The Week Ahead
We are quickly approaching Donald Trump’s Friday inauguration. The event will mark a key inflection point for the markets. After the big rally in stocks and sharp sell-off in bonds following the November election, a plethora of expectations for the future will soon meet the reality of what is possible, as we move into the first 100 days of the President’s term.
This week we provide some insights on our latest thinking for Amazon, Facebook, Google, Netflix, Bristol-Myers Squibb, and Tesoro Petroleum.
 
Highlights From The Past Week
Recession Watch. History has shown us that a recession has generally occurred during the first term of a new president, especially when following a two-term presidency. Could this be the case this time around? The leading economic indicators (LEIs) are positive, and there has never been a recession without those indicators going negative. CEO confidence is moving up and consumer confidence is exploding, which seemingly points to the likelihood that a recession is not imminent. We are not big believers in patterns, to tell you the truth. So we are leaning towards a continued strong economy and a continued bullish stock market.
There may be a Trump backlash coming though. You know, the one we expected in November after the election. We have talked to a number of our subscribers and many of you are worried about this. Our suggestion is that if you are worried so much so that you are losing sleep, with commissions as low as they are in this century, it is easy enough for you to sell those stocks that make you nervous and look to some of the issues in our High Yield Portfolio. They are generally more stable than other stocks.
However, there is also talk that the Trump presidency could be the best thing Wall Street has seen in a long time. Cutting taxes, bringing back the huge horde of cash overseas, tackling the infrastructure building that needs to be done, etc.; these are all things that could help the economy. Dow 25,000 soon? Oh wait – we haven’t hit 20,000 yet! Stay tuned.
Interest Rates. If the economy continues to grow steadily, the US Treasury 10-year Note could hit 6% in four years, about the time of the next presidential election, up from its current level of 2.4%. Inflation and economic growth are already at levels similar to 2006, when interest rates were at that level.
Stronger dollar. The dollar holds a unique position in the global economy, and a rapidly rising dollar exchange rate has historically caused something somewhere in the global economy to break. Those in emerging markets that have borrowed in dollars face the reality of a liability stream that has become more expensive to repay. Meanwhile, the second largest economy on the planet, China, has informally pegged the yuan to the dollar. A stronger dollar generally means a stronger yuan; a stronger yuan means a less competitive export sector for an economy that is all about trade.
BMR Companies and Commentary
Amazon (AMZN: $817, +3% for the week)
JP Morgan Chase is offering a new, co-branded Visa rewards card through Amazon that offers compelling rewards for both Amazon Prime purchases and all other purchases outside of Amazon. Specifically, the new Chase card offers 5% cash back on all Amazon purchases by eligible Amazon Prime members. This deal marks another win for Amazon deepening their existence in banking.
How about the core business of Retailing? What started out as an online bookseller is now on pace to overtake Macy’s as the world’s largest apparel retailer, a startling development when you remember that e-commerce was once considered an impossible way to sell clothing. Amazon has reportedly recorded record holiday season sales at the same time that traditional department stores, including Macy’s, Sears, and Kohl’s, have reported declines. These companies aren’t adding thousands of new workers like Amazon. To the contrary, Macy’s plans to close 100 stores to improve profitability, and Sears has sold its Craftsman tools line for $900 million to raise cash.
BMR Take: Amazon is currently not far from its all-time high of $844, set in October. There is still the potential for upside for investors here, and the stock could go even further, perhaps passing the $1,000 mark sometime in 2017 or 2018.
Facebook (FB: $128, +4%)
Facebook has underperformed the Nasdaq since the company’s 3Q16 earnings report, due to a number of factors, including concerns about slowing growth, heightened expenses in 2017, and sector rotation out of Technology.
Investors have also cited concern about the headwind from a possible 1Q17 IPO of Snap. As far as the competitive risks of new more exciting Tech IPOs stealing away investors from Facebook, any impact is likely to be temporary and potentially more modest than investors fear. Press reports suggest that Snap (aka Snapchat) was considering an IPO as early as March at a valuation as high as $40 billion. Given that Snap’s IPO will represent the largest tech IPO since Alibaba went public in 2014, some investors have begun to question how the issuance may impact existing public market Tech stocks and in particular its closest comp, Facebook.
BMR Take: Yes, it has underperformed since November, but it has been on a TEAR since the start of the year. Be advised that the upcoming Snapchat IPO will be all over the headlines, but don’t sell your Facebook over this. Facebook’s long term prospects are fantastic. Facebook is fast approaching its all-time high of $133.50 set in October. And fast approaching 2 billion users. The company adds 1 million subscribers every two days. With growth of 35% a year projected for the next two years, the stock is not over-priced.
Netflix (NFLX: $134, +2%)
A big name stock analyst that was short Netflix covered his call this week. It’s nice to see them come join our camp. There is so much to like about Netflix. In fact, the stock hit an all-time high of $133.93 this week!
On the heels of new details about Hulu’s upcoming live TV offering (pricing, content lineup, etc.), Netflix reiterated that it has no plans to make any other meaningful changes to its business model or content strategy, stressing that the simplicity of its offering is a key advantage.
The company has also evaluated the merits of an ad-supported model but continues to believe that focusing on its core business provides the greatest return on investment. Looking back at Netflix’s pricing changes and the un-grandfathering it worked through in 2016, the company feels good about its pricing power and is satisfied with the outlook. They also expect future price increases to be more staggered by country/region rather than by universal global changes.
While Netflix intends to keep pricing relatively consistent globally, in Japan, for instance, it has a lower price for its lowest tier ($5/month) in order to address Netflix’s more limited brand recognition in that market (i.e., to better spur new user adoption).
Netflix now has 50%+ of its content catalog available for downloads on Android and iOS today, and it expects that percent to increase. The company is increasingly self-producing content, which it believes can ultimately be 30%+ cheaper than licensing. Like what began in 3Q16, this will continue to impact cash burn in the near-term given the up-front costs associated with producing content.
BMR Take: Netflix is changing the game for television. We continue to believe they are on a long term path to 2020 EPS of $10 where a 20x PE multiple supports a $200+ valuation.
Google (GOOG: $808, flat)
Speaking of the future of media, Google’s YouTube is just crushing it. We highlight the following data points tracking YouTube through December 2016:
--- YouTube worldwide video views for the top 1000 publishers in December 2016 totaled 70 billion, which was up dramatically from last year. This brings total cumulative views on YouTube for these top publishers to 1.97 trillion – wow. On a trailing three-month basis, total views were 190 billion - these numbers are astronomical! In November 2016 alone, videos uploaded to YouTube generated 147 Billion views, both organic and paid.
--- The total number of subscriptions to the top 1000 YouTube video publishers’ channels was 3.9 billion at the end of December, adding 120 million channel subscriptions in the last month alone, up nearly 70% from this time last year. Â
--- The total number of videos available on YouTube from these top publishers was 5 million at the end of December, accounting for 19% more content on the platform than in December 2015.
BMR Take: If these numbers don’t describe a healthy business, we don’t know what does. We view Google as a core holding, given: 1) the company remains a top player in the internet space 2) management's track record of execution, 3) the potential to maintain double-digit earnings growth for many years, and 4) attractive valuation.
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Tesla (TSLA: $238. Up 4%) has been on a tear. At $182 on December 1st, the stock is up over 30%. The company just opened a showroom in Aspen and the place is packed. I met a friend on the street on Friday and motioned for him to come in. Guess what: He is taking a test drive next week and might buy one of the Model X’s that start at $85,000. 0-60 in 2.9 seconds. Call it a cult, or call it what you will, but this company is real and this company is exciting. With Saturday’s Space X launch of 10 satellites on the Falcon 9 and then landing the rocket on the drone ship in the ocean, Elon Musk’s star is riding high. Musk sent out this Tweet:
Elon Musk @elonmusk
Mission looks good. Started deploying the 10 Iridium satellites. Rocket is stable on the droneship.
BMR Take: We’ve said many times before in these pages that the stock is not for the conservative and that the stock could go to $150 before it goes to $250 due to its volatility, but we will tell you that this stock could go to $400 this year or next. We hereby raise the Price Target from $250 to $290 and raise the Sell Price from $150 to $180.
FAANG Stocks Bite Back Adding $90 Billion In Market Cap Over the Past Two Weeks. Technology stocks have found a cure for whatever was plaguing them during the early stages of the Donald Trump bull market. In especially brisk health is the FAANG block of Facebook, Amazon, Apple, Netflix and Google, which have rallied at 3.8% on average this week, poised for their best performance since October. About $85 billion has been added to their value as investors rotate back into post-election laggards. FAANG stocks were oversold after the election, although there’s likely no real impact from a Trump administration on the highest quality internet names. These five stocks could potentially outperform in 2017, despite pretty clear skepticism among almost all investors, who see a sustained rotation away from growth stocks in the wake of the Trump election. Not us. We are sticking with them. Like glue.
Alphabet (GOOG: $802, up $30)
Apple (AAPL: $119, up $3)
Facebook (FB: $127, up $12)
Amazon (AMZN: $808, up $58)
Netflix (NFLX: $140, up $16)
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The Border Tax
Notes at the Margin
Philip K. Verleger, Jr.
Former Director of the Office of Energy Policy
at the United States Department of Treasury
The House of Representatives’ Republican leadership seems set on pushing the plan through despite suggestions from some experts that it is a bad idea. Indeed, their determination to pass the law seems palpable even though major economic players such as James Bullard, president of the Federal Reserve Bank of St. Louis, have admitted publicly that they do not understand the concept.
Still, for the world’s oil industry, it is critical to understand the border tax quickly. Why? Because its passage will likely change oil flows completely. Most US oil producers would have every incentive to sell at home and none to export. Bluntly speaking, for oil the law’s passage is pure mercantilism. Exporters from Mexico, Canada, and the rest of the world could be shut out.
How might this happen? Start with the fact that the “Made in America” price could be 25% higher than world prices. The boost occurs because US producers would pay no tax if they export oil while US importers would pay a 20% tax. This means US producers would receive $50 per barrel if they export. On “paper,” at the margin they would have to pay a 20% tax if they sell to domestic buyers. This means those buyers would have to pay $62.50 per barrel in a $50-per-barrel world for the domestic producer to net $50.
The High Yield Corner
By Michael Foster
Special to The Bull Market Report
It was a quiet week for the markets, with the S&P 500 ending flat with few dramatic days. Donald Trump’s odd press conference, in which the president-elect took a victory lap after his election win but failed to provide clarity on fiscal spending plans or an economic blueprint, caused a brief upset to the markets, but strong results from financial firms on Friday offset the macro worries quickly.
With that in mind, it’s unsurprising that the market was mostly quiet for high yield assets. The UBS BDC ETF (BDCS: $23) was mostly unchanged this week after accounting for its dividend payout, while the SPDR Barclays High Yield Bond ETF (JNK: $37) also saw no major move in any direction. Impatient traders may be frustrated at the lack of volatility, but we are pleased. Junk bonds and BDCs had a tremendous year in 2016, causing many funds and companies in these spaces to become worryingly overvalued. If we don’t see an aggressive run-up in pricing this year, we would be in a better position to hold our positions, add more on short-term dips, and avoid the need to sell overbought assets without viable alternatives for our cash.
This situation is particularly good for the PIMCO Dynamic Income Fund (PDI: $28, down -1%), which fell slightly this week but still has excellent dividend coverage and growth potential. After the fund paid out a massive special dividend last month (which we predicted), the fund is now in a position to accumulate new investment income and pay another big special at the end of this year. We fully expect this to happen, so we want to hold on. There’s only one problem: this fund's premium to its NAV is around 9%, bringing us dangerously close to a point where we would need to offload and choose another, lower-priced bond fund. We’d rather avoid making that trade because there are maybe two funds in the world that can match this fund in terms of yield, portfolio quality, and management acumen. As it stands, we can avoid choosing an alternative to the Pimco fund and enjoy its massive yield.
While things were quiet in BDCs and corporate bonds, there was a bit more action in municipal bonds, although this sleepy asset class is notorious for its low volatility and small moves. The iShares S&P National AMT-Free Municipal Bond Fund (MUB: $109) was flat this week, but our municipal bond picks both outperformed the broader index. Invesco Municipal Trust (VKQ: $12.58) and the Nuveen AMT-Free Fund (NVG: $14.63) both rose over 1% this week thanks to the market finally realizing these funds were underpriced relative to their portfolio quality. It makes little sense for these funds to offer discounts to their NAV, so we expect both to continue to rise in price as municipal bonds strengthen from the blood bath of 2016. For this reason we recommend a solid weighting of your overall portfolio in these bond funds for the foreseeable future.
Our biggest winner this week was AstraZeneca (AZN: $29, up 3%), which has been recovering from the broad panic that President-elect Trump is going to reign in drug prices and pressure Pharmaceutical firms’ profit margins. While a lot of talk before the election from both sides of the aisle pressured Pharma firms, the lack of clarity in Trump’s speech this week was ironically a positive for AstraZeneca. Investors are becoming more certain than ever that promises to reign in drug prices will get watered down heavily before they ever become a legislative reality - and that might never even happen. With that in mind, the big dip that this and other Pharma companies have suffered over the last year is becoming a buying opportunity. We’re pleased to keep AstraZeneca in our high yield portfolio for this very reason.
There is one sector that really took a beating this week: REITs. The SPDR Dow Jones REIT ETF (RWR: $93, down 2%) was the biggest loser of all the indices we track, but our REIT picks outperformed by a substantial margin. Even high-risk and overly volatile Government Properties Trust (GOV: $20, down 1%) saw declines only a fraction of the REIT sector as a whole. This is rare, as Government Properties Trust is notorious for rising more aggressively and falling more precipitously than REITs more broadly.
With one exception, our other REITs fared as well or better. Omega Healthcare Investors (OHI: $32, down 1%) and Care Capital Properties (CCP: $25, down 1%) fell slightly alongside the market, but Digital Realty Trust (DLR: $102) held on to its 2016 gains and ended the week flat. Digital Realty Trust has seen some of the highest capital gains of any of our high yield picks, but we aren’t selling quite yet. As we lap the year since we picked this stock and short-term capital gains become long-term capital gains, we might revisit this stock and consider changing our recommendation to a sell if (and only if) its price rises too fast and its upcoming earnings results shows weak FFO growth. This is something for us to keep our eye on.
Finally, our REIT under-performer is a surprising one: Kimco Realty (KIM: $25, down 3%). Usually a solid and low volatile firm, Kimco slid this week despite getting an upgrade by Raymond James. Kimco also announced that its next dividend will match its last one: 27 cents per share, which is up over 6% from just four months ago. The sell-off may be a result of impatient investors disappointed that we aren’t seeing another rate hike, although Kimco tends to do just one rate hike per year, and they did their last one last quarter. We’re shrugging at this dip, although it does mean Kimco is now flat on a year-over-year basis. Still, we aren’t in Kimco for capital gains, we’re in it for the dividend, so if we see Kimco start to fall further we might recommend doubling down.
All in all, a peaceful week for high yield, which is great for us since we’re getting paid 8% to hold these names. It’s also nice to see high yield resist growing market certainty that an interest rate hike is around the corner. If this trend continues for a few more weeks, we could easily expect high yield to be one of the strongest asset classes of 2017.
This coming week: Watch for a new research report on a fast-growing, powerful company in the virtualization and cloud infrastructure solutions space. Sounds pretty technical, doesn’t it? We’ll make it simple and understandable for you. As always.
Good Investing,
Todd Shaver, Founder, CEO and Editor
The Bull Market Report