – that's simple enough – as long as oil doesn't collapse back to the $30s and rates stay low. The many reasons to be bullish outweigh the many reasons to be bearish at this time.
We would add one important caveat to this "forever low rates" forecast: Earnings. Rates may stay low forever, but without corporate earnings growth, stocks can only form a bubble if they keep rising higher. UBS released its 2nd Quarter Earnings Recap Monday:
"Q2 2016 Recap
“Approximately 89% of the S&P 500 index has announced results. Reported earnings and revenue growth was -3.8% and -0.7%, respectively. 67% of companies have beaten earnings expectations (vs. an average of 69% since '09) while 43% have beaten revenue expectations (vs. 47% since '09). Turning to guidance, 86 of 194 companies have delivered above-consensus outlooks for the FY. On average, FY guidance is in line with consensus estimates, quarterly guidance for Q3 is 12.8% below consensus.
“With better than expected earnings results, consensus EPS estimates seems to have finally found a floor, with economic activity picking up in Q2 and Q3 of 2016. Current estimates now imply a growth rate of 0.5% for 2016 S&P 500 EPS, with a recovery in 2017 to 13.9% growth, a level we find reasonably overoptimistic given our UBS top-down estimate of 5.9% growth………."
These numbers are basically unchanged from a prior UBS recap dated 6/6/16 which estimated 2016's earnings for the S&P 500 will come in around $119 and are forecast to rise 6% in 2017 to $126. At today's level of 2180, the S&P 500 would trade at 17X forward earnings and at 18X trailing earnings. That doesn't leave a whole lot of wiggle room for stocks this year. If next year's consensus forecast of 14% growth materializes, earnings for 2017 jump up to around $135, which would result in a trailing P/E of 16%. If the market kept the same 18X for trailing earnings of $135, we would see the S&P500 at 2470. That is 17 months away but it is a whopping 13% higher than today.
Bottom line: If we had to guess, earnings will likely come in somewhere between UBS's forecast of $126 and the consensus estimate of $135. That still gives stocks some room to the upside. And, as always, companies with superior earnings should do much better than this somewhat restrained backdrop for equities.
OPTIONS CORNER
Do you think Microsoft (MSFT: $58) can get to $70 or $75 by early 2018? That’s about a year and half away. Well, if you do, you could make some serious money buying some calls on the stock. (You could also lose all your money. Gotta remind you about this AGAIN. Options are risky.)
If you think it could get to $75 because it’s paying a 2.5% dividend; because it has $113 billion in cash with $54 billion in low-interest debt; because is making 30%+ after tax returns on sales; because they have a monopoly on the PC operating system marketplace; because they are a cash machine (oh – we already said that); because they are one of the most innovative companies in the world; because they are worth $450 billion, one the highest market caps in history. We could go on and on, but for these reasons you might surmise that the stock could get to $75.
If it were to get to $75 you could make some serious money. The January 2018 $70 calls are trading at a shade under $1.50. If the stock gets to $75 the calls would be worth $5 for a return of 333%. If you invested $20,000 you would have $66,000.
Now, if the stock were to hit $80, the options would be worth $10 for a return of 666%, so your $20,000 would be worth $132,000. (The risk: If the stock doesn’t hit $71.50, the breakeven point, you would lose all your money.)
Of course, another, more conservative way to play the options game with Microsoft would be to buy the stock and sell an option against it. We love SELLING options, because options are a wasting asset and if you sell something and get money for it now, the fact that it is wasting away is a good thing. The June 2017 $62.50 call is trading for a little over $2, so you buy the stock and sell the option and if the stock goes to $62.50 by June, you would return 11% on the trade in 10 months, plus receive the dividend of 2.5% for a nice 12-13% return on a great company. (Of course, if it goes higher than $62.50 you wouldn’t participate in the gains on the stock unless you bought back the call. You could then replace it with a higher strike price – very easy to do.)
Note that options on Microsoft are relatively not very dear. Why? Because the company is now a value stock rather than a growth stock and the market doesn’t think the stock is going to explode in price like the old days. This is a good thing if you want to speculate by buying calls, but not a great thing if you are selling calls. If you want more action with options, you need to be trading stocks that are a bit wilder, like Netflix or Tesla.
Tesla (TSLA: $225, down 2%) is good stock to sell calls on. For example, with the stock at $225, you could sell the January 2018 $250 call for about $28. If the stock goes higher than $250, you would make $25 on the stock and $28 on the call for a return of $53 on a $197 investment, or 27% in less than a year and half.
Do you think the stock can go to $300? Sell the January 2018 $300 call for $14. If the stock hits $300, your net gain would be $89 on a $211 investment or 42%. Not bad.
You don’t want to tie up your stock until 2018? Sell the January 2017s. The $250s are selling for about $9. If the stock goes to $250, you’d see a $34 return on a $216 investment or 18% in five months. Wow. We like this one.
As you can see, there are many, MANY variations of options. Go here to make up your own trade:
http://finance.yahoo.com/quote/TSLA/options?p=TSLA&date=1484870400
That’s all for the week.
Good Investing,
Todd Shaver
Editor in Chief
The Bull Market Report