The Week Ahead
What a week. The Dow and S&P 500 ended the week at fresh all-time highs. Early in the week there was some early turbulence around Europe and oil. However, momentum recovered with the Jobs report and the Atlanta Fed’s GDP growth outlook for 3Q16 on Friday. It seems that despite an array of concerns here and there, the big picture is comprised of general stability for the current economic expansion, enough to be able to handle a moderate rise in rates, should the Fed so decide.
As we look to the week ahead, it sets up to be a very quiet five trading sessions. We are in the middle of the seasonally slowest period of the year for Wall Street - August is when most go on vacation. Don’t stop reading though! We think now is the opportune time to be bottom fishing for good ideas. Once everybody gets back to work after their summer vacations we expect to see the usual stampede into what is increasingly a shorter list of investment opportunities. We see Under Armour, Goldman Sachs, Blackstone, and UPS are worth a closer look. Have a great week!
Here is How The Major Indices Performed Last Week
Here is How Last Week Progressed
Monday (8/1) - S&P 500 (down 0.1%)
US investors woke up on Monday morning to learn the results of the EU stress tests, which initially seemed to restore confidence, but Italian banks reversed gains in short order as the concerning debate over the Eurozone banking system continued. The NY FRB President Bill Dudley proceeded to tell the markets that a flatter path for US short-term interest rates seems broadly appropriate, but it’s premature to rule out further monetary policy tightening this year. Tumbling oil prices reflected how hopes for the near term rebalancing were pushed out a few more months following reports of a prolonged inventory overhang coupled with lackluster demand. Tesla and SolarCity announced a $2.6 billion merger. Uber sold its money losing business in China. The NY Fed announced 15% of American’s currently have a negative net worth. US construction spending data revealed growth hit fresh 5 year lows. JP Morgan’s equity strategist joined Goldman’s strategist, so now both are making a bearish three month call on equities.
Tuesday (8/2) - S&P 500 (down 0.6%)
New data revealed that US personal income growth slumped to the lowest level seen since 2013, but consumer spending remained near the trailing 12-month highs as savings are falling and credit is growing. Earnings season results began to sink in with two-thirds of companies having now reported results. The consensus 2Q16 S&P EPS estimate was $26.70 in early April, $26.40 as of late June, fell sharply to $24.90 as of late July after the initial third of companies reported, and drifted lower to $24.10 at this time. Sentiment about the EU stress test finally arrived at a more definitive view, unfortunately ‘all is not well’ causing the EU bank index to end down mid-single digits.
Oil tumbled below $40 until the unexpected Cushing inventory draw of 1.3 million was reported better than the 1.0 million expected.
Wednesday (8/3) - S&P 500 (up 0.3%)
A report published by the IMF’s Independent Evaluation Office crushed the credibility of a very visible IMF Managing Director. Nomera’s top credit analyst sent a chilling message calling for 30-year UST yield to trend toward zero over the next two years as a result of yield-starved foreign money running to the US. Ongoing concerns about central bank policy were for the moment eased by stabilizing oil prices. Kate Spade shares fell 17% on lowered guidance in part attributable to a lack of tourists, which reverberated across Retail markets. ADP employment data showed slowing in small business hiring and particular weakness in construction jobs. Bill Gross of Janus Capital Group caught everyone’s attention as usual, this time with a scandalous headline for institutional speak, where he proceeded to explain not liking bonds, most stocks, private equity, but rather being in favor of land, gold, and tangible plant and equipment. (We take his comments with a grain of salt.)
Note this rarity: The S&P 500 exceeded the average year-end forecast by Wall Street strategists, which for the 21 brokerages stands at 2,146. And it’s only August. Amazing.
Thursday (8/4) - S&P 500 (up 0.1%)
The big news came right away. The Bank of England cut rates for the first time since 2009 in a unanimous 9-0 vote, as widely expected, to a 322 year low. (This is not a misprint.) However, in a somewhat surprising move, the BOE also expanded its QE (qualitative easing) by €60 billion to €435 billion, in a more indecisive 6-3 vote. The FTSE (The British market) ended the day up just over 1.5% thanks to the BOE. In the US, Class A truck orders for July came in at an abysmal 10,500, down 57% YoY to a level and now 77% off their 2014 peak, reflecting uncharacteristic levels of order cancelations due to too lofty growth expectations, with the industry now frantically dealing with waning freight shipments. Barclays called out that the debt-to-EBITDA ratio for the S&P 500 excluding financials is now at the highest point this century at 2.3x compared to the last peak seen in 2002 of 2.1x. US factory orders fell 5.6% YoY marking the worst drop since September, extending the trend line to a 20 consecutive month period, a move that historically has spelled out a leading indicator for recession. Crude recovered 6% in 24 hours continuing the prior day’s recovering sentiment.
Friday (8/5) - S&P 500 (up 0.8%)
Good news. The whisper number for the Jobs report was below the 180,000 consensus, after two consecutive months of missing expectations. However, the Bureau of Labor Statistics reported a surge in July to 255,000 new jobs, which surpassed even the highest Wall Street estimate. The strength was in the (not so core) sector of Leisure and Hospitality, while performance out of Construction and Retail was wobbly. Way more importantly, the industrial arena of Mining, Manufacturing, Truck and Rail, while weak showed warmly welcomed signs of a bottoming. On top of the jobs data, the Atlanta Fed came out with the highest forecast for GDP growth since 1Q15 of +3.8% for 3Q16 versus the 1.6% consensus estimate. The onslaught of good data pushed the S&P 500 to all-time record highs with Financials outperforming.
Upcoming Economic News
The highlights of this week’s economic data release schedule come in the back half of the week. On Wednesday, we will see the US Job Openings figure, which is popularly known for being Yellen’s favorite labor market indicator, as it sheds light into the velocity of new hiring activity for the amount of job openings, where increasing/decreasing velocity is a leading indicator for upcoming unemployment rate statistics. On Thursday, the initial jobless claims figure comes out, which while a key metric in times past is currently bouncing along historical lows and less of an emphasis right now. On Friday, retail sales figures are due, where the most interesting story line we see is what the growth trends mean for brick and mortar retailers, or more importantly the commercial real estate sector exposure, as we and many others have serious concerns over the downside risk.
BMR: Companies and Commentary
Under Armour (UA: $40, up 3%) Our interest in the new Kohl’s agreement has carried over from last week’s earnings report. The agreement starts in March, and adds 600 locations of distribution in the first phase, with the potential for 500 more locations to be added later, specifically aimed at capturing more of Kohl’s female consumers and Kohl’s most loyal consumers that shop there on average 18 times per year. However, investors are myopic right now about the near-term outlook, specifically the Sports Authority liquidation, and expectations for inventory clearance continuing through the 3rd quarter. Under Armour shares are 10% below levels prior to the most recent earnings report.
Is this a good entry point? 20 out of 34 Wall Street analysts say Buy, with an average price target of $50. Analysts expect the 1,100 new Kohl’s stores when up and running to be worth around $250 million of annual sales or 6 cents of EPS, which is over and above what is in current consensus figures.
BMR Take: The consensus EPS growth outlook is already a stellar 32% and this Kohl’s agreement extends the visibility of this growth trajectory, if not enhances it. Consequently, we see the Kohl’s agreement as a catalyst and attractive upside in the stock. The price of Under Amour reflects the track record of consist high quality EPS growth. Businesses delivering results like this is what we look for here at The Bull Market Report. Under Armour's valuation based on historical levels is arguably not expensive.
Goldman Sachs (GS: $162, up 2%) Goldman said this week in a regulatory filing that the UK vote to exit the European Union could force it to restructure some of its activities in the Kingdom. Specifically, Brexit would likely change the arrangements by which UK firms are able to provide services to the EU. The timing and outcome is uncertain, they said. Recall that Goldman employs 5,500 in its London office. The noise of Brexit has contributed to keeping the stock trading below tangible book value of $173. There are a number of levers for the upside, however. The recently announced $700 million cost savings effort is worth $1.00 of incremental EPS by some estimates. While the investment banking backlog is down mid-single digits YoY, the outlook is relatively upbeat around Goldman's market share.
The new digital consumer lending initiative at Goldman, which is an online lending effort similar to Lending Club aimed at capturing market share of one of the most explosive growth areas in all of consumer finance, will launch its first product this fall. This is a big thing at Goldman, as they are building a new business, something they haven’t done in years. Lastly, the recent Comprehensive Capital Analysis and Review approval was a success. Recall, CCAR is the annual process whereby Goldman and others receive regulatory approval to pay dividends and make share repurchases. So the current $0.65 dividend is here to stay and the company is now accretively buying back stock below book value, a very good thing.
BMR Take: We maintain Goldman to be undervalued.
Blackstone Group (BX: $27, up 2%) Shares have nearly recovered back to their $27.50 level prior to last week’s earnings report, which confirmed long term investor interest. The bull case for the shares is a low to middle $30 level, based on a low double digit PE. It is currently at 9 times earnings. You also get the current 6.5% dividend yield while you wait. While the reaction to last week’s earnings was somewhat mixed, the key long term drivers were solid and worth revisiting in more depth, so we at BMR did more work for you.
First, Blackstone has signed or closed $7 billion of transactions across more than 15 transactions over the past two months. Management stated it expected to be in “active disposition mode” in the second half of this year signaling more to come.
Secondly, fundraising totaled $21 billion in the quarter and $70 billion over the past 12 months. The firm has won “multiple mandates of $1 billion or greater each” over the past two months and continues to see strong demand for the alternative asset class as a whole.
Third, late cycle concerns about deteriorating credit quality have been a major overhang throughout the first part of the year for any company with exposure. To the surprise of many, we have seen credit performance remain resilient across several areas ranging from subprime consumer loans to junk bonds, even including pockets linked to the oil patch. For Blackstone this has meant a reversal of the past few quarters of weak credit and distressed strategy performance. The most recent quarter credit and distressed strategy gross returns of 10% and 7% prove there is a lot more left in the tank for this economic expansion in terms of credit quality.
Lastly, concerns around the Brexit impact are not so material as originally thought. The company noted only 3% of total assets under management are in the United Kingdom, with a meaningful portion of these assets currency-hedged or invested in euro-denominated funds.
BMR Take: We remain positive on the long term outlook. The stock is WAY undervalued.
United Parcel Service (UPS: $109, +1%) Investors have now had a bit over a week to digest the most recent earnings report, and shares look poised to test 52 week highs of $112. The latest Jobs data on Friday directly addressed concerns over a sluggish macroeconomic outlook weighing on UPS. Core trends for the company are solid, in particular eCommerce growth and this year’s peak holiday season outlook.
First, UPS should continue to benefit from its increased exposure to eCommerce activity. Business performance for the company is a tale of two cities with strong B2C* and eCommerce growth offsetting softer B2B* and industrial activity. In fact, B2C is now 45% of the business and grew more than 5 times faster than the B2B business this past quarter.
Second, the outlook for peak season is shaping up well and will benefit from an extra workday between Thanksgiving and Christmas. In fact, management expects fourth quarter operating profit growth to be roughly 10%, above its annual guidance.
BMR Take: At $109, the stock trades at 18x the consensus 2017 EPS. Valuation has consistently been able to hold a 20x PE in recent history. We like this company a lot.
*B2B – Business to Business
*B2C – Business to Consumer
Mobile Advertising Rises at Facebook
Facebook (FB: $125, up 1%, after rising 2% the week before) once again reported growing profit on the strength of its mobile-advertising business. For the latest quarter, the company saw net income of $2.05 billion, or 71 cents a share, compared with $720 million, or 25 cents a share, a year ago. The stock closed near the all-time high of $128 hit after earnings were released a week ago Thursday. Facebook is now tied with Exxon with a market cap of $360 billion. Unreal.
Energy News of Note
Exxon Mobil (XOM: $88) reported its quarterly profit fell 60% to the lowest level since 1999, while Chevron disclosed its biggest quarterly loss since 2001. With its other businesses struggling, Exxon Mobil’s chemical division delivered more than half of the company’s profits in the first six months of 2016. Two years earlier, during better times, chemicals accounted for less than 10% of profits.
The Apple Corner
Apple keeps chugging away. To use our favorite term lately, it is TRICKLING UP day by day, week by week. Two weeks ago it was at $99. Now it’s at $107.50, up 3% for the week, and paying their whopping dividend of 57 cents. Well, not whopping. But nice nevertheless. (If you want more income from Apple, read our Options Corner (below.)
There is lots of negativity about Apple out there. We read it and generally discard it. Why? Well, for one thing, they have $232 billion in cash. Yes, we know – most of it is overseas and to get it back they would have to pay a 30-40% tax. Let’s think about this for a minute. Let’s say you have $5 million overseas and can’t get it back here without paying a tax. Nice problem to have, right? So you go to Europe and spend it. Or you pay some tax and bring back $3-4 million free and clear.
Need we go further? OK – we will: $232 billion in cash is the equivalent of $43 a share in cash (OK – we KNOW that they have to pay tax on the cash.) But still, no other company in history has had 40% of its stock price in cash. [Google (GOOG: $782) has $77 billion in cash – that’s $112 per share, but only 14% of their stock price. (Wait – did we say “only”?)]
Secondly, they have the iPhone. So sales were a little slower last quarter. But they still sold 40 million iPhones! That’s still 440,000 A DAY! And every one of them is going to load up iTunes and buy music, and go to the App Store and buy stuff. And love it so much that they will buy a Mac down the road. Need we go further?
Third – a new version of the iWatch is coming out, a truly revolutionary product.
4th – They are working on the TV market. They WILL get it right one of these days.
5th – Autonomous cars. It’s coming, and Apple will be at the forefront. (This is certainly a way off, so we are not banking on it, but felt we had to mention it.)
6th – The iMac. The greatest computer ever made. Need we say more?
BMR Take: We firmly believe we will see new all-time highs in the stock if the market behaves. What’s its all-time high? $134.
Words from Gary Jefferson
First Vice-President, Investments
Jefferson Financial Group
Forget for a moment that the consensus earnings forecast is for a strong 3rd Quarter followed by a stronger 4th Quarter. If the remainder of the 2Q earnings season ends as it has shaped up thus far, it will be the fifth straight quarter of earnings growth decline. (Note that the 2Q GDP has just been officially declared worse than expected, coming in at 1.2% versus a consensus for 2.6%) Of all the fundamentals that support stock market value, corporate earnings is "the big dog." After five straight declines, one might ask, "Why isn't the market in the doghouse instead of acting like everything is great?"
Energy companies have been devastated by falling prices; banks were hurt by artificially low rates; and multinationals got hit by a stronger dollar. Over the past year we have seen a rally in oil prices, a bump up in interest rates and the US dollar has taken a significant breather - all good. But recently, "negative rates" have appeared around the globe, oil has retreated over 15% and the dollar has surged upward – not good. Yet the market has continued to surprise to the upside. So what's the deal?
According to the rule of KISS, the simple answer is investors are betting that corporate America is turning the corner; i.e., the earnings contraction that started over a year ago has bottomed out earlier this year. From everything we read, however, a good bit of the much rosier outlook for the rest of this year is based on oil prices and the idea of forever-low interest rates. The very recent wrong-way moves in oil and the dollar, raise concerns about their possible negative impact on manufacturing and further disruption in the Energy patch. And heck, why stop with just a couple of "worries" – there are countless worries to be had.
All of this brings to mind one of the oldest and most respected stock market epigrams: "Stocks climb a wall of worry". Meaning, without worry there would be no opportunities in the stock market. There's plenty to worry about – oil, the dollar, rates, the election, Brexit, China and terrorism, just to name a few. But what we see is a wall that will crumble under the pressure of good earnings, despite all the worries. However, should earnings surprise to the downside we will see a wall the market can't climb over. The majority of experts believe that earnings will come through just fine, and if they are right, the market should continue to “climb” its way higher by year end.
HIGH YIELD CORNER
One week is not enough to make a trend, but this week’s action could be the beginning of a change in the high yield markets.
The broader market was up less than 1% for the week, helped by another strong Friday after a somewhat humdrum week. Similar performance was seen in the UBS Etracs BDC ETF (BDCS: $21.60), which was up just about as much as the S&P 500 for the week. Everything else high yield was a disappointment, however. High yield bonds were flat, as the iShares High Yield Corporate Bond ETF (HYG: $86) ended the week flat, helped in large part by strength on Thursday and Friday.
Similarly, the MLP world ended the week flat after early-week volatility, as the Alerian MLP (AMLP: $12.85) ended the week flat after losing nearly 4% at its lowest point on Tuesday. This extreme volatility, combined with a 1-year decline of 17%, again strengthens our resolve that the MLP world is fraught with danger and volatility - the kinds of things that long-term investors seeking reliable income do not want. Combine that with a dividend cut in May for the MLP ETF - a necessary move after dividend cuts (or halts entirely) in the Energy sector. While further dividend cuts in the short term are likely for some MLPs, being selective in this market - or avoiding it altogether for higher quality income instruments - seems the prudent thing to do. At a 9% yield, the Alerian MLP retains a poor risk/reward profile even as oil markets become increasingly volatile. We’re not back to the darkest days of 2014 or 2016 for that matter, but we definitely aren’t out of the woods quite yet in the Energy sector.
So what income instruments are a better option? For a while, The Bull Market Report has been recommending REITs as a great income opportunity, with the best players in this asset class providing tremendous returns so far in 2016. However, it may be time to look elsewhere. The SPDR Dow Jones REIT ETF (RWR: $102) fell over 2% last week, falling every day except Friday, when the rest of the market rallied and REITs closed slightly in the green. This is stunning since the SPDR Dow Jones ETF has a very conservative allocation among low-risk REITs. Unfortunately, it is those low-risk REITs that are getting hit the hardest. If we compare Realty Income Corporation (O: $69) to one of our more contrarian picks, this paradox of volatile low risk stocks becomes clear. Realty Income is an old favorite of high yield investors thanks to its size, diversified portfolio, excellent management team, and incredible dividend coverage. That’s why the stock soared 40% from the beginning of 2016 to the beginning of this week. But this week showed consecutive declines, causing the stock to fall 4%. Meanwhile, Bull Market Report pick Government Properties Income Trust (GOV: $23.90) ended the week flat and remains up 50% year-to-date.
This doesn’t mean declines for some REITS or some MLPs aren’t in the cards. In fact, a major correction in the REIT space seems to be coming soon after meteoric rises earlier this year. However, the selling pressure we saw this week demonstrates that the more risk-averse investors - the ones who prefer Realty Income over Government Properties - are the ones who are selling off the most aggressively. With strong dividend coverage but thin volumes and relative unpopularity, we actually see Government Properties better positioned to hold onto its gains longer than other REITs for as long as this risk-averse sell-off continues.
That doesn’t mean we are aggressively buying more REITs right now. The capital gains The Bull Market Report portfolio has enjoyed are wonderful, and justify considering a reallocation to other high yielding assets that remain well-valued and less at risk.
On that topic, let’s turn back to the bond world. Formerly Pimco Dynamic Credit Income Fund has renamed itself to PIMCO Dynamic Credit and Mortgage Income Fund (PCI: $19.95), properly reflecting its new investment mandate. Like the high yield bond world, the Pimco Fund was flat for the week and saw minimal volatility. Up 10% year-to-date with a 10% dividend yield excluding special dividends, which the fund has a history of paying, we remain in love with this fund and see it as a great place to pick up income in the current market. The fund is still trading at a discount (6%) to its net asset value, and net investment income still remains above dividend payouts, with a massive amount of undistributed income still remaining in the fund.
We especially like the Pimco Fund because of trouble that is hitting the corporate bond and BDC markets. We also still like its sister fund, Pimco Dynamic Income Fund (PDI: $29), which is up only 6% and may have more room to go in 2016 thanks to its more aggressive focus on mortgage bonds and its limited use of corporate bonds. Why? Simple: Corporate defaults are up. In fact, they reached a 6-year high this week, and Moody’s released another warning about the credit markets. This news didn’t cause high yield bonds to fall - in fact, the markets shrugged off the news. Meanwhile, average yields on high yield debt have plummeted to less than 7% - their lowest point in a couple years. The danger of non-accruals to BDCs is also mounting, leaving investors in the credit market to face a dilemma.
The way we see it, the increased risks and falling yields on corporate debt mean that you cannot simply hold a corporate bond or a corporate bond index fund. You need active management to avoid these surging defaults. This is especially true as junk bond interest rates fall, and the likelihood of rising rates later this year or in 2017. We would like to limit our exposure to junk bonds right now, while still enjoying the high income that an aggressive credit strategy offers. These funds offer it. In the coming weeks, we will need to continue to monitor the junk bond and BDC markets to see if this week’s relative weakness in credit gets worse.
THE OPTIONS CORNER
Two weeks ago we wrote about an options strategy for Apple. Here’s how it went:
Let’s look at some Apple strategies. Do you like Apple? We do. Has it been a laggard lately? Yes. Will it jump out of its trading range here in the upper 90s? We certainly think so. As you know, the stock closed Friday at $99, up 1% for the week.
How do you get a huge bump in income from the stock? Answer: Sell the January 100 call. Let’s say you have 100 shares worth just less than $10,000. The dividend is currently 2.3% giving you an income of $230 per year. If you sell the January 100 call for its current price of $5.25, you would have an immediate inflow of $525, or an annual return of 10.6%. [The math: $9900 investment; Income of $525; Time period – six months.] Now, if the stock goes higher than $100, you will get called away and have to sell the stock. But we are not talking about anything other than an income plan here. If you don’t want to lose the stock, then you should consider selling a higher-priced options like the January $110. That only gives you $2.00 ($200) on 100 shares. But, it does give you $10 of upside on the stock which is worth $1000.
Let’s review what happened in the last two weeks, and what moves you can make if you like. The stock was at $99 two weeks ago and is now at $107. This is good news, as you have made 8 points on the stock, $800, but if you had sold the $100 call, you are at risk of having the stock called from you. So what you can do is BUY BACK the January 100 call for $11 and SELL the January 110 for $5. You are ROLLING OUT the options and this gives you the upside to $110 for a potential gain of 11 points from the $99 that you paid, which is a good thing, and you would only lose a point on selling the calls. All in all, a good trade.
News of Note:
We discovered some news from The Mercury News about the amount of cash that is being held by Tech companies. We know about Apple, with $232 billion at the end of June, with about 90% held overseas, but listen to how much cash these companies have using end of 2015 numbers:
Microsoft: $100 billion, 95% overseas
Google: $73 billion, 60% overseas
Oracle: $52 billion, 87 overseas
Cisco: $60 billion, 95% overseas
Other companies with a lot of cash include Intel, Gilead Sciences, Facebook, Amazon, and Qualcomm.
That’s a wrap! (We almost wrote – That’s a warp!)
We’re pumped on announcing our new Bull Market app. Check it out at the iTunes store or on Android.
Good investing,
Todd Shaver
Editor in Chief
The Bull Market Report