February 26, 2017
by Todd Shaver | Feb 26, 2017 | Weekly Newsletter 7pm Sunday
The Week Ahead
“US Talks With Mexico Clouded By Mixed Message” was the front page Wall Street Journal headline going into the weekend. For months now all the focus has been on the new administration. Does anything else matter? Washington DC policy is seemingly the only driver of financial markets right now. Accordingly, we will likely need to start seeing some tangible results on healthcare, tax, and trade reform sooner than later. We eagerly await to see where reality meets the promises made on the campaign trail.
No matter what, there is always a bull market here. Week in and week out, we you can find it right here at The Bull Market Report. This week we highlight evidence of a bull market in the following securities: Amazon, Apple, Home Depot, Netflix, Bristol-Myers Squibb, and Tesla.
Highlights From The Past Week
Top Investor Says He Is Disinvesting. Jeffrey Ubben, the CEO of activist investor ValueAct Capital, told the press that his firm had been taking money out of the capital markets as valuations have become overextended, leaving it with $3 billion in cash. "I really feel that the large-cap activist plays are very treacherous with high PEs and not a lot of growth," Ubben said, speaking at the Reuters "Future of Shareholder Activism" event in New York.
Well, it takes all kinds. That’s what makes a market. We certainly aren’t jumping on his bandwagon. We’re watching, but this market may have a LONG way to go on the upside. Over-extended markets can get more over-extended and who’s to say the market is over-extended? We don’t think so. Either way, we at The Bull Market Report are not trying to predict the macro direction of the world. Our philosophy is that it is unknowable. What we can do is recognize good companies that will do well no matter what the world throws its way.
Are Trump’s Aggressive Plans Achievable? Concerns about Trump's tax cut plan - arguably the biggest catalyst behind the market's daily record highs - are mounting. Rising opposition to a simple "repeal and replace" of Obamacare could spill-over into other domestic policy targets, most notably tax reform. The current debate suggests that tax legislation might not be finalized until late 2017 or early 2018. Along with the potential for a phased-in tax cut, this would likely spread the growth effects between 2018 and 2019. That’s a long way away and lots can happen in the meantime.
We at The Bull Market Report feel that a tax cut is a bad idea. The budget is operating at a deficit now, so a tax cut will make it worse. David Stockman, former Budget Director under Reagan and the perennial bear feels this would be a disaster financially for the United States. We generally don’t agree with Stockman much because he is SO negative but we sure do in this case.
Look – we are flirting with a debt of $20 trillion. Cut taxes and we could be looking at $22 trillion to $25 trillion in debt. It just scares us to write this. And it seems like no one is talking about the debt any more. Listen, if you own a company and it brings in $5 million in revenue but you have $5.5 million in expenses you have to borrow that $500,000 to move to the next year. If it happens the following year, you now owe $1 million. If you do it EVERY YEAR you eventually have to cut people, cut expenses, and ultimately if you don’t act fast enough, you go bankrupt. Just add 10 or 20 zeros to this example to get the results for the United States. (Just kidding about the 20 zeros, but we hope you get our point.)
BMR Companies and Commentary
Amazon (AMZN: $845, flat for the week – all prices in The Bull Market Report are for the week)
This week was the launch of DXagents, a first-of-its-kind group of business leaders and technologists from leading private, public and not-for-profit organizations in Canada, that aims to accelerate the national digital transformation. The year-long partnership includes Deloitte, SAP, Amazon Web Services (AWS), Intel, and others. The mission of the group is to help Canadian businesses better understand and get on the path to realizing their digital transformation opportunities.
Digital transformation refers to the adoption of digital technologies such as cloud, big data, mobile and social media. With recent IDC research finding that 63% of Canadian companies are 'digital laggards' leaving themselves vulnerable to competition from less risk-averse global peers, DXagents was created as a community for Canada-based CIOs, CFOs and other decision makers to more easily and effectively share and discuss experiences related to digital innovation.
BMR Take: Here is a big growth opportunity (this time Canada). Yet again, guess who is involved? (Amazon). Where is Microsoft Azure? Where is Google Cloud? It sure looks like Amazon Web Services has an “in” to doing more business with Canadian companies.
Apple (AAPL: $137, +1%)
Apple has Samsung on the ropes like never before. The competition for the lucrative high-end of the smartphone market is a race between these two companies, which ship over 36% of smartphones globally, according to an IDC estimate.
The war between the two companies for smartphone buyers has raged for years, but the power balance is shifting in favor of Apple, especially after last year's Galaxy Note 7 fiasco and the rising anticipation for the next iPhone.
Mobile World Congress kicks off Monday. This event is one of the biggest smartphone trade shows of the year. Although Apple never makes announcements at the conference, competitors, especially Samsung, usually launch their new mobile product in order to get some press. This year, Samsung is not expected to launch a new phone at the show. Instead, it will likely launch new tablets. While it could be nothing, it could also be a leading indicator that Samsung is really in a tough spot this year, perhaps something has gone really wrong with this year’s model. In contrast, over in Apple’s camp, Apple's Asian supply chain is raising rumors of a very cool redesigned iPhone, with a better screen, longer battery life, and a next-generation 3D selfie sensor.
BMR Take: Apple is taking a bigger bite out of the smartphone market as Samsung is stumbling. Apple is leading the way by innovation. That is what we love to see for our stock picks at The Bull Market Report.
SEE MORE on Apple below in this Report.
Home Depot (HD: $146, +2%)
It’s not too late to buy into the housing recovery. While some fear we are in the 8th or 9th inning of the housing cycle, a recent fundamental analysis published by a major Wall Street investment bank suggests we are not yet that far along. This mean there is still some gas left in the tank for Home Depot.
Home Depot is enjoying strong fundamentals as housing demand continues to outstrip supply. Rising interest rates are not likely to hurt the industry near-term as bad as some may think. For example, it usually takes as much as eight quarters for tightening interest rate cycles to hurt home improvement spending, and Home Depot stock has performed well in rising rate environments in the past.
There is more to like. Home Depot has more stores than peer Lowe’s in yet-to-recover and recovering markets. Accordingly, many think there is upside to the consensus same-store growth outlook of 4-4.5% for Home Depot in 2017-2018. One can also argue that the stock is nowhere near stretched, trading at a PE of 20 that is on par with the 3-year average, and is compelling relative to expectations for low-teens EPS growth.
BMR Take: Business at Home Depot is charging forward. Don’t let all the “late-cycle” discussion talk you out of this holding.
Bristol-Myers Squibb (BMY: $56, +3%)
Bristol is our featured story of the week. It has been a bit of a turbulent ride so far. But hang in there, big time help has just arrived. While JANA Partners pushing for more buybacks and board seats has been helpful, the one and only Mr. Carl Icahn just showed up. Icahn has a history of taking positions in companies and then working to force a sale. Worth about $20 billion, Icahn primarily invests his own fortune.
Icahn was reported to see this drug-maker as potentially ripe for a takeover. Possible buyers could include Pfizer, Gilead Sciences. and Novartis, all of which have an interest in cancer drugs and have money to spend. “I think everybody is looking at Bristol,” Allergan CEO Brent Saunders said in an interview.
Bristol-Myers was itself once one of the drug industry’s major acquirers, snapping up pipeline assets in what it referred to as its “string of pearls” strategy. Those deals landed it the drug Opdivo, which uses the immune system to attack cancers and got remarkable results in once-fatal diseases like advanced melanoma. More recently, though, it’s lost ground to rivals like Merck, which has a similar drug, Keytruda, that has taken the lead in some oncology markets.
Bristol-Myers is still a tempting takeout target. If you believe in the immuno-oncology franchise, then it’s obviously an attractive asset because there’s not many ways to get into this space. While Pfizer has a partnership in immune-system-based cancer drugs, it’s well behind Bristol-Myers and Merck. Novartis, another player in oncology, could raise the cash to do a deal through asset sales and debt. Gilead has amassed billions of dollars from sales of its hepatitis C drugs and is looking for its next move.
BMR Take: Icahn has made a fortune for himself as well as the shareholders who have been there alongside him. Bristol just became one of the most interesting holdings in your portfolio.
Tesla (TSLA: $257, -6%)
What does Tesla's new CFO mean for business? Tesla CFO Jason Wheeler is leaving the company after just 14 months on the job and will be replaced by the electric car maker's original CFO. Tough to be the new guy?
Wheeler, who left his job as vice president of finance at Google to join Tesla in 2015, is leaving to pursue a position in public policy. Hmmm. We wonder what the real story is. When a company changes CFOs -- particularly by returning to a previous CFO -- it's often an indication that it's "tightening up operating performance” and specifically focusing on margins. Tesla's gross margins showed a drastic decline from 28% in the third quarter to 19% in the fourth quarter. The executive level change is likely a step to fix this problem.
Investors want to know if Tesla is going to lose money on each car it manufactures now as it ramps up production, or if it can come close to earning money off each sale. Tesla said that its Model 3 automobiles will start at a price of $35,000, but the company spends about $80,000 to build each car. Many say that this includes capital investment so it not a comparable statistic. There is a lot of heavy lifting to be done to get to profitability.
BMR Take: Change can be good or bad. In this case, we see good things happening. Tesla is getting back some needed deep expertise at a critical juncture. We continue to see long term value in Tesla. Who else is disrupting the Auto industry is such a big way? (Hint: no one.) But we also note that innovation in the Auto industry is a tough business. It hasn’t been done for decades, so an investment here is fraught with risk. As we’ve said many times using different numbers, Tesla could be heading to $400, or $150, we’re not sure which. And if it does go to $400, it just might hit $150 first. If you don’t like risk, please exit the kitchen.
Netflix (NFLX: $143, +1%)
Competition is getting red hot. Sling TV is helping Dish Networks add subscribers. U.S. satellite TV provider Dish Network reported a better-than-expected profit as it unexpectedly added more pay-TV subscribers in the fourth quarter than expected.
Analysts said the subscriber additions were largely driven by Dish's lower-priced streaming service Sling TV, even as the company's quarterly revenue missed estimates. Sling TV, launched in 2015, is a way for Dish to target cord-cutters, or customers who are dropping traditional cable TV for streaming services like Netflix.
BMR Take: The success of Sling TV can be viewed from a few different angles. On one hand, it further reaffirms the momentum in chord cutting, meaning the sandbox Netflix is playing in is extremely lucrative. On the other hand, perhaps Sling TV is turning into more of a competitor for Netflix. Even if the latter trend is true, we think the former trend is big enough overall to take Netflix shares higher. Remember we also have the potential upside of the rumored Apple Services move into TV. People are saying Apple is going to get much, much bigger in this area. After all, everyone is watching Netflix on their Apple phones and tablets!
Upcoming Economic News
MONDAY, FEBRUARY 27
Durable Goods Orders – January
Time: 8:30 am
Forecast: 2.0% overall, 0.5% ex transportation
Durable goods orders are forecast to expand in January after being held back by the Transportation sector in the two previous months. Core orders growth is steadily improving, rising 2.1% year-over-year in the fourth quarter for the largest gain in two years. The general strengthening of global growth prospects and the upturn in the commodity sector are lifting demand for US produced goods.
Pending Home Sales Index – January
Time: 10:00 am
Forecast: 0.9%
The Pending Home Sales Index is set to rise for the second straight month in January as the housing recovery remains firmly on track. Existing home sales rose to a 10-year high in January, lifting sales over the past three months by 6% year-over-year. The home sales pace is aided by rising home lending volume. The MBA index of mortgage applications for home purchases saw its moving four-week average reach a 7-month high in January before dipping a bit in February.
TUESDAY, FEBRUARY 28
GDP – Fourth Quarter (Second Estimate)
Time: 8:30 am
Forecast: 2.1%
Trade activity held back GDP growth in the fourth quarter and continued gains in imports may produce a similar result in the current quarter. But the underlying pace of consumer spending is holding firm, with Retail sales excluding autos and gasoline rising 0.7% in January, equaling an 11-month high. Though annual growth for real GDP is still likely to top 2% this year, lowered expectations for fiscal stimulus reduce much of the potential upside.
S&P Case-Shiller Home Price Index – December
Time: 9:00 am
Forecast: 5.2% yearly change of 20-city index
Historically tight supply of existing home available for sales can keep the S&P Case-Shiller Home Price Index chugging along in excess of 5% annually to December. The four months’ worth of inventory of existing homes at January’s sales pace is near the record low. That has kept home prices rising significantly faster than broad inflation growth for over four years, as seen in the 6.9% yearly rise of the median price of existing homes sold in January.
Conference Board Consumer Confidence – February
Time: 10:00 am
Forecast: 110.9
The Conference Board measure of consumer confidence can continue to ease back a bit in February after reaching the 15-year high in December. Robust levels of confidence will not necessarily translate into a big burst of consumer spending, as the share consumers who indicated in January that they intend to buy a car or home lags the average of the past three years. Yet firmly positive income expectations still point to a solid pace of spending among other consumer goods and services.
WEDNESDAY, MARCH 1
Personal Income & Spending – January
Time: 8:30 am
Forecast: 0.3% income, 0.3% spending
Skimpy recent monthly gains in average hourly earnings hint of a restrained advance for personal income in January. The recent 2.5% annual advance in hourly earnings is not showing the break out in wages many expected, although some other indicators point to faster growth. Continued labor market progress will be needed to push annual income growth back above 4% for the first time since late 2015.
ISM Manufacturing Index – February
Time: 10:00 am
Forecast: 55.8
Heightened business sector confidence and positive output trends are forecast to keep the February ISM Manufacturing Index near January’s two-year high. The new orders component of the index topped 60 in each of the past two months, a firm signal of rising demand. And manufacturing output’s annual pace was positive in each of the three months ending January after declining on this basis throughout much of last year.
Construction Spending – January
Time: 10:00 am
Forecast: 0.8%
Sturdier growth in residential activity is expected to lift overall January construction spending after a decline in December. Housing starts rose 6% year-over-year in the three months ending January following lackluster results towards the middle of last year. And private commercial construction is also aiding the cause, rising 7% year-over-year last quarter.
Vehicle Sales – February
Forecast: 17.6 million
Vehicle sales may show little movement in February relative to January after falling sharply from December’s 11-year high. Even including December’s cyclical high, the yearly advance in the three months ending January was a mere 0.7%. While vehicle sales volume is likely to remain strong in 2017 amid improving consumer finances, sharp gains of the recent past leave little room for further growth.
FRIDAY, MARCH 3
ISM Non-Manufacturing Index – February
Time: 10:00 am
Forecast: 56.5
The ISM Non-Manufacturing Index is projected to hold onto its post-election bounce in February due to sturdy demand for domestic services. The sub-index measuring general business activity in the service sector topped 60 in each of the past three months, signaling a sustained upturn in sales growth. Yet businesses will have to contend with some rising cost pressures, as the Non-Manufacturing index reading on prices rose to the 30-month high in January
Our Take on the Snap IPO
If you are looking at the soon-to-come Snap IPO, look long and hard. It’s coming out at a high valuation and the market may push it much higher after it starts trading. Note that management has gone overboard on the different classes of stock, offering stock to you with NO voting rights, and maintaining 100% control, no matter how many shares you own. This is not the American way. Google has done this and Facebook has done this, but they have done it in a quiet, professional way. And furthermore we know their track record. Snap is being belligerent about it and they have no public track record. We are passing on the stock.
How to Use Options to Lower the Cost of Buying High-Priced Stocks
Tesla ($257), Google (GOOG: $829) and Amazon (AMZN: $845) have risen so much that sometimes folks don’t like to buy the stock at these lofty levels. After all, with Google, 100 shares will cost you $83,000. We at The Bull Market Report don’t have a problem with this but many of you do. If you only have $20,000 to invest in Google then just buy 24 shares. After all, they could split the stock tomorrow 10 for 1 and the price would drop to $83, and you would then have 240 shares. It’s all the same. It is just psychological.
OK, with that said, using options you can control 100 shares of Google for only $18,000. How? You could buy the January $700 2019 option (called a LEAP) for $18,000, or $180 per share. There are two negatives though. 1) You would control the stock for only two years, and 2) You would pay a $50 premium to the price of the stock today. In this example this option allows you to buy the stock at $700, but you have to pay $180 for it, which gives you a breakeven price of $880. If the stock goes higher than $880 in two years you make money, possibly a lot. If it goes lower, you can lose some or all of your investment. So it is not for all. And like everything in life there are at least two sides to every story. If you would like us to expound on this concept please drop us a note at Info@BullMarket.com.
A Word from Gary Jefferson
First Vice-President, Investments
Jefferson Financial Group
UBS Financial Services
"Don't fight the tape." "The trend is your friend." "If you're not long, you're wrong"…………..These are just a few of the Wall Street adages being bantered about as the market continues to climb higher.
What the market senses and, more importantly, expects, is a reduction in corporate and personal income taxes and a meaningful reduction in government regulations that stand to increase (perhaps doubling) the rate of gross domestic product (GDP) growth by the year's end. Investors who are betting against this inertia are, in track parlance, trying to beat the favorite horse by picking longshots.
How high can the market go? That's the biggest question on investors' minds. What we have learned over the past 30 years is that market predictions are not much better than a coin flip. In fact, a lot of them are mostly headline grabbers and entertainment marketing rather than a serious study of behavioral science. Remember back in the 1990s, when some of the best sellers were "DOW 36,000: Why This Time Is Different"…….or "DOW 40,000: Strategies for Profiting from the Greatest Bull Market in History". That said, every serious investment firm is obligated to make a prediction, and each one generally has one which is reasonably based on a set of "what if's"; i.e., if earnings are this, then the market should be that. One publication that has taken forecasting to a new level based on scientific quantifying of "uncertainty" is Modern Trader. They say that there is a possible downside of about 6% and upside of about 24%.
Some other interesting forecasts we read recently include what many experts believe will be the most profitable sectors. There is a consensus that the best performers include Healthcare (biotechs), Financials (regional banking) and Technology, with a lot of support for Energy.
There are many opinions on what will be the biggest fundamental factors affecting the market. Some of our favorite picks were:
1. Interest rates, the dollar, and the price of oil. (Throughout our 30 years in the business, oil has always been a wild card for the market.)
2. Tax cuts and infrastructure investment.
3. Brexit, Chinese economic growth, South China Sea tension.
4. Three things: Trump, Trump and Trump.
Finally, Modern Trader selected Cybersecurity as the one sector every investor should own in 2017, citing the consistently growing number of cyber incidents across the globe and analyst expectation of worldwide spending on cybersecurity to eclipse $1 trillion cumulatively for the five-year period from 2017 to 2021.
[Note that The Bull Market Report pick Splunk (SPLK: $63) is up 36% since we added it 11 months ago. Our Target Price is $75.]
Letter to the Editor – about First Solar (FSLR: $38, up 9%)
From: Peter Goransson
[Note that we had sent out a News Flash last week saying that the stock was down sharply in after-hours trading after the earnings report came out, and we were a bit worried about the stock.]
Peter said: “First Solar is actually up 11% today [Thursday]. Looks like yesterday's movement may have been an overreaction. Are you still considering removing this from portfolio?”
Our response:
Hi Peter –
The market turned around this morning when level heads prevailed. We are breathing a sigh of relief.
It was terribly disappointing to us to see the reaction to the earnings announcement Wednesday evening, so this 11% move today is very heartening. No, we are not going to remove the stock from our portfolios. We are going to hang with it for a while.
We really do love this company and if you look at their history, their revenues have been very big, and we believe they will get big again. And earnings will follow, because historically they are very profitable.
Todd Shaver
Ferrellgas (FGP: $5.89, down 8%)
This stock continues to disappoint and we’ve decided not to wait any longer. The company made a terrible decision in buying Bridger Logistics with the whopping price tag of $840 million. And it bought Sable Environmental for $125 million in 2014. These purchases were financed mostly by new debt and this is what is dragging down the company. The firm has made over 240 acquisitions over the past 75 years but these two are icing on the cake – heavily, sludge-filled icing – that is bringing down the company. When we added Ferrellgas to our High Yield portfolio last year we had no idea how bad a deal this was for the firm and more importantly for the stockholders. We have said many times that the turnaround is going to take 12-18 months. We now feel it may be on the order of 2-3 years, if not longer, and may in fact bring the entire company down.
We’re not going to wait any longer. We hereby remove the stock from our High Yield portfolio. (It’s not even a high yield stock anymore. As they have cut their dividend so drastically because they are losing money.)
Now, what should YOU do? If you have a small position in the company you might just forget about it, keep it in your portfolio, and take a look in a year. If you have a big position then you might consider taking a loss and moving into some stable growth companies.
More on Apple
Berkshire Hathaway’s gain on Apple is more than $1.6 billion after shares have surged since it hit $105 in November. In fact, Apple was the Dow’s best performer in 2016. The news just came out on Warren Buffett’s investment in Apple: Berkshire Hathaway bought 61 million shares last year for $6.75 billion, at an average of about $110 apiece. The holding was valued at more than $8.3 billion as of Friday’s $137 closing price.
Berkshire became one of the top 10 Apple investors in 2016, taking a stake of more than 9 million shares in the first quarter and then accelerating purchases in the last three months of the year. The initial purchases were for an average of $99. Not that Buffett’s company bought $12 billion in stocks after the Nov. 8 U.S. election, indicating a continued strong faith in the American economy. Buffett said the market system that has propelled U.S. economic growth for more than two centuries will continue unabated, echoing his optimism about the country. “The build-up of wealth will be interrupted for short periods from time to time, but it will not, however, be stopped. I’ll repeat what I’ve both said in the past and expect to say in future years: Babies born in America today are the luckiest crop in history.”
Now there is one bullish investor! (With a stock price of over $250,000 a share!) We tend to agree with Warren and we would be vigilant in making changes in our portfolio if the market decides it has peaked. If, and we repeat IF that were to happen, there are lots of great stocks in our High Yield portfolio that will allow us 6, 8 and more than 10% a year returns while we sit and watch the market take a breather. However, at this time the market remains strong, with the Dow at 20 thousand eight. That’s 20.8 thousand. Or 20,822. For heaven’s sake, we just hit 20,000 on February 3rd!
The Weekly High Yield Report
By Michael Foster
Special to The Bull Market Report
It's been another quiet week in the markets, and even quieter in high yield than anywhere else. But before we get to that, we want to talk a bit about some Wall Street chatter we've been hearing from friends both on the buy side and the sell side of the business. Hiring is up in fixed income, especially in the high yield and distressed debt sectors. This bit of insider gossip doesn't sound all that exciting, but it's actually a really big deal. Wall Street hiring is trend driven and often a leading contrarian indicator. When Wall Street starts to invest heavily in one particular corner of the market that is a signal that that part of the market is at or near its peak and a downturn in the next couple of years is likely.
Let's take a look at why that's the case. If you're an investment bank, you make money buying and selling assets for investors. Investors tend to avoid assets when they're down (thus exacerbating the trend) and pile in when they're up (think of how many people were buying investment houses in 2005-2006). When more investors want to buy, say, junk bonds, that creates more demand for people to buy and sell junk bonds, thus turning into more jobs in that sector.
This is especially worrying because hiring is down across Wall Street. This has been an issue since 2008 and it is just getting worse. The fact that fixed income has a temporary reprieve suggests that demand in that sector is really getting hot.
If you want proof, just look at the SPDR Barclays High Yield Bond ETF (JNK: $37). This fund is already up 20% including dividends over the last year, the best one-year performance since 2009. Volumes have also exploded five-fold over the same period. Demand for high yield bonds has heated up.
But what about those surging defaults? Remember in late 2015 when everyone was panicking about the oil-driven defaults in corporate bonds? There was worry that the real risk that higher interest rates would cause even more defaults as cash-strapped companies struggled to keep cash flow enough to service their outstanding obligations. Remember that revenues hadn't been growing for years back then? That's why high yield bonds fell 20% in a little over a year after Yellen raised interest rates.
Those risks remain, but investors don't care anymore. This doesn't surprise us, as the risk of those defaults have been priced into the corporate bond market for over a year now.
There are two lessons to learn here. Firstly, ignore financial press headlines warning about an upcoming apocalypse in an asset class. Trading on that noise is a fast track to poverty. Secondly, being a contrarian investor and rotating into unfavored assets can produce strong medium-term returns.
But now that corporate bonds aren't unfavored, does that mean it's time to sell? Not exactly. There remain good funds that trade in corporate bonds or similar assets like the AGIC Equity and Convertible Income Fund (NIE: $19.46) and the PIMCO Dynamic Income Fund (PDI: $28), which are up about 24% and 26% respectively, including dividend payouts, over the last year. And the dividend payouts haven't gone down and remain safe. If anything, they're getting safer as interest rates go up. That means there is no reason to sell either of these until the market bids their prices to an absurd premium. The Pimco fund is unfortunately trading at an 8% premium to NAV, almost its highest premium in history.
This is especially disconcerting because the Pimco fund historically trades at a discount and it's rarely desirable to buy a closed-end fund at a premium pricing. We would not recommend buying this fund at its current price level, but selling is not a good idea yet either. This is a very obvious hold in lieu of desirable alternatives. Outside of Pimco, there are few funds that can deliver such a substantial market out-performance.
But we also don't think the fund's premium is going to disappear anytime soon. The closed-end fund investment world is getting smarter and the fund's primary income stream (mortgage-backed securities) are getting less underpriced. In the past, a lot of money avoided this sector because of the hangover of the subprime mortgage crisis. That was an irrational mispricing of the sector, so now money is coming back. As money comes back, it makes sense for Mortgage Backed-focused funds to start trading at smaller discounts or, in the case of Pimco's Dynamic Income Fund, at a premium.
Elsewhere in the high yield world, funds have had a muted week indicating there's still time to buy where there is an undervaluation relative to history. The Invesco Municipal Trust (VKQ: $12.65 , down -1%) and Nuveen AMT-Free Fund (NVG: $14.64, flat) had a week of muted action although the news regarding interest rate hikes remains unchanged: The Fed signaled what everyone was already expecting this week, which is great for high yield. Similarly, things were quiet in REITs as higher borrowing costs is causing less panic than it used to. The SPDR Dow Jones REIT ETF (RWR: $95) rose a bit over 1%, with only a few REITs under- or over-performing in a week of little news.
For now, high yield remains an attractive sector but it's not a "no brainer buy” like it was a year ago. There are pockets of attractive undervaluations, especially municipal bonds and some REITs, while fair valuation is becoming more common in the junk bond sector. This is a trend that's likely to continue for a while, assuming we don't get any shocking news to the upside or downside. This confirms our view to buy and hold these funds, since they have outperformed the broader market and are likely to continue to do so for a very long time.
Good Investing,
Todd Shaver, CEO, Founder and Editor
The Bull Market Report
Since 1998
February 20, 2017
by Todd Shaver | Feb 20, 2017 | Monthly Newsletter Daily 6am if new
The S&P, Nasdaq and the Dow closed at a record high Friday.
With more than 75% the S&P 500 having reported results, fourth-quarter earnings are on track to have climbed 8%, which would be the best performance since the third quarter of 2014. The S&P 500 posted 48 new 52-week highs and no new lows; the Nasdaq Composite recorded 150 new highs and 22 new lows.
The reality is there is always a Bull Market somewhere and right now it is in the United States. This week we provide some insights on our latest thinking for Twilio, the iShares Energy Sector ETF, CBRE Group, the Nuveen Municipal fund, and Facebook.
Highlights From The Past Month
Leadership Turnover At The Fed. Dan Tarullo unexpectedly announced that he is resigning in early April, just days after the Fed's general counsel Alvarez also announced that he is departing the Fed. What makes Tarullo's resignation particularly notable is that he has been the Fed's "regulatory point man" since 2009, suggesting some regulatory friction has emerged. In light of Trump's vow to crush Wall Street regulations, one can see why Tarullo thought his services are no longer necessary. His brief resignation letter to Fed Chairwoman Janet Yellen didn’t give a reason for his departure. He said he has been privileged to serve at the Fed for eight years. The letter said his resignation will take effect “on or about” April 5. We wonder just what is in store for Yellen and other members of the Fed. This is such a critical juncture for interest rates.
Prime Minister Abe Visits The USA. With a hug and a handshake, President Donald Trump and Japanese Prime Minister Shinzo Abe opened a new chapter in U.S.-Japan relations a week ago with Trump abruptly setting aside campaign pledges to force Tokyo to pay more for U.S. defense aid. Trump avoided repeating harsh campaign rhetoric that accused Japan of taking advantage of U.S. security aid and stealing American jobs. "We are committed to the security of Japan and all areas under its administrative control and to further strengthening our very crucial alliance," Trump said. "The bond between our two nations and the friendship between our two peoples runs very, very deep. This administration is committed to bringing those ties even closer," he added.
BMR Companies and Commentary
Apple (AAPL: $136, +3%)
It’s 13-F season. The 13-F report is filed by all investment shops detailing their holdings. This is where anybody with a computer and the internet can peer into the investment portfolios of the best investors on the planet. Well, our curious mind traveled through quite a few of the filings. We were surprised – though not really – to see investor after investor had recently increased their stake in Apple. The list of famous investors includes Greenlight Capital, Berkshire Hathaway, and Third Point. Berkshire won the prize for the largest increase in the size of their position, +277%. We recall that Warren took a position in Apple in May, right at the lows. He now holds 57.4 million shares, worth $7.8 billion. (This is the influence of Warren’s new young bucks who are making many of the new decisions in the company as the founder is now 86.)
So something must be going very right. Big investors are buying. Goldman Sachs research raised their price target from $133 to $150. What is going on? It is slowly coming to light just how undervalued the Services business is. People still don’t widely appreciate that Apple’s Services business alone would be a Fortune 100 company. Services now contributes profit greater than all non-iPhone segments combined.
UBS research estimates that if Services were valued similarly to PayPal, shares would be at least 10% higher.
BMR Take: There are times to be a contrarian, but now sure does not look like one of those times. The Apple train is breaking new speed.
Consensus Ratings for Apple
1 Sell Rating, 10 Hold Ratings, 36 Buy Ratings, 2 Strong Buy Ratings
2/14/2017 Robert W. Baird Target: $145
2/13/2017 Goldman Sachs Target: $150
2/8/2017 Bank of America Target: $145
2/7/2017 Canaccord Genuity Target: $154
2/6/2017 RBC Capital Markets Target: $140
2/2/2017 Wells Fargo & Company Target: $117
Come on, Wells Fargo. Get with the program!
Apple set a new all-time high last week of a shade over $136. We hereby raise the Price Target from $140 to $155. Our Sell Price remains: “We would not sell Apple.”
Twilio (TWLO: $32, +16% for the month*)
*All prices in The Bull Market Report are for the past 30 days
We wrote early this in the Weekly Bull Market Report week about Twilio’s encouraging quarter. We wanted to circle back and follow up with more detail here about what investors are worried about. Sometimes when you ask the hard questions and go searching for the answers, you find out that the risks are less of a concern than one fears on the surface.
Investors’ worries on this stock generally fall into several categories: 1) gross margins; 2) eventual competition from AWS**; 3) pricing pressure from current competitors; and 4) the lock-up expiration. Let’s hit each one.
**Amazon Web Services
Twilio’s gross margin of 59% this quarter was above consensus of 56%. When asked about how the company plans to get from here to its long-term target 60-65%, CFO Lee Kirkpatrick pointed out that Twilio has “significant levers” that it can pull. The first is product mix. Management described the second lever as efficiencies gained through scale – this includes driving better deals with carriers and passing less of the savings to customers.
Another risk for investors to keep an eye on longer term is the potential for competition from AWS. AWS is not a competitor today, but Amazon CEO Jeff Bezos is known to covet large markets and the communications services market is substantial. In fact, Amazon and Twilio are currently working together. The Amazon relationship seems to be strong and is multifaceted. Note that Twilio runs entirely on AWS. Second, Twilio is already helping AWS with mobile products. Third, CEO Jeff Lawson was on stage at AWS re:Invent in November and commented, “We’re really excited to announce some upcoming collaboration with AWS soon.” Last, Rick Dalzell (Amazon’s former SVP of Worldwide Architecture and Platform Software and CIO) has been a member of Twilio’s board of directors since 2014.
Investors are also concerned Twilio may face pricing pressure from its current competitors, which include Nexmo (Vonage acquired them in May) and Plivo, among others. Twilio’s services are generally priced at a premium to these competitors. For example, for outbound SMS messages, Twilio charges $0.0075/message, compared to $0.0061 for Nexmo and $0.0035 for Plivo. Our view is that Twilio is generally able to charge a premium because it: 1) has significant mindshare within the developer community; 2) offers a high-quality, reliable solution; and 3) continues to release new features and software products. Mr. Lawson indicated on the earnings call that he seeks to “build a broad platform that is widely applicable, priced aggressively, and designed to enable developers’ creativity to flourish across the widest set of use cases imaginable.”
The availability of additional shares for sale in the market could adversely affect Twilio’s stock price. Twilio went public in June, selling 10 million shares at $15. Twilio completed a follow-on offering in October selling 7 million shares at $40. Roughly 30 million shares cleared lock-up restrictions in December and another 36 million shares were set to clear lock-up restrictions on January 19th. However, roughly 31M of those shares were subject to the company’s black-out period for insiders. Our understanding is these shares will clear the restricted period this Friday. Some of the largest shareholders of Twilio include Bessemer Venture Partners, Union Square Ventures, and Redpoint Ventures, which owned 17M, 10M, and 3M shares immediately after the follow-on offering, respectively.
BMR Take: Okay, we might see some pressure from the lock-up expiration that happened a week ago Friday, but this is normal Wall Street procedure. Besides, we are sure that many of these owners will want to hold on for the coming years of growth. Furthermore, the business is building momentum making the stock attractively priced at this level.
CBRE Group (CBG: $36, +16%)
What a week. CBRE ended 2016 on a high note. For the year, revenue was $13.1 billion, up 20%, and EPS was $2.30, up 12%. CBRE recorded double-digit earnings growth for the fourth quarter and the year, with excellent performance in all three regional services businesses.
These results are particularly noteworthy in a year of generally softer market-wide property sales volumes, virtually no carried interest income, and tepid global economic growth. In fact, the company’s revenue and earnings performance set new record highs in 2016.
In addition to achieving record financial performance, very importantly, CBRE continued to advance its strategy. This strategy centers around delivering exceptional outcomes to clients. The company’s people and the operating platform that supports them are the key elements to delivering these outcomes. Both advanced materially in 2016, and the impact is showing up on the company’s results.
CBRE is in a stronger competitive position than ever. A good example of the strategic gains made in 2016 is the work done integrating the Global Workplace Solutions acquisition, one of the largest and quite possibly the most complex in the history of the real estate sector. This effort involved massive client facing, and line of business and back-office transformations. The result of having largely completed this challenging work is that the company’s occupier outsourcing business is much larger, much more capable of producing strong client outcomes, and well-positioned for strong long-term growth.
The company is now serving clients with employees on the ground in over 100 countries. What a big business. CBRE remains riveted on sustaining progress with particular focus on areas such as technology and data analytics where it can capitalize on the expertise and vast amounts of information it possesses. For example, last month CBRE acquired Floored, a leading software-as-a-service platform that produces scalable, interactive 3D visualization technologies for commercial real estate. Clients should expect continued visible advancements from CBRE in the technology area.
BMR Take: CBRE’s nickname is the “Bentley” of the real estate sector and in 2016 the business lived up to the expectations. The key takeaway from the earnings call was that no matter the interest rate environment, performance should be rock solid in 2017.
Facebook (FB: $133, +4%)
The controversy is nearing an end as Facebook committed to an audit of ad metrics by a media watchdog. Facebook agreed to submit to audits by the media industry’s measurement watchdog, the Media Rating Council, helping address concerns among some advertisers who had become skeptical of the social network’s metrics.
Facebook had come under fire recently after a series of missteps in which it disclosed several mistakes in reporting data to partners and advertisers. The company conducted its own review of practices and vowed to be more transparent about errors in the future. According to plans for the next year laid out in a statement Friday, Facebook said it aims to release more detailed information, such as metrics on how long users view an ad and how much of it was visible on the screen.
“We want to provide transparency, choice and accountability,” Facebook said. “Transparency through verified data that shows which campaigns drive measurable results, choice in how advertisers run campaigns across our platforms, and accountability through an audit and third-party verification.” Representatives from Facebook gave a presentation Thursday in Washington to the board of the Association of National Advertisers, a trade group for marketers. The meeting attendees were particularly interested in the promise for more transparency and an audit process.
BMR Take: Investors have been waiting for the advertising reporting issues to go away. Well, here we are - the event is happening. This new audit should address and resolve the issue. No more overhang for the stock from this. Having an independent organization validate the metrics Facebook puts out makes the data more trustworthy and provides advertisers with the ability to compare results across ad platforms. Now we can go back to focusing on the fundamentals where Facebook is firing on all cylinders. We are big believers in Facebook as it hovers near its all-time high of $135.50. And despite all of the controversy as discussed above, the stock stays within a whisker of its all-time high.
Upcoming Economic News
WEDNESDAY, FEBRUARY 22
Existing Home Sales – January
Time: 10:00 am
Forecast: 5.55 million
Existing home sales look to move higher in January after sliding in December. Sales rose 7% year-over-year in the fourth quarter, keeping the housing recovery steadily on track. With only four months’ worth of inventory at the latest monthly sales pace, prices will continue to climb, encouraging more homeowners to sell.
FOMC Meeting Minutes
Time: 2:00 pm
The minutes from the uneventful February FOMC meeting will give some indications about what policymakers expect for growth and inflation. The outlook for the economy is clouded by the potential actions of the new administration. Yet some near-term upward pressure on prices and wages still keeps the Fed on track to lift its policy rate three times this year. SO THEY SAY. Who is they? The analysts and pundits. We at The Bull Market Report aren’t so sure. We are watching the 10-year note which is stuck at the 2.4% range. We are in the camp of LOWER interest rates ahead, not higher. Watching and waiting are we.
FRIDAY, FEBRUARY 24
New Home Sales – January
Time: 10:00 am
Forecast: 575,000
New home sales are projected to rebound sharply in January after slumping to a 10-month low in December. Even with the December setback, the sales pace remains exceptionally strong at 25% year-over-year in the fourth quarter. Growth in new home sales can continue to be stellar. The most recent monthly sales pace is 25% above the average of the past 20 years.
University of Michigan Consumer Sentiment – February
Final Time: 10:00 am
Forecast: 96.0
The preliminary value of the Michigan Sentiment Index showed above-average confidence despite slipping from January’s 12-year high. Consumers are starting to feel the bite of higher gasoline prices, as short-term inflation expectations rose to equal the 23-month high. But long-term inflation expectations are muted at just 2.5% annualized between five and ten years ahead, as a sustained acceleration in price growth is doubtful.
Our Favorite Warren Buffet Quote:
"You can't produce a baby in one month by getting nine women pregnant." -- Warren Buffett
Love it. Be patient out there.
More On Stocks We Follow
Opko Health Update (OPK: $8.81, flat) Here is a typical report from a typical day in the life of Opko CEO Philip Frost: “CEO Philip Frost bought 10,000 shares of the business's stock in a transaction on Monday, January 30th. The shares were acquired at an average price of $8.49 per share, with a total value of $85,000. Following the transaction, the chief executive officer now directly owns 3,069,000 shares of the company's stock, valued at $26,055,000. The acquisition was disclosed in a document filed with the Securities & Exchange Commission.”
Here is another: “Opko Health CEO Phillip Frost acquired 12,000 shares of the business's stock in a transaction dated Friday, January 27th.”
BMR Take: This guy knows something we don’t know. Have you read the article in Forbes about him yet? We published the url twice now. (If you haven’t read it and would like to, please write us at Info@BullMarket.com) Despite these purchases the stock remains weak. We believe in this man and this company. We would buy some here, buy some at $7 if it goes lower, and we would buy some every dollar higher as it moves towards $15 again.
Annaly Capital Management (NLY: $10.82, up 5%).
Why We Love Thee.
With an 11.1% dividend yield, it's one of the highest yielding stocks on the market today. It is a real estate investment trust and a Mortgage REIT, specializing in mortgage-backed securities, or MBS's. A REIT is simply an investment fund that owns income-producing real estate or real estate-related assets. Among other requirements, a REIT must invest at least 75% of its total assets in real estate assets and cash, and derive at least 75% of its gross income from real estate-related sources. And it has to pay out 90% of its income.
In Annaly's case, it doesn't invest directly in real estate, but rather in MBS's. These are fixed-income securities, much like bonds, that are backed by residential mortgages. Annaly invests in securities that are issued by Fannie Mae or Freddie Mac, and are thus backed by the full faith and credit of the United States government. It means that the risk that its assets will default is nil.
On Annaly's most recent balance sheet, for instance, agency MBS's accounted for $82 billion out of $88 billion in total assets.
Annaly's biggest task is to deal with the interest rate risk. Annaly uses leverage to buy assets. They borrow money at low short-term interest rates and invest that money in higher-yielding long-term assets - MBS's. The firm has $88 billion in assets, composed of $13 billion in equity and $75 billion in debt. Thus the leverage is about 5 to 1. In years past, this leverage has been as high as 10-1. We are pleased to see the leverage at this lower level. Annaly hedges the risk of rising short term rates by buying interest rate swaps. These are financial derivatives designed to lock in the cost of financing. Annaly has outstanding interest rate swaps of approximately $31 billion.
As we mentioned above, as a REIT Annaly must distribute at least 90% of its income to shareholders to qualify as a REIT. Thus, Annaly doesn't have to pay corporate income taxes on its earnings.
The dividend yield of Annaly is currently 11.1%. That's almost six times greater than the 1.95% yield on the S&P 500.
In order to grow its capital Annaly sells new shares of stock in secondary offerings. In the old days they used to do this as much as twice a year, each time raising $500 million to $1 billion in fresh equity. In the new Annaly world, they don’t do as many secondaries, as management is content with growing the NAV slowly, with the company now worth over $11 billion.
BMR Take: We are comfortable with the company growing NAV slowly, as we hope you are too. Patient investors can sit back contentedly and enjoy the 11% dividend and if the stock is up just 50 cents in a year, that’s another 5% in overall growth producing over 15% in a year. And note that last week the stock was up 30 cents!
The Yield Curve Today. Or, Where are Interest Rates Going?
“Everyone” thinks rates are going higher. Right? You feel this way too, don’t you! Well, we don’t think this way. We think rates might just decide to peter out here and fall back. The 10-year US Treasury Note is at 2.42% right now, up from the 1.8% level before the election. But note that rates around the world are in many cases much lower than what we have in this country. In fact, late last year over $11 trillion was paying ZERO interest.
Take a look at this chart, concentrating on the 10-year notes in gray:
Note that Germany, Switzerland and Japan are hovering around 0%. How could this be? The answer to that may take our writing a book, but suffice it to say that IT IS REAL. And if it can happen in Germany and Switzerland, can it happen here?
BMR Take: The short answer? Yes it can. It “could” happen here. Will it? We wish we knew, but with all the turmoil in the world economically, we think there is more likelihood of rates going down rather than up at this time. We are not convinced that Yellen will have the power to buck THE MARKET. The MARKET will dictate interest rates, not the Fed. We see interest rates going lower rather than higher. And when rates go down, bonds and bond-like funds go up. Food for thought.
The World of the Supernova
This is Tom Friedman’s name for the Cloud. We don’t generally plug books here at The Bull Market Report, but if you want to know what the world of Technology is doing right now, the book to read is his new book, Thank You for Being Late. What the internet and Moore’s Law* is doing in this world of ours is astounding. Here’s some food for thought, a quote from Tom Goodwin of Havas Media in March, 2015: “Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate. Something interesting is happening.” Friedman goes on to say: “In the age of the supernova, there has never been a better time to be a maker – anywhere.”
*Moore’s Law – The power of the microprocessor doubles every two years. Since 1971.
BMR Take: Why are we printing this here? We want you to THINK about the Technology companies that are driving this growth. The Facebooks, the Apples, the Googles, the Amazons, the Microsofts. These companies are all in our High Technology portfolio and they will continue to lead and drive the growth and innovation in the world in the next decade(s).
What the Street Thinks of Athenahealth (ATHN: $119, down 1%)
Consensus Ratings: 1 Sell, 8 Hold, 12 Buy
Consensus Price Target: $135
Some Ratings from the Street:
2/6/2017 KeyCorp Target $140
2/7/2017 Piper Jaffray Target $162
2/7/2017 Berenberg Bank Target $143
2/6/2017 Dougherty Target $143
2/4/2017 Oppenheimer Holdings Target $142
2/3/2017 Robert W. Baird Target $155
1/31/2017 Cantor Fitzgerald Target $135
1/4/2017 Pacific Crest Target $140
The High Yield Corner
By Michael Foster
Special to The Bull Market Report
This week was another quiet one for the markets, and high yield assets saw minimal movements with a couple of important exceptions. The biggest exception is the BDC sector, which was driven higher by some good earnings results. The UBS BDC ETF (BDCS: $23, up 2%) was one of the biggest gainers among high yield ETFs this week, thanks to constituent firms like Pennant Park Floating Rate Capital (PFLT: $14.00) and Medley Capital Corporation (MCC: $8.00) reporting solid earnings. Medley alone soared over 4% by the end of the week despite a 1% decrease to NAV that has become expected for BDCs. Also baked into valuations was a 16% decrease in net investment income per share - we’re now sitting at 19 cents for the company. Yet Medley’s dividend is 22 cents per share, so this quarter the company under-earned its payout by over 13%. That’s a pretty big miss.
Medley Capital is just one example of a problematic industry that requires more selective investing and a lot more due diligence than was necessary in the past for BDCs. These are effectively funds that leverage assets that are then lent to companies picked by management. In such a situation, debt quality is critical. Yet many of these companies have no real credit rating to speak of - and many of them are tiny, with revenues below $100 million per year. BDCs comprise dozens, sometimes over 100 of such companies. To really determine the value of a BDC and its relative future strength, you would need to look into the revenue trends for each of these companies and the condition of their existing capital. No small task, and a lot of time to invest for what should ultimately remain a very small portion of any one investor’s portfolio.
And that’s why we’re currently on the BDC sidelines, despite some strength in the broader index. The problem is this: we’re seeing net investment income per share drop for most of these companies, with only the best and brightest outperforming. In the past, such as in 2013, the market viciously punished these sorts of declines, but we’re not seeing that punishment yet. There is a clear disconnect between fundamentals and the value that the market is seeing in the BDC space. That’s enough to make anyone cautious, and has left us clearly on the sidelines until we can get some more coherent and consistent income growth. Especially since income growth is easy to find in many other pockets of the market.
Take, for instance, PIMCO Dynamic Income Fund (PDI: $29, up 1%), which has seen its NAV grow at an annualized 17% since its IPO. The fund has already appreciated by over 2% in 2017, and we’re not even at Valentine’s Day. The feat this fund has accomplished is really incredible - so much so that many people fundamentally misunderstand and mistrust how this fund makes money.
So how do they do it? The rather simple answer is asset selection. By combining undervalued corporate bonds with a variety of mortgage-backed securities, the Dynamic Income Fund has been able to sustainably return double-digit yields to investors without depleting capital. The market has rewarded this outperformance with a premium to NAV - something that one must always watch carefully, especially in a world as volatile as closed-end funds. And PDI’s premium is growing. In fact, PDI’s 10% premium is almost at the highest level we have ever seen for this fund. But there’s no fundamental weakness in this fund and no reason to expect its strong historical performance to stop.
So what is an investor to do? At the moment, we recommend holding, but a rotation of assets from PDI to a similar but better-valued fund may be in order in the future. This is an area worth watching closely and we’ll have ideas for you if things change.
It would be nice to see a similar problem come to the AllianzGI Equity and Convertible Income Fund (NIE: $19.44, up 1%), but this fund’s current 10% discount is pretty much par for the course when we look at its historical discount. Allianz’s fund hasn’t been priced at a premium since 2009, but its discount has frequently dipped below 15% in recent years. The fact that we’re at the upper end of the historical range for the discount indicates that even this unloved but strong performer is getting closer to pricing to perfection. But that doesn’t mean we need to sell the fund. This is a great closed end fund that has given investors a 6% annualized NAV return since inception, and its NAV is even 9% higher than it was at inception - a rare feat for CEFs. Allianz has done a great job of doing, in the convertible and equity sectors, what Pimco has done with its Dynamic Income Fund in the corporate and mortgage-backed bond markets: Make great investments by selective choices, and provide a strong return as a result.
This doesn’t mean we’re recommending holding these funds forever. We are getting closer and closer to a portfolio rotation moment in high yield, which means watching the market weekly is getting more important than ever before.
And the markets are telling us that there’s some exhaustion in the protracted Trump bull rally. Again, you can forget the political controversies surrounding the executive orders; they make great talking points for both sides of the aisle, and they’ve unfortunately made their ways into the editorial pages of the financial press, but none of this has any significant impact on America’s financial or economic future at the moment. The real action is elsewhere, namely in monetary policy and GDP growth. We really need to see changes to the Fed’s monetary policy (or at least a delivered rate hike as promised) or significant changes in the GDP growth rate to drive high yield assets away from their current trendline.
We’re not seeing that, so the indexes are a bit sleepy. The SPDR Barclays High Yield Bond ETF (JNK: $37) and the SPDR Dow Jones REIT ETF (RWR: $94) were flat for the week, with minimal gains in the REIT world offset by a small decline in the Alerian MLP ETF (AMLP: $13.04, down -2%). Meanwhile, there was more sleepy action with the iShares S&P National AMT-Free Municipal Bond Fund (MUB: $108, flat).
This quiet is actually good news for long-term investors. We’ve been inundated with gloom and doom economic forecasting since 2008 - and why not? Plenty of data points look bad, and the Global Financial Crisis is still a recent memory for most of us. And every passing year since the crash urges more pundits and analysts to tell us that we’re “overdue” for a correction or an outright recession. Yet the markets do not see things that way.
At the same time, markets aren’t going crazy. We’re not seeing the heady bubble days of 2006-2007. No one is suggesting there is any “sure thing” in the markets, just like people insisted buying a house was a “sure thing” in 2006. There is a lot of price growth in equities, but no real sign of a runaway market where prices have gone far past fundamentals. Things look even more cautious in the municipal and junk bond markets, where prices still remain below their high point in 2014 and 2015. We are far away from the irrational exuberance that Nobel-winning economist Robert Shiller warned about both before the dotcom bust and before the housing crisis. That means income-seeking investors can still find funds to invest their money and get strong returns.
Unfortunately, such a state of affairs won’t last forever, so investors need to remain aware of the risks in the market. But they don’t need to be in a panic.
Finally, a quick word on one outperformer that bears a bit of particular scrutiny. AstraZeneca (AZN: $29.50, up 6%) continued to have a monstrous bull run after their recent earnings results. Fourth quarter earnings surged 56% and beat expectations by 3 cents at $1.21 per share despite a 13% slide in total revenues. This was driven by a 52% decline in Crestor sales and a 14% decline in Symbicort sales, which was offset by growth in newer drugs like Zoladex. Following the news, Bloomberg published a rumor that the company may sell off its old drug businesses to raise cash that could be applied to new research initiatives.
Our take on all this is clear: AstraZeneca has been a thorn in our high yield portfolio, being the only significant decliner in a portfolio of otherwise sharp outperformers. It was only a matter of time before the company lived up to its potential, and we’re happy to finally see that start to happen. We’re still down slightly from a year ago (excluding dividends.) But the recent turnaround tells us there’s more room for Astra-Zeneca to redeem itself.
Good Investing,
Todd Shaver, Founder, CEO and Editor
The Bull Market Report
Since 1998
February 19, 2017
by Todd Shaver | Feb 19, 2017 | Weekly Newsletter 7pm Sunday
The Week Ahead
“Kraft Makes Surprise Bid For Rival” was the weekend’s front page Wall Street Journal headline. The deal would be one of the biggest ever valued around $150 billion, ranking 2nd. However, it was flat out rejected on the premise of not being enough. Analysts expect Kraft to up the ante, perhaps substantially, so we could soon see the biggest deal ever in the next week or so. The largest deal so far was Vodafone buying Mannesmann for $172 billion in 2000. The second largest deal was Verizon Communications buying Verizon Wireless for $130 billion.
Why is all this M&A monitoring so important? If this deal passes, we would now have seen four out of the top five deals of all-time occur in the past two years. This flurry of mega deals reaffirms the strength of today’s bull market, which is perhaps turning into the greatest bull market of all-time.
Ha. This just in as we go to press. Kraft has withdrawn its bid. Story over for now.
The reality is, no matter what, there is always a bull market somewhere and you can always find it here. This week we highlight evidence of a bull market in the following securities: PayPal, Apple, Kinder Morgan, Home Depot, and Eli Lilly.
Highlights From The Past Week
Auto Bubble Bursting? For years there has been concern that record auto sales have been propped up by (i) low interest rates, (ii) a perpetual loosening of auto lending standards with terms being stretched to the max, and (iii) a wave of leases. All of these factors have allowed the American consumer to trade up to more expensive vehicles while maintaining low monthly payments. A quick look at the 61+ day delinquencies in General Motors' subprime securitization book would seem to support the rather negative thesis on future auto sales. January 2017 delinquency rates soared to the highest levels since 2010.
Mark Zuckerberg Rejects "America First" Calling For Global Community. Take a few moments to read the internal memo that he sent out to all Facebook (FB: $133, flat) employees:
“On our journey to connect the world, we often discuss products we're building and updates on our business. Today I want to focus on the most important question of all: Are we building the world we all want? History is the story of how we've learned to come together in ever greater numbers -- from tribes to cities to nations. At each step, we built social infrastructure like communities, media and governments to empower us to achieve things we couldn't achieve on our own. Today we are close to taking our next step. Our greatest opportunities are now global -- like spreading prosperity and freedom, promoting peace and understanding, lifting people out of poverty, and accelerating science. Our greatest challenges also need global responses -- like ending terrorism, fighting climate change, and preventing pandemics.
“Progress now requires humanity coming together not just as cities or nations, but also as a global community. This is especially important right now. Facebook stands for bringing us closer together and building a global community. When we began, this idea was not controversial. Every year, the world got more connected and this was seen as a positive trend. Yet now, across the world there are people left behind by globalization, and movements for withdrawing from global connection. There are questions about whether we can make a global community that works for everyone, and whether the path ahead is to connect more or reverse course.
“This is a time when many of us around the world are reflecting on how we can have the most positive impact. I am reminded of my favorite saying about technology: "We always overestimate what we can do in two years, and we underestimate what we can do in ten years." We may not have the power to create the world we want immediately, but we can all start working on the long term today. In times like these, the most important thing we at Facebook can do is develop the social infrastructure to give people the power to build a global community that works for all of us.
“There are many of us who stand for bringing people together and connecting the world. I hope we have the focus to take the long view and build the new social infrastructure to create the world we want for generations to come.”
A $17 Billion Trade Gone Wrong. Many traders across the Street were talking all week about a multi-billion dollar forced short cover by Catalyst Funds' Hedged Futures Strategy Fund (HFXAX). The fund was short upwards of $17 billion of S&P 500 call options and got backed into a corner and had to cover the position. Many believe this event pushed the S&P 500 Index over 2,300.
BMR Companies and Commentary
PayPal (PYPL: $42, +3% for the week)
The European commission has quietly launched the next offensive in the war on cash. These unelected bureaucrats have boldly asserted their intention to crack down on paper transactions across the E.U. and solidify a trend that has been gaining momentum for years. The financial uncertainty amplified by Brexit has incentivized governments throughout Europe to seize further control over their banking systems. France and Spain have already criminalized cash transactions above a certain limit, but now the commission has unilaterally established new regulations that will affect the entire union. The fear of physical money flowing out of the trade bloc has manifested a draconian response from the State.
The European Action Plan doesn’t mention a specific dollar amount for restrictions, but as expected, their reasoning for the move is to thwart money laundering and the financing of terrorism. Border checks between countries have already been bolstered to help implement these new standards on hard assets.
The above event further reinforces the secular idea of a cashless economy. This environment would be terrific for a purely online payments service like PayPal, just terrific! We highlight some additional opinions from credible sources on the topic below.
Governments around the world have pushed forward their agendas towards a cashless society. Former Chief Economist at the International Monetary Fund (IMF), Kenneth Rogoff, published a paper last year advocating for the U.S. $100 bill to be removed. He wrote: “There is little debate among law-enforcement agencies that paper currency, especially large notes such as the U.S. $100 bill, facilitates crime: racketeering, extortion, money laundering, drug and human trafficking, the corruption of public officials, not to mention terrorism. There are substitutes for cash - cryptocurrencies, uncut diamonds, gold coins, prepaid cards - but for many kinds of criminal transactions, cash is still king. It delivers absolute anonymity, portability, liquidity and near-universal acceptance.”
Former Treasury Secretary Larry Summers wrote last year that the E.U. would likely be the trailblazer of the West towards this new digital model: “But a moratorium on printing new high denomination notes would make the world a better place. In terms of unilateral steps, the most important actor by far is the European Union. The €500 bill is almost six times as valuable as the $100. Some actors in Europe, notably the European Commission, have shown sympathy for the idea and European Central Bank chief Mario Draghi has shown interest as well.”
PayPal announced this past week that it is acquiring the bill payment firm TIO Networks, which serves as a major player in the North American bill pay market, for $230 million. This will continue to help PayPal become more embedded in all of our financial lives.
PayPal has 200 million customers now and TIO Networks will add another 15 million. The market is big for bill pay. In the US, 15 billion bills were paid online worth $4 trillion. PayPal wants in and with TIO processing $7 billion worth, this a strong step in the right direction. PayPal did over $350 billion in payment volume last year, so this acquisition is small by any standard, but the way PayPal operates we can see this business doubling and tripling in the next five years. PayPal is a patient company and this is just another step in the right direction.
BMR Take: We are keeping eye on government actions that accelerate the speed the world is traveling at towards a cashless economy. PayPal is a big beneficiary. We’re up 18% since we added PayPal last year. We think it is lagging a bit lately and would definitely overweight the stock here at $42. Our Target remains the same at $48 which we would hope to see sometime in the first half of this year.
Apple (AAPL: $136, +3%)
It’s 13-F season. The 13-F report is filed by all investment shops detailing their holdings. This is where anybody with a computer and the internet can peer into the investment portfolios of the best investors on the planet. Well, our curious mind traveled through quite a few of the filings. We were surprised – though not really – to see investor after investor had recently increased their stake in Apple. The list of famous investors includes Greenlight Capital, Berkshire Hathaway, and Third Point. Berkshire won the prize for the largest increase in the size of their position, +277%. We recall that Warren took a position in Apple in May, right at the lows. He now holds 57.4 million shares, worth $7.8 billion. (This is the influence of Warren’s new young bucks who are making many of the new decisions in the company as the founder is now 86.)
So something must be going very right. Big investors are buying. Goldman Sachs research raised their price target from $133 to $150. What is going on? It is slowly coming to light just how undervalued the Services business is. People still don’t widely appreciate that Apple’s Services business alone would be a Fortune 100 company. Services now contributes profit greater than all non-iPhone segments combined.
UBS research estimates that if Services were valued similarly to PayPal, shares would be at least 10% higher.
BMR Take: There are times to be a contrarian, but now sure does not look like one of those times. The Apple train is breaking new speed.
Consensus Ratings for Apple
1 Sell Rating, 10 Hold Ratings, 36 Buy Ratings, 2 Strong Buy Ratings
2/14/2017 Robert W. Baird Target: $145
2/13/2017 Goldman Sachs Target: $150
2/8/2017 Bank of America Target: $145
2/7/2017 Canaccord Genuity Target: $154
2/6/2017 RBC Capital Markets Target: $140
2/2/2017 Wells Fargo & Company Target: $117
Come on, Wells Fargo. Get with the program!
Apple set a new all-time high last week of a shade over $136. We hereby raise the Price Target from $140 to $155. Our Sell Price remains: “We would not sell Apple.”
Home Depot (HD: $143, +2%)
The Home Depot recently announced its first major investment in a wind-powered renewable energy project. The energy purchased from the wind farm is enough to power 100 Home Depot stores for a year while also providing $150,000 in local community benefits.
The Los Mirasoles Wind Farm, owned and operated by EDP Renewables North America, is located in Hidalgo and Starr Counties, near McAllen, Texas. Through a 20-year power purchase agreement, Home Depot's annual purchase of 50 megawatts (MW) is a fifth of the wind farm's 250 MW capacity. The farm utilizes Vestas V110 2.0 MW wind turbines and produces enough power to provide more than 70,000 average U.S. homes with clean electricity each year.
As a part of its renewable energy initiative, The Home Depot's goal is to procure 135 megawatts of various renewable energy sources, including solar and wind, by the end of 2020.
The company also procures energy from solar farms in Delaware and Massachusetts. More than 150 stores and distribution centers utilize on-site fuel cells that produce roughly 85% of the electricity each store needs to operate.
BMR Take: We are glad to see Home Depot acting more like Amazon by getting more deeply involved in all aspects of their business--even it has nothing to do with lumber. The behavior is likely to lead to many more good things to come for Home Depot. The stock hit a new all-time high last week and the company is now worth $175 billion. Management knows what they are doing and we see no reason why the stock can’t hit $160 sometime this year if the market stays steady to higher. We hereby raise our Price Target to $160 from $135 and raise the Sell Price from $105 to $130. We are up 20% on the stock since we added it a year ago.
Kinder Morgan (KMI $22, -3%, market cap $49 billion)
Kinder’s CFO John Edwards spoke to investors at the Credit Suisse conference on Wednesday. Some insightful perspective was shared. Below we review the key points.
Kinder has an unparalleled asset footprint. They are the largest Energy Infrastructure company in the United States. They are the leader in all of their business segments. They are the largest natural gas network in North America moving over 40% of the gas in the U.S. They are the largest independent transporter of petroleum products, moving a little over 2 million barrels a day. They are the largest transporter of CO2. They are the largest independent terminal operator with approximately 155 terminals. And in the Canadian segment, they are the only pipeline serving the West Coast. These assets make Kinder well-positioned to take advantage of growth in North American energy.
While it might not seem like it to the casual eye, Kinder Morgan has a much simpler structure now than a few years ago. There is one publicly traded equity security versus four a few years ago, and that security is very liquid. It trades over 15 million shares a day, and the management team that is aligned with investors. Management and directors, own about 14% of the outstanding shares, a good thing.
Having survived the latest energy downturn, management is more than ever focused on remaining cost conscious. They want to control costs. Some people refer to management as cheap, but they want to make sure that they are spending money where they need to spend money, and they are not spending money where they don't need to. They do want to spend money on their assets to keep them operating safely and efficiently. On 35 out of 36 of metrics, they rank better than the industry average. Wow.
There is a very deep pool of capital out there in terms of the Canadian pension funds, The company is currently considering a Canadian IPO to tap that money. The IPO would be attractive capital. It would be long term. It would allow for growth investments and balance sheet improvement (paying off debt).
BMR Take: Fellow shareholders, Kinder has the best assets in North American energy. They have a management team that could be flashy but is instead frugal. We may get access to a flood of Canadian pension money. Life is good.
Eli Lilly (LLY: $80, +3%)
Additional results from the pivotal RA-BEAM study were published in New England Journal of Medicine. The study on their arthritis drug is being done by Eli Lilly along with Incyte Corporation. The goal is to greatly improve treatments for arthritis.
The New England Journal of Medicine publication included supplementary data, which showed that starting as early as week 8, and sustained through week 52, a higher proportion of patients taking baricitinib (a drug fighting arthritis) achieved 50% and 70% improvement - compared to the old drug adalimumab. These improvements were statistically significant. A breakthrough!
Lilly and Incyte previously announced positive topline results of at least a 20% improvement.
This is an exciting time for rheumatology, with potential new treatments for arthritis. The RA-BEAM study of baricitinib is the first phase 3 trial showing that a once-daily, oral treatment significantly improved clinical outcomes compared with a current standard of care, injectable adalimumab used with background methotrexate therapy. These data demonstrate that baricitinib could provide another treatment option for people with arthritis.
BMR Take: Eli Lilly’s success with the arthritis drug just further shows the business has a healthy pipeline of new products and is not broken. The stock has had a big rally from $64 back in December to now $80. Between a favorable trial outcome and the big rally recently, the Lilly turnaround is manifesting.
Lilly has reached our Price Target of $80. We are up 18% from where we added it just two months ago. We hereby raise the Price Target to $88 and raise the Sell Price to $76.
Upcoming Economic News
WEDNESDAY, FEBRUARY 22
Existing Home Sales – January
Time: 10:00 am
Forecast: 5.55 million
Existing home sales look to move higher in January after sliding in December. Sales rose 7% year-over-year in the fourth quarter, keeping the housing recovery steadily on track. With only four months’ worth of inventory at the latest monthly sales pace, prices will continue to climb, encouraging more homeowners to sell.
FOMC Meeting Minutes
Time: 2:00 pm
The minutes from the uneventful February FOMC meeting will give some indications about what policymakers expect for growth and inflation. The outlook for the economy is clouded by the potential actions of the new administration. Yet some near-term upward pressure on prices and wages still keeps the Fed on track to lift its policy rate three times this year. SO THEY SAY. Who is they? The analysts and pundits. We at The Bull Market Report aren’t so sure. We are watching the 10-year note which is stuck at the 2.4% range. We are in the camp of LOWER interest rates ahead, not higher. Watching and waiting are we.
FRIDAY, FEBRUARY 24
New Home Sales – January
Time: 10:00 am
Forecast: 575,000
New home sales are projected to rebound sharply in January after slumping to a 10-month low in December. Even with the December setback, the sales pace remains exceptionally strong at 25% year-over-year in the fourth quarter. Growth in new home sales can continue to be stellar. The most recent monthly sales pace is 25% above the average of the past 20 years.
University of Michigan Consumer Sentiment – February
Final Time: 10:00 am
Forecast: 96.0
The preliminary value of the Michigan Sentiment Index showed above-average confidence despite slipping from January’s 12-year high. Consumers are starting to feel the bite of higher gasoline prices, as short-term inflation expectations rose to equal the 23-month high. But long-term inflation expectations are muted at just 2.5% annualized between five and ten years ahead, as a sustained acceleration in price growth is doubtful.
Our Favorite Warren Buffet Quote:
"You can't produce a baby in one month by getting nine women pregnant." -- Warren Buffett
Love it. Be patient out there.
More on Stocks We Love
CBRE (CBG: $36, up 5%)
CBRE set a new 52-week high this week and is within a whisker of the all-time high of $38.50 set in 2015. We see no reason why the stock can’t hit $40 this year. It hit our Price Target of $35 this week, so we hereby raise the Target to $40. We are changing the Sell Price to $32.
Annaly Capital Management (NLY: $10.82, up 5%). Why We Love Thee.
With an 11.1% dividend yield, it's one of the highest yielding stocks on the market today. It is a real estate investment trust and a Mortgage REIT, specializing in mortgage-backed securities, or MBS's. A REIT is simply an investment fund that owns income-producing real estate or real estate-related assets. Among other requirements, a REIT must invest at least 75% of its total assets in real estate assets and cash, and derive at least 75% of its gross income from real estate-related sources. And it has to pay out 90% of its income.
In Annaly's case, it doesn't invest directly in real estate, but rather in MBS's. These are fixed-income securities, much like bonds, that are backed by residential mortgages. Annaly invests in securities that are issued by Fannie Mae or Freddie Mac, and are thus backed by the full faith and credit of the United States government. It means that the risk that its assets will default is nil.
On Annaly's most recent balance sheet, for instance, agency MBS's accounted for $82 billion out of $88 billion in total assets.
Annaly's biggest task is to deal with the interest rate risk. Annaly uses leverage to buy assets. They borrow money at low short-term interest rates and invest that money in higher-yielding long-term assets - MBS's. The firm has $88 billion in assets, composed of $13 billion in equity and $75 billion in debt. Thus the leverage is about 5 to 1. In years past, this leverage has been as high as 10-1. We are pleased to see the leverage at this lower level. Annaly hedges the risk of rising short term rates by buying interest rate swaps. These are financial derivatives designed to lock in the cost of financing. Annaly has outstanding interest rate swaps of approximately $31 billion.
As we mentioned above, as a REIT Annaly must distribute at least 90% of its income to shareholders to qualify as a REIT. Thus, Annaly doesn't have to pay corporate income taxes on its earnings.
The dividend yield of Annaly is currently 11.1%. That's almost six times greater than the 1.95% yield on the S&P 500.
In order to grow its capital Annaly sells new shares of stock in secondary offerings. In the old days they used to do this as much as twice a year, each time raising $500 million to $1 billion in fresh equity. In the new Annaly world, they don’t do as many secondaries, as management is content with growing the NAV slowly, with the company now worth over $11 billion.
BMR Take: We are comfortable with the company growing NAV slowly, as we hope you are too. Patient investors can sit back contentedly and enjoy the 11% dividend and if the stock is up just 50 cents in a year, that’s another 5% in overall growth producing over 15% in a year. And note that last week the stock was up 30 cents!
The Yield Curve Today. Or, Where are Interest Rates Going?
“Everyone” thinks rates are going higher. Right? You feel this way too, don’t you! Well, we don’t think this way. We think rates might just decide to peter out here and fall back. The 10-year US Treasury Note is at 2.42% right now, up from the 1.8% level before the election. But note that rates around the world are in many cases much lower than what we have in this country. In fact, late last year over $11 trillion was paying ZERO interest.
Take a look at this chart, concentrating on the 10-year notes in gray:
Note that Germany, Switzerland and Japan are hovering around 0%. How could this be? The answer to that may take our writing a book, but suffice it to say that IT IS REAL. And if it can happen in Germany and Switzerland, can it happen here?
BMR Take: The short answer? Yes it can. It “could” happen here. Will it? We wish we knew, but with all the turmoil in the world economically, we think there is more likelihood of rates going down rather than up at this time. We are not convinced that Yellen will have the power to buck THE MARKET. The MARKET will dictate interest rates, not the Fed. We see interest rates going lower rather than higher. And when rates go down, bonds and bond-like funds go up. Food for thought.
The High Yield Report
By Michael Foster
Special to The Bull Market Report
Another week, another bull run for the S&P 500.
The action has certainly slowed, but a 1% gain for the index is still impressive considering the long stretch of strength we’ve seen since November. The strength came on the back of Janet Yellen’s surprisingly hawkish testimony to Congress, an increase to unemployment claims that surprised analysts, and inflation rising to near 2%.
There’s a lot to unpack here.
First, let’s address Yellen, because this is most important to high yield markets. The Fed Chairwoman made her intentions very clearly in this paragraph:
"The Committee's view that gradual increases in the federal funds rate will likely be appropriate reflects the expectation that the neutral federal funds rate- - that is, the interest rate that is neither expansionary nor contractionary and that keeps the economy operating on an even keel- - will rise somewhat over time. Current estimates of the neutral rate are well below pre-crisis levels - a phenomenon that may reflect slow productivity growth, subdued economic growth abroad, strong demand for safe longer-term assets, and other factors. The Committee anticipates that the depressing effect of these factors will diminish somewhat over time, raising the neutral funds rate, albeit to levels that are still low by historical standards.”
Keep in mind that Yellen’s job is to talk in complicated, confusing phrases. But Yellen is actually a lot clearer than Greenspan was back in his day. In this block of awkward verbosity, we interpret what Yellen had to say:
1. Interest rates are going to naturally rise over time.
2. The Federal Reserve needs to anticipate these natural rises, because the market isn’t anticipating improvements in productivity, global conditions, investment, etc.
3. The Fed is going to raise interest rates swiftly and frequently.
If Yellen said this in 2014, the market would have tanked. Saying this in 2017, though, the markets barely budged. This is good for the Fed and bad for interest rates. It clearly means the Fed feels that it has the room to raise interest rates often and will do so throughout 2017. (We at The Bull Market Report are not so sure. See the following chart on interest rates around the world. We are not convinced that Yellen will have the power to buck THE MARKET. The MARKET will dictate interest rates, not the Fed. We see interest rates going lower rather than higher. And when rates go down, bonds and bond-like funds go up. Food for thought.
Where does that leave high yield assets?
On the surface, higher interest rates are bad for BDCs, junk bonds, and REITs. But remember that raising interest rates has been expected for years now; much of this is already priced in. The market knows this and so has not sold high yield assets in a panic.
Just look at the indices for high yield assets. The UBS BDC ETF (BDCS: $23, up 1%) ended the week up solidly, while the SPDR Barclays High Yield Bond ETF (JNK: $37, flat) held its ground. REITs did better than both of these assets. The SPDR Dow Jones REIT ETF (RWR: $94, up 2%) had yet another strong week despite the fact that higher borrowing costs will negatively impact REIT profitability. The market knows this and has already priced it into the sector.
In other words, everyone knows Yellen is getting more hawkish; they just don’t care.
Does this mean the market is overconfident and we should panic? No, not exactly. It does mean that there aren’t as many “screaming buys” in today’s market as there were at the start of 2016, when it was a much less obvious call to say junk bonds were worth snapping up at current valuations. But it also doesn’t mean those assets are overbought, either.
We’re clearly making the transition from “fear” to “greed,” as Warren Buffett would put it. But we’re not exactly at greed quite yet. In a market where buying and selling aren’t obvious choices, what can an investor do?
Simple: be selective. When it comes to being selective, it means finding assets that aren’t moving with the broader market. Fortunately there are some great values out there that are not performing as well as they should be. This week offered some new ones.
The first is a BMR favorite: Care Capital Properties (CCP: $25, down -2%), which failed to track the REIT bull run. Likewise, Omega Healthcare Investors (OHI: $32, down -2%) stumbled this week. Both REITs are in the Healthcare sector, which is being hit by greater uncertainty than the REIT universe as a whole. We’ve discussed in previous reports why we like both REITs. They’re well-managed and fear is driving the Healthcare REIT industry, making it a rare value play in a swiftly appreciating asset class.
To demonstrate just how undervalued these REITs are getting, compare them to our other REIT favorites Kimco Realty (KIM: $24, up 2%) and Government Properties Trust (GOV: $20, up 3%). Both outperformed the REIT sector as a whole this week.
Two more funds are getting attractively valued: the AllianzGI Equity and Convertible Income Fund (NIE: $19.35, up 1%) and the PIMCO Dynamic Income Fund (PDI: $28, up -1%). The Allianz fund went up this week, but its NAV has been going up at a faster rate than its stock price; as a result, its discount to NAV has grown to over 11%, making it a stronger buy than it’s been for months. Similarly, the Pimco fund’s decline this week makes it another great buy.
One final word on a stock that’s been a pain for us for a long time: Astra-Zeneca (AZN: $29, up 5%) had a stellar week. We’re now just 3% off from a year ago. This is a stock that has proven the old adage: best things come to those who wait. We’re still holding strong after liking what we heard at the company’s earnings release. Now we’re just anticipating possible dividend growth in this best-of-breed Pharma stock.
Good Investing,
Todd Shaver
Founder, Editor and CEO
The Bull Market Report
Since 1998
February 12, 2017
by Todd Shaver | Feb 12, 2017 | Weekly Newsletter 7pm Sunday
The Week Ahead
“Trump Mulls New Order On Travel” was the weekend’s front page Wall Street Journal headline. Everyone can’t seem to look away from what is happening in the oval office. Big name after big name investor keeps trying to make a call on the future from what is happening in Washington, only to be proved wrong. The latest is the $30 billion money manager Seth Klarman of Baupost. He says to look out for a negative year from equities due to elevated volatility from Trump’s leadership style; a major pick-up in inflation; problems from rising rates to the US debt; and slower global growth from protectionist trade policies.
The S&P and Dow closed at a record high for a second straight session, while the Nasdaq extended its streak of record closes to a fourth day.
With more than 70% the S&P 500 having reported results, fourth-quarter earnings are on track to have climbed 8%, which would be the best performance since the third quarter of 2014. The S&P 500 posted 48 new 52-week highs and no new lows; the Nasdaq Composite recorded 150 new highs and 22 new lows.
The reality is there is always a Bull Market somewhere and right now it is in the United States. This week we provide some insights on our latest thinking for Twilio, the iShares Energy Sector ETF, CBRE Group, the Nuveen Municipal fund, and Facebook.
Highlights From The Past Week
Leadership Turnover At The Fed. This week Dan Tarullo unexpectedly announced that he is resigning in early April, just days after the Fed's general counsel Alvarez also announced that he is departing the Fed. What makes Tarullo's resignation particularly notable is that he has been the Fed's "regulatory point man" since 2009, suggesting some regulatory friction has emerged. In light of Trump's vow to crush Wall Street regulations, one can see why Tarullo thought his services are no longer necessary. His brief resignation letter to Fed Chairwoman Janet Yellen didn’t give a reason for his departure. He said he has been privileged to serve at the Fed for eight years. The letter said his resignation will take effect “on or about” April 5. We wonder just what is in store for Yellen and other members of the Fed. This is such a critical juncture for interest rates.
Prime Minister Abe Visits The USA. With a hug and a handshake, President Donald Trump and Japanese Prime Minister Shinzo Abe opened a new chapter in U.S.-Japan relations on Friday with Trump abruptly setting aside campaign pledges to force Tokyo to pay more for U.S. defense aid. Trump avoided repeating harsh campaign rhetoric that accused Japan of taking advantage of U.S. security aid and stealing American jobs. "We are committed to the security of Japan and all areas under its administrative control and to further strengthening our very crucial alliance," Trump said. "The bond between our two nations and the friendship between our two peoples runs very, very deep. This administration is committed to bringing those ties even closer," he added.
BMR Companies and Commentary
Twilio (TWLO: $32, +2% for the week*)
*All prices in The Bull Market Report are for the week
We wrote early this week about Twilio’s encouraging quarter. We wanted to circle back and follow up with more detail here about what investors are worried about. Sometimes when you ask the hard questions and go searching for the answers, you find out that the risks are less of a concern than one fears on the surface.
Investors’ worries on this stock generally fall into several categories: 1) gross margins; 2) eventual competition from AWS**; 3) pricing pressure from current competitors; and 4) the lock-up expiration. Let’s hit each one.
**Amazon Web Services
Twilio’s gross margin of 59% this quarter was above consensus of 56%. When asked about how the company plans to get from here to its long-term target 60-65%, CFO Lee Kirkpatrick pointed out that Twilio has “significant levers” that it can pull. The first is product mix. Management described the second lever as efficiencies gained through scale – this includes driving better deals with carriers and passing less of the savings to customers.
Another risk for investors to keep an eye on longer term is the potential for competition from AWS. AWS is not a competitor today, but Amazon CEO Jeff Bezos is known to covet large markets and the communications services market is substantial. In fact, Amazon and Twilio are currently working together. The Amazon relationship seems to be strong and is multifaceted. Note that Twilio runs entirely on AWS. Second, Twilio is already helping AWS with mobile products. Third, CEO Jeff Lawson was on stage at AWS re:Invent in November and commented, “We’re really excited to announce some upcoming collaboration with AWS soon.” Last, Rick Dalzell (Amazon’s former SVP of Worldwide Architecture and Platform Software and CIO) has been a member of Twilio’s board of directors since 2014.
Investors are also concerned Twilio may face pricing pressure from its current competitors, which include Nexmo (Vonage acquired them in May) and Plivo, among others. Twilio’s services are generally priced at a premium to these competitors. For example, for outbound SMS messages, Twilio charges $0.0075/message, compared to $0.0061 for Nexmo and $0.0035 for Plivo. Our view is that Twilio is generally able to charge a premium because it: 1) has significant mindshare within the developer community; 2) offers a high-quality, reliable solution; and 3) continues to release new features and software products. Mr. Lawson indicated on the earnings call that he seeks to “build a broad platform that is widely applicable, priced aggressively, and designed to enable developers’ creativity to flourish across the widest set of use cases imaginable.”
The availability of additional shares for sale in the market could adversely affect Twilio’s stock price. Twilio went public in June, selling 10 million shares at $15. Twilio completed a follow-on offering in October selling 7 million shares at $40. Roughly 30 million shares cleared lock-up restrictions in December and another 36 million shares were set to clear lock-up restrictions on January 19th. However, roughly 31M of those shares were subject to the company’s black-out period for insiders. Our understanding is these shares will clear the restricted period this Friday. Some of the largest shareholders of Twilio include Bessemer Venture Partners, Union Square Ventures, and Redpoint Ventures, which owned 17M, 10M, and 3M shares immediately after the follow-on offering, respectively.
BMR Take: Okay, we might see some pressure from the lock-up expiration that happened on Friday, but this is normal Wall Street procedure. Besides, we are sure that many of these owners will want to hold on for the coming years of growth. Furthermore, the business is building momentum making the stock attractively priced at this level.
CBRE Group (CBG: $34, +8%)
What a week. CBRE ended 2016 on a high note. For the year, revenue was $13.1 billion, up 20%, and EPS was $2.30, up 12%. CBRE recorded double-digit earnings growth for the fourth quarter and the year, with excellent performance in all three regional services businesses.
These results are particularly noteworthy in a year of generally softer market-wide property sales volumes, virtually no carried interest income, and tepid global economic growth. In fact, the company’s revenue and earnings performance set new record highs in 2016.
In addition to achieving record financial performance, very importantly, CBRE continued to advance its strategy. This strategy centers around delivering exceptional outcomes to clients. The company’s people and the operating platform that supports them are the key elements to delivering these outcomes. Both advanced materially in 2016, and the impact is showing up on the company’s results.
CBRE is in a stronger competitive position than ever. A good example of the strategic gains made in 2016 is the work done integrating the Global Workplace Solutions acquisition, one of the largest and quite possibly the most complex in the history of the real estate sector. This effort involved massive client facing, and line of business and back-office transformations. The result of having largely completed this challenging work is that the company’s occupier outsourcing business is much larger, much more capable of producing strong client outcomes, and well-positioned for strong long-term growth.
The company is now serving clients with employees on the ground in over 100 countries. What a big business. CBRE remains riveted on sustaining progress with particular focus on areas such as technology and data analytics where it can capitalize on the expertise and vast amounts of information it possesses. For example, last month CBRE acquired Floored, a leading software-as-a-service platform that produces scalable, interactive 3D visualization technologies for commercial real estate. Clients should expect continued visible advancements from CBRE in the technology area.
BMR Take: CBRE’s nickname is the “Bentley” of the real estate sector and in 2016 the business lived up to the expectations. The key takeaway from the earnings call was that no matter the interest rate environment, performance should be rock solid in 2017.
iShares Energy Sector ETF (IYE: $40, -1%)
The largest holding of the ETF at 22% is Exxon Mobil (XOM: $83, $340 billion market cap). The second largest holding is Chevron (CVX: $113, $210 billion market cap) at 14%. With the most recent earnings reports of these two behemoths of the Energy sector still being digested by the markets, we wanted to weigh in.
Exxon delivered its first increase in revenue after nine quarters of declines. The company provided a reassuring long term outlook. Global energy demand is expected to grow about 25% by 2040. Oil and natural gas is expected to meet about 60% of global energy demand by then. Attention quickly turned to 2017 capital expenditure guidance, with several suggesting the plans may be a bit aggressive at an early stage in the recovery, while others believe the increase shows increased management confidence in the recovery and the company's cash cycle. Everyone is much anticipating the expected detailed presentation on spending during the March analyst day meeting.
Chevron returned to profitability on Friday, reporting a huge quarterly earnings beat as the company continued to cut costs amid a protracted oil price rout now entering its third year. The company made progress toward its goals of lowering the cash breakeven in the upstream business and getting cash flow balanced. Capital spending and operating expenses have been reduced by over $10 billion since September 2015 as a result of a series of deliberate actions taken by the company.
BMR Take: The Energy sector recovery is happening. You can see in the rig count numbers and the earnings results out of both industry titans Exxon and Chevron. The IYE ETF gives you broad diversified exposure to the whole sector. There is a lot more room to run here for this stock.
Nuveen Municipal Credit Income Fund (NVG: $14.62, flat)
The AAA municipal curve steepened over the week outpacing the sell-off in Treasuries. 2 yr, 10 yr and 30 yr AAA municipal yields increased 2 bp, 17 bp, and 15 bp respectively over the past week. Supply dwindled at the end of January as this week's supply is projected to be just under $7 billion after $9 billion last week.
Meanwhile, the upcoming 30-day supply is at $11 billion, near the lowest level in a month and below the $12 billion 1 year average. On the demand front, mutual funds saw their first weekly inflow since the election. Mutual funds saw $1.6 billion of inflows for the week ending January 11th after 13 weeks of outflows. The outflow cycle was relatively short from a historical perspective as the last 3 cycles of mutual fund outflows averaged 24 weeks while this current outflow cycle stands at just 13 weeks. However, there is more room for outflows as new taxes are debated and uncertainty looms over the municipal market.
On the macro front, the Treasury curve steepened over the past week as 30 year rates increased 6 bp while the 2 yr was unchanged due to elevated CPI and positive NY Empire Manufacturing Survey buoyed rates. After two months of gains following the November post-election optimism, we are not yet seeing the underlying economic data improve to match the optimistic expectations. The Fed’s Empire Manufacturing Survey moved lower highlighting no spike in manufacturing business conditions. Hard data like industrial production remains lackluster. The decline in forward looking indicators such as new orders further suggests that underlying activity in the factory sector is not building any momentum. Trump-related euphoria might begin to dissipate.
All eyes remain on underfunded pension risks. Connecticut may be the next shoe to drop. The chief investment officer of the $30 billion Connecticut Retirement Plans, Hartford, resigned last week. We see a back story here that is troublesome.
BMR Take: The Municipal bond sector still represents a safe haven for those of you more focused on protecting your principal right now as opposed to trying to make a fortune. Nuveen Municipal Credit Income Fund is a solid fund for the job.
Facebook (FB: $134, +3%)
The controversy is nearing an end as Facebook committed to an audit of ad metrics by a media watchdog. Facebook agreed to submit to audits by the media industry’s measurement watchdog, the Media Rating Council, helping address concerns among some advertisers who had become skeptical of the social network’s metrics.
Facebook had come under fire recently after a series of missteps in which it disclosed several mistakes in reporting data to partners and advertisers. The company conducted its own review of practices and vowed to be more transparent about errors in the future. According to plans for the next year laid out in a statement Friday, Facebook said it aims to release more detailed information, such as metrics on how long users view an ad and how much of it was visible on the screen.
“We want to provide transparency, choice and accountability,” Facebook said. “Transparency through verified data that shows which campaigns drive measurable results, choice in how advertisers run campaigns across our platforms, and accountability through an audit and third-party verification.” Representatives from Facebook gave a presentation Thursday in Washington to the board of the Association of National Advertisers, a trade group for marketers. The meeting attendees were particularly interested in the promise for more transparency and an audit process.
BMR Take: Investors have been waiting for the advertising reporting issues to go away. Well, here we are - the event is happening. This new audit should address and resolve the issue. No more overhang for the stock from this. Having an independent organization validate the metrics Facebook puts out makes the data more trustworthy and provides advertisers with the ability to compare results across ad platforms. Now we can go back to focusing on the fundamentals where Facebook is firing on all cylinders. We are big believers in Facebook as it hovers near its all-time high of $135.50. And despite all of the controversy as discussed above, the stock stays within a whisker of its all-time high.
Upcoming Economic News
TUESDAY, FEBRUARY 14
Producer Price Index – January
Time: 8:30 am
Forecast: 0.2% overall, 0.2% core
The January Producer Price Index is forecast to report steady gains for the third straight month. The recent run-up in the index brought the yearly gain to 1.6% in December, the fastest rate in 27 months. Yet businesses should be well-equipped to handle somewhat quicker cost growth after the PPI rose only 0.9% annualized over the past five years.
WEDNESDAY, FEBRUARY 15
Consumer Price Index – January
Time: 8:30 am Forecast: 0.3% overall, 0.2% core
Higher gasoline costs can lead the Consumer Price Index to expand for the sixth straight month in January. Those fuel price gains have joined with rising housing costs to lift the broad CPI by the 30- month high rate of 2.1% yearly to December. Yet with crude oil prices holding flat last month, the significant feed-through to higher consumer prices may not accelerate substantially after the first quarter.
Retail Sales – January
Time: 8:30 am
Forecast: 0.1% overall, 0.4% ex auto
The drop in Auto sales may produce a lackluster overall result for January Retail sales. Auto sales eked out only a 0.7% year-over-year gain in the three months ending January, removing a once strong contributor to retail results. Sales outside of autos and gasoline managed a stronger if not overly robust 3.6% yearly gain in the fourth quarter, aided by rapid growth in online sales.
Industrial Production & Capacity Utilization – January
Time: 9:15 am
Forecast: 0.0% industrial production, 75.4% capacity utilization
Moderating Utility sector output can leave industrial production unchanged in January. December’s 6.6% gain in utility output was the largest monthly advance in 27 years. Meanwhile, manufacturing is pushing toward more sustained growth, rising 0.2% yearly to December for the first annual gain in six months.
NAHB Housing Market Index – February
Time: 10:00 am
Forecast: 68
Homebuilder confidence is likely to remain elevated in February, keying off especially strong expectations for future sales. The index of projected sales was at 76 in January, well above the historical average of 57. Seasonally warm weather is giving a near-term boost to building, with the 36,000 added construction jobs in January representing the most in 10 months.
Business Inventories – December
Time: 10:00 am
Forecast: 0.4%
Business inventories are expected to expand strongly for the second straight month in December. Inventories added 1.7% to the overall gain in fourth quarter GDP, the largest such positive contribution in 10 quarters. The inventories-to-sales ratio is edging lower after hitting the post-recession high last March, giving businesses reason to boost output.
THURSDAY, FEBRUARY 16
Housing Starts & Building Permits – January
Time: 8:30 am
Forecast: 1.23 million starts, 1.23 million permits
Recent gains in building permits give Homebuilding activity an upward bias in the near future. Permits rose 20% annualized in the fourth quarter, undoing the weak levels seen early in 2016. That raises the prospects that 2017’s total starts can achieve the projection of 8% yearly growth after almost always falling short of expectations over the past decade.
FRIDAY, FEBRUARY 17
Leading Economic Indicators Index – January
Time: 10:00 am
Forecast: 0.5%
The Leading Economic Indicators Index is anticipated to equal December’s strong gain thanks in part to falling unemployment insurance claims and a projected increase in building permits. Multi-decade lows in unemployment insurance claims point to labor market tightness where firms are extremely reluctant to cut staff. That condition naturally points to continued hiring gains and potential wage increases.
More On Stocks We Follow
Opko Health Update (OPK: $8.22, down 4%) Here is a typical report from a typical day in the life of Opko CEO Philip Frost: “CEO Philip Frost bought 10,000 shares of the business's stock in a transaction on Monday, January 30th. The shares were acquired at an average price of $8.49 per share, with a total value of $85,000. Following the transaction, the chief executive officer now directly owns 3,069,000 shares of the company's stock, valued at $26,055,000. The acquisition was disclosed in a document filed with the Securities & Exchange Commission.”
Here is another: “Opko Health CEO Phillip Frost acquired 12,000 shares of the business's stock in a transaction dated Friday, January 27th.”
BMR Take: This guy knows something we don’t know. Have you read the article in Forbes about him yet? We published the url twice now. (If you haven’t read it and would like to, please write us at Info@BullMarket.com) Despite these purchases the stock remains weak. We believe in this man and this company. We would buy some here, buy some at $7 if it goes lower, and we would buy some every dollar higher as it moves towards $15 again.
A Word from Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
According to Thomson Reuters, 72% of the S&P 500 companies that have already reported have beaten earnings estimates. Based on the current reports and estimates, profit growth looks to be around 7% for the fourth quarter - its fastest pace in two years. That's good news and guidance for 2017 earnings seem to indicate there is more of this to come.
Prior UBS predictions as to what Trump growth policies could add to overall earnings growth estimates: as much as 15% over the next three years. Gains follow earnings, and assuming the 15% is equally divided over the three years, estimates could reasonably be revised upwards to gains hitting around 12% at yearend. If the economy does get jump-started by the repatriation of cash overseas, deregulation and infrastructure stimulus, we could see far more than a 5% rise for the Dow and S&P 500. Even if this happens, however, it should still beat bonds on a total return basis.
On the flip side, fund managers are holding the least cash in history. As of the end of December, mutual fund managers had 3% of their assets invested in the most liquid instruments that are readily exchanged for cash. That's the smallest cash cushion they've ever had, and with the increase in short-term interest rates, their "cash deficit" is now the most extreme since 2007.
Regardless of how good earnings are, money has to come from somewhere in order to buy stocks and drive prices higher. If it comes from selling one stock to buy another, we may be facing big sector rotation moves, a scenario of haves and have nots, and a lot more volatility than we would like to see. Fund managers have no alternative to selling stocks to cover redemptions when their cash positions are too low. This could be an interesting twist to an otherwise very positive outlook.
The World of the Supernova
This is Tom Friedman’s name for the Cloud. We don’t generally plug books here at The Bull Market Report, but if you want to know what the world of Technology is doing right now, the book to read is his new book, Thank You for Being Late. What the internet and Moore’s Law* is doing in this world of ours is astounding. Here’s some food for thought, a quote from Tom Goodwin of Havas Media in March, 2015: “Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate. Something interesting is happening.” Friedman goes on to say: “In the age of the supernova, there has never been a better time to be a maker – anywhere.”
*Moore’s Law – The power of the microprocessor doubles every two years. Since 1971.
BMR Take: Why are we printing this here? We want you to THINK about the Technology companies that are driving this growth. The Facebooks, the Apples, the Googles, the Amazons, the Microsofts. These companies are all in our High Technology portfolio and they will continue to lead and drive the growth and innovation in the world in the next decade(s).
What the Street Thinks of Athenahealth (ATHN: $114, up 5%)
Consensus Ratings: 1 Sell, 8 Hold, 12 Buy
Consensus Price Target: $135
Some Ratings from the Street:
2/6/2017 KeyCorp Target $140
2/7/2017 Piper Jaffray Target $162
2/7/2017 Berenberg Bank Target $143
2/6/2017 Dougherty Target $143
2/4/2017 Oppenheimer Holdings Target $142
2/3/2017 Robert W. Baird Target $155
1/31/2017 Cantor Fitzgerald Target $135
1/4/2017 Pacific Crest Target $140
What the Street Thinks of United Parcel Service (UPS: $107, flat)
Ratings Rating: 1 Sell, 8 Hold, 5 Buy
Consensus Price Target: $114
Some Ratings from the Street:
2/8/2017 Aegis Target $120
2/7/2017 Loop Capital Target $124
2/5/2017 Credit Suisse Group Target $110
2/1/2017 Barclays PLC Target $115
2/1/2017 BMO Capital Markets Target $115
A Letter from a Subscriber
From: Richard Reed [reed99277@xxxx.com]
Sent: Friday, February 10, 2017
To: Info at The Bull Market Report
Hello Todd,
I owned Annaly years ago when I subscribed to your service the first time. Three questions about it. First, is this a good entry point? The current price is near the 52 week high. Second, how safe is the dividend? Last, based on your email statements you feel that rising rates may not necessarily impact the stock price negatively. If rates go up gradually over the next few years do you feel the stock price won't be negatively impacted?
Richard Reed
Our Answer:
Hi Richard –
Annaly Capital Management (NLY: $10.52, up 2%, 11.5% dividend) – The stock could be headed to $11 or $10; no one can really say. What we do know is that they have weathered bull markets and bear; and high interest rate environments and low for the last 20 years. They are worth almost $11 billion, listed on the NYSE.
Interest rates – I personally feel that the bull market in bonds is NOT over (meaning rates will continue to go down.) Yes, they are up big since November, but they have actually been declining since December 15th, almost two months. So predicting interest rates is of course impossible.
Their dividend varies each quarter. Up a little; down a little. Management knows what they are doing and unless interest rates jump 100 basis points in a month or two, which is highly unlikely, Annaly should be able to continue to churn out their high dividends each month.
Todd Shaver
The Bull Market Report
PS: Note that we featured Annaly back in the late 1990s when it was paying 18% a year. It’s one of our favorites.
The High Yield Corner
By Michael Foster
Special to The Bull Market Report
This week was another quiet one for the markets, and high yield assets saw minimal movements with a couple of important exceptions. The biggest exception is the BDC sector, which was driven higher by some good earnings results. The UBS BDC ETF (BDCS: $23, up 2%) was one of the biggest gainers among high yield ETFs this week, thanks to constituent firms like Pennant Park Floating Rate Capital (PFLT: $14.00) and Medley Capital Corporation (MCC: $8.00) reporting solid earnings. Medley alone soared over 4% by the end of the week despite a 1% decrease to NAV that has become expected for BDCs. Also baked into valuations was a 16% decrease in net investment income per share - we’re now sitting at 19 cents for the company. Yet Medley’s dividend is 22 cents per share, so this quarter the company under-earned its payout by over 13%. That’s a pretty big miss.
Medley Capital is just one example of a problematic industry that requires more selective investing and a lot more due diligence than was necessary in the past for BDCs. These are effectively funds that leverage assets that are then lent to companies picked by management. In such a situation, debt quality is critical. Yet many of these companies have no real credit rating to speak of - and many of them are tiny, with revenues below $100 million per year. BDCs comprise dozens, sometimes over 100 of such companies. To really determine the value of a BDC and its relative future strength, you would need to look into the revenue trends for each of these companies and the condition of their existing capital. No small task, and a lot of time to invest for what should ultimately remain a very small portion of any one investor’s portfolio.
And that’s why we’re currently on the BDC sidelines, despite some strength in the broader index. The problem is this: we’re seeing net investment income per share drop for most of these companies, with only the best and brightest outperforming. In the past, such as in 2013, the market viciously punished these sorts of declines, but we’re not seeing that punishment yet. There is a clear disconnect between fundamentals and the value that the market is seeing in the BDC space. That’s enough to make anyone cautious, and has left us clearly on the sidelines until we can get some more coherent and consistent income growth. Especially since income growth is easy to find in many other pockets of the market.
Take, for instance, PIMCO Dynamic Income Fund (PDI: $29, up 1%), which has seen its NAV grow at an annualized 17% since its IPO. The fund has already appreciated by over 2% in 2017, and we’re not even at Valentine’s Day. The feat this fund has accomplished is really incredible - so much so that many people fundamentally misunderstand and mistrust how this fund makes money.
So how do they do it? The rather simple answer is asset selection. By combining undervalued corporate bonds with a variety of mortgage-backed securities, the Dynamic Income Fund has been able to sustainably return double-digit yields to investors without depleting capital. The market has rewarded this outperformance with a premium to NAV - something that one must always watch carefully, especially in a world as volatile as closed-end funds. And PDI’s premium is growing. In fact, PDI’s 10% premium is almost at the highest level we have ever seen for this fund. But there’s no fundamental weakness in this fund and no reason to expect its strong historical performance to stop.
So what is an investor to do? At the moment, we recommend holding, but a rotation of assets from PDI to a similar but better-valued fund may be in order in the future. This is an area worth watching closely and we’ll have ideas for you if things change.
It would be nice to see a similar problem come to the AllianzGI Equity and Convertible Income Fund (NIE: $19.44, up 1%), but this fund’s current 10% discount is pretty much par for the course when we look at its historical discount. Allianz’s fund hasn’t been priced at a premium since 2009, but its discount has frequently dipped below 15% in recent years. The fact that we’re at the upper end of the historical range for the discount indicates that even this unloved but strong performer is getting closer to pricing to perfection. But that doesn’t mean we need to sell the fund. This is a great closed end fund that has given investors a 6% annualized NAV return since inception, and its NAV is even 9% higher than it was at inception - a rare feat for CEFs. Allianz has done a great job of doing, in the convertible and equity sectors, what Pimco has done with its Dynamic Income Fund in the corporate and mortgage-backed bond markets: Make great investments by selective choices, and provide a strong return as a result.
This doesn’t mean we’re recommending holding these funds forever. We are getting closer and closer to a portfolio rotation moment in high yield, which means watching the market weekly is getting more important than ever before.
And the markets are telling us that there’s some exhaustion in the protracted Trump bull rally. Again, you can forget the political controversies surrounding the executive orders; they make great talking points for both sides of the aisle, and they’ve unfortunately made their ways into the editorial pages of the financial press, but none of this has any significant impact on America’s financial or economic future at the moment. The real action is elsewhere, namely in monetary policy and GDP growth. We really need to see changes to the Fed’s monetary policy (or at least a delivered rate hike as promised) or significant changes in the GDP growth rate to drive high yield assets away from their current trendline.
We’re not seeing that, so the indexes are a bit sleepy. The SPDR Barclays High Yield Bond ETF (JNK: $37) and the SPDR Dow Jones REIT ETF (RWR: $94) were flat for the week, with minimal gains in the REIT world offset by a small decline in the Alerian MLP ETF (AMLP: $13.04, down -2%). Meanwhile, there was more sleepy action with the iShares S&P National AMT-Free Municipal Bond Fund (MUB: $108, flat).
This quiet is actually good news for long-term investors. We’ve been inundated with gloom and doom economic forecasting since 2008 - and why not? Plenty of data points look bad, and the Global Financial Crisis is still a recent memory for most of us. And every passing year since the crash urges more pundits and analysts to tell us that we’re “overdue” for a correction or an outright recession. Yet the markets do not see things that way.
At the same time, markets aren’t going crazy. We’re not seeing the heady bubble days of 2006-2007. No one is suggesting there is any “sure thing” in the markets, just like people insisted buying a house was a “sure thing” in 2006. There is a lot of price growth in equities, but no real sign of a runaway market where prices have gone far past fundamentals. Things look even more cautious in the municipal and junk bond markets, where prices still remain below their high point in 2014 and 2015. We are far away from the irrational exuberance that Nobel-winning economist Robert Shiller warned about both before the dotcom bust and before the housing crisis. That means income-seeking investors can still find funds to invest their money and get strong returns.
Unfortunately, such a state of affairs won’t last forever, so investors need to remain aware of the risks in the market. But they don’t need to be in a panic.
Finally, a quick word on one outperformer that bears a bit of particular scrutiny. AstraZeneca (AZN: $29.50, up 6%) continued to have a monstrous bull run after their recent earnings results. Fourth quarter earnings surged 56% and beat expectations by 3 cents at $1.21 per share despite a 13% slide in total revenues. This was driven by a 52% decline in Crestor sales and a 14% decline in Symbicort sales, which was offset by growth in newer drugs like Zoladex. Following the news, Bloomberg published a rumor that the company may sell off its old drug businesses to raise cash that could be applied to new research initiatives.
Our take on all this is clear: AstraZeneca has been a thorn in our high yield portfolio, being the only significant decliner in a portfolio of otherwise sharp outperformers. It was only a matter of time before the company lived up to its potential, and we’re happy to finally see that start to happen. We’re still down slightly from a year ago (excluding dividends.) But the recent turnaround tells us there’s more room for Astra-Zeneca to redeem itself.
Good Investing,
Todd Shaver, Founder, CEO and Editor
The Bull Market Report
February 5, 2017
by Todd Shaver | Feb 5, 2017 | Weekly Newsletter 7pm Sunday
The Week Ahead
“US Stocks Rise On Banks” was the front page of the paper going into the weekend. This highlights continued optimism about the prospects for the economy under the new administration. Specifically, at the moment, the rolling-back of Dodd-Frank is front and center. Can the momentum continue? Will new policies lead to real results? These are questions yet to be answered. But there is certainly a widespread optimism good things can happen.
This week we provide some insights on our latest thinking for Amazon, Facebook, Apple, Google, Athenahealth, Visa, and Blackstone Group.
Highlights From The Past Week
Trump signs order to roll-back Dodd-Frank. President Trump signed an executive order to begin rolling-back Dodd-Frank. The legislation was put in place after the Financial Crisis to crack down on the banking system and help protect the consumer. The Financial sector traded up on the news. Among the targets are rules that protect against predatory lenders, force brokers to lower fees for retirees, and ban proprietary trading. While it will take a while to fully roll back the financial regulations, Wall Street is likely already preparing for a big push into more aggressive business practices. And this latter point is why the market rallies in spite of what many in this country call chaos in the White House. Let’s give it some time. Remember, the checks and balances built into the Constitution may just begin to take effect over the coming months and years.
Japan set to make huge investment in the United States. They are calling it the "Appease Trump" proposal. Japan is putting together a package it says could generate 700,000 U.S. jobs. The five-part package, to be unveiled when Prime Minister Shinzo Abe visits Trump on Friday in Washington, encompasses investments in infrastructure projects such as high-speed trains and cyber security. Apparently, Abe wants to be sure Trump doesn't blow up at Japan again as he did earlier this week when he accused it of devaluing its currency, which hurt Japan’s yen and government bond yields.
Military tensions rise. While there were some hopes President Trump would demilitarize US presence in the Middle East, they are quickly getting dashed with every passing day. Following Trump's announcement last week that he would implement "safe zones" in Syria which would boost US troop presence in the region, US officials announced Friday they had moved a Navy destroyer - the USS Cole, which in 2000 was infamously attacked by terrorists while on dock in Yemen's Aden harbor - off the coast of Yemen to protect waterways from Houthi militia aligned with Iran. Tensions with Iran increased further on Friday when the U.S. Treasury Department announced sanctions on 13 people and 12 entities.
BMR Companies and Commentary
Amazon (AMZN: $810, -3% for the week)
Amazon traded lower on earnings results. The spending outlook took the shine off profit in the holiday quarter that beat analysts’ estimates. Net income was $750 million, or $1.54 a share versus analyst estimates for profit of $1.36 a share. We are happy to see the company bring profits higher but the Street didn’t feel quite the same.
Amazon will spend big in the coming months on warehouses, movies, gadgets and growth into India, renewing investor concerns that CEO Jeff Bezos cares more about generating revenue far in the future than turning a profit now. The company will double-down on its delivery system that gets products quickly into the hands of its customers. It will keep investing in original movies and shows to encourage people to buy Amazon Prime memberships, which makes them loyal shoppers. It will enhance its hot-selling Echo voice-activated personal assistant to gain a presence in homes.* And it will keep pushing into India, which it sees as a vast frontier for e- commerce growth.
*We at The Bull Market Report have one here at home and we love it. We get most of our music from Alexa and query Wikipedia through her probably 10 times a day.
All these initiatives will crimp profits. Operating income in the current quarter will be $250 million to $900 million, less than a year ago even though revenue is forecast to increase as much as 23% to $36 billion. “When you see revenue go up and earnings go down, it spooks people,” said a Wall Street analyst. “It’s called negative leverage and the Street hates it.”
Some Street Ratings on Amazon:
2/3/2017 Wedbush Reiterated Outperform $900.00
2/3/2017 FBN Securities Boost Price Target Buy $925.00
2/3/2017 J P Morgan Chase Price Target Buy $945.00
2/3/2017 Jefferies Group Set Price Target Buy $975.00
2/3/2017 Macquarie Set Price Target Buy $895.00
2/3/2017 Atlantic Securities Set Price Target Buy $960.00
2/3/2017 Stifel Nicolaus Boost Price Target Buy $912.00
2/3/2017 Cantor Fitzgerald Price Target Buy $965.00
2/3/2017 Credit Suisse Price Target Buy $900.00
2/3/2017 RBC Capital Mkts Price Target Buy $900.00
2/3/2017 Mizuho Price Target $905.00
2/3/2017 Evercore ISI Price Target $970.00
2/3/2017 Morgan Stanley Price Target $900.00
2/1/2017 Piper Jaffray Reiterated Rating $900.00
Amazon posted a 55% rise in fourth-quarter profit. But shares of the online retailer dropped in after-hours trading as the company's total sales fell short of analyst expectations. Again, for the quarter, profits rose to $750 million, or $1.54 a share, from $480 million, or $1.00 per share, a year earlier. Sales of $44 billion, up from $36 billion, were below analysts' expectations of $44.7 billion. Sure didn’t miss by much.
BMR Take: Amazon is in growth mode again. We like the long term outlook, but admit heavy investment could bring more near-term volatility. Hold on tight through the turbulence. Amazon is doing all the right things to cause the stock to soar over the long term, including announcing last Monday it would build a $1.5 billion air hub near Cincinnati to accommodate its growing fleet of cargo planes!
More on Amazon:
Amazon has something up its sleeve that may just compete heavily with Google and Facebook. Online advertising. There’s a category in their financials called Other Revenue which jumped 60% in 2016 to $1.3 billion. Still small, but obviously growing rapidly. Amazon has been ramping up its online advertising offerings and could one day be a major threat in the industry. The company said: "Our goals in advertising are to be helpful to customers and enhance their shopping and viewing experiences, mostly with targeted recommendations. We think that's a good strategy rather than invasive things that take away from the shopping experience."
They also said "sponsored product" ads were "off to a great start" and a "very effective way" to reach interested customers, adding that the company was working on some video ads as well. "We are balancing customer experience with advertising at all times, and we like the team that's working on it."
Facebook (FB: $131, -1%)
Facebook’s fourth-quarter revenue climbed more than forecast, driven by advertisers’ continued push to reach consumers on mobile phones. The world’s largest social-media company said sales jumped 51% to $8.8 billion, topping the $8.5 billion average analyst projection. Monthly active users on its main social network increased 17% from a year earlier to 1.86 billion people, with 1.2 billion checking daily and 1.7 billion accessing it via their smartphones.
Total revenue of $8.8 billion increased 51% from last year. The company posted a profit of $4.15 billion, or $1.41 a share, compared to the year-earlier profit of $1.56 billion, or 54 cents a share. We were particularly encouraged with engagement trends whereby improvement was seen across the U.S. and Canada, Europe, and Asia. We like that Instagram now has 400+ million daily active user, adding 100 million new daily users to its impressive tally in just over seven months. We note that WhatsApp now has 1.2 billion monthly active users. We also like the fact that Facebook’s top 100 advertisers represent less than 25% of total revenue, a ratio that decreased from 4Q15, highlighting the company’s increasingly broad and diverse marketplace revenue stream.
Facebook has solidified its position as #2 in the market for mobile advertising, behind only Google. However, it’s still early in the game, as just last year Facebook started selling more marketing spots and added e-commerce tools to Instagram, its photo-sharing app that now has more than 600 million users. Facebook also just recently expanded video advertising, drawing ad dollars that might otherwise have gone to television commercials. So the fight between Facebook and Google over the top spot in advertising is just getting going.
Facebook’s revenue gains had been expected to slow this year because the company has said it won’t keep increasing the percentage of ads shown in users’ News Feeds. That means it’s leaning on other growth areas, like Instagram, as well as new forms of advertising, such as ads in live video. Meanwhile, the company has said it plans to substantially increase its spending on new data centers and engineers.
All in all, “There’s effectively no change in the outlook,” per Chief Financial Officer David Wehner on the earnings call. “We continue to invest aggressively to grow out the business for the long term.”
BMR Take: As Facebook’s influence grows, its users have also started to hold it more accountable for its role in society. Around the U.S. presidential election last year, the company faced an uproar over the use of its social network to spread fake news. Accordingly, poor sentiment has really held the stock back in recent months, but that trend seems to be turning, and turning quickly.
Facebook earnings. Listen to this:
Revenue (Q4): $8.8 billion vs. $5.8 billion last year
Revenue Change (Y-o-Y): 51%
Earnings (Q4): $4.15 billion vs. $2.27 billion last year
Earnings Growth (Y-o-Y): 83%
The stock set a new all-time high of $135 in after-hours trading after they announced. The company is now worth almost $400 billion.
So on $8.8 billion of revenue they made $4.15 billion in profit, AFTER TAXES!! That’s 47% after tax. Insane.
Apple (AAPL: $129, +6%)
Apple will begin assembling iPhones in India by the end of April. The U.S. company has tapped Taiwan’s Wistron Corp to put together its phones in the tech capital of Bangalore. The start of iPhone assembly in India signals a renewed focus on India, perhaps as growth begins to slow in China and other more mature markets. Apple is said to have put forward a long list of demands in negotiations with India’s federal government, including a 15-year tax holiday to import components and equipment.
We highlight the above because we could see President Trump soon having something to say about this. Chief Executive Officer Tim Cook said on the earnings call this week that India is “the place to be.” Apple doesn’t manufacture devices itself, but rather partners with contract manufacturers to handle the capital intensive demands of building factories and hiring staff. Could Trump force Apple’s hand to move all that activity to the US? He expressed interest in doing so during the campaign.
BMR Take: We see a lot of upside for Apple. We just hope the company stays out of the political spotlight. The all-time high of $134 is within sight. The market cap is now a stone’s throw from $700 billion and they have $246 billion in cash, or $47 per share. So, of the $129 you pay for a share, $46 or 36% is in cash. This is unprecedented in the history of Wall Street. We continue to wait for the repatriation push from President Trump – the freeing up of the more than $1.3 trillion of cash being held overseas. This alone could cause a surge in stock prices in the Tech world as well as the overall market.
Blackstone Group (BX: $31, -2%)
President Donald Trump and top U.S. executives had a spirited, balanced discussion about tax issues during a gathering Friday, according to Blackstone’s CEO Steve Schwarzman, who attended the meeting.
“It was spirited intellectually,” Schwarzman said in an interview, adding that differing views were raised about the new administration’s proposed border-adjusted tax, which would put tariffs on imports.
Some companies run by leaders in attendance, including Walmart’s CEO Doug McMillon, have disagreed with Trump and Congressional Republicans on the proposal. “You don’t want to do something that hurts a significant part of the economy, but you want to get benefits from the exports,” Schwarzman said. “Both sides have good points.”
Trump invited 18 executives to the White House to discuss topics ranging from trade and education to women’s roles in the workforce. He called the members “the biggest and best minds in the country.” Trump appointed Schwarzman, who has a net worth of $11 billion, as chairman of the council in December, with the goal of receiving advice on economic growth and job creation from a group of business leaders.
BMR Take: We think Schwarzman’s tight relationship with the President positions Blackstone to be on the winning end of the political change happening. We continue to believe the stock is undervalued. And we can’t help but note a level of optimism in the stock. It appears to us to be “inching up.” Watch this one please. We believe this stock should be at $40. With Schwarzman's more public profile lately, this just might relate to a higher stock price. But at the same time, beware of getting too close to Trump. The CEO of Uber, Travis Kalanick, has resigned from the Trump Advisory Council after taking lots of flak from investors and customers. You just never know.
Athenahealth (ATHN: $109, -13%)
Athenahealth missed the mark this quarter. Earnings were 42 cents per share, which beat consensus of 27 cents. However, the figure came below the 45 cents posted in the year-ago quarter. Revenues of $288 million missed consensus of $304 million but increased 12% from $257 million a year ago.
The company’s expanding network now connects care across nearly 88,000 providers, nearly 86 million patients*, and over 143,000 offices. And, as the largest network in Healthcare, its data-driven insights combined with highly efficient and scalable back office work enables doctors to focus on the health of their patients, not paperwork, and expand their market share and get paid more, faster. Management is more confident than ever about its ability to achieve its vision of building the Healthcare internet. Its increasing depth and breadth of product management, technical design and development expertise, combined with increasing bandwidth to focus on its strategy versus the government mandates of recent years, should make Athena even more productive in 2017 as it deepen its services and builds out its unique network.
*We find this number hard to believe, but it came from the company. We double- and triple-checked.
That said, near-term, the business is tracking below annual targets. The number of new enterprises that went live with the platform was at an all-time high, growing the large customer base. But some doctor and hospital attrition offset some of this and weighed on growth.
Cash was $147 million at the end of 2016 compared with $142 million at 2015 end. Long-term debt was $18 million compared with the 2015-end level of $11 million.
BMR Take: All in all, management maintained 2017 guidance calling for revenue of $1.31 billion and annual bookings of $425 million. The prospects for the company are still bright. We think this week’s sell-off was overdone.
Google (GOOG: $801, -3%)
Planet Labs, a startup that launches small satellites into orbit and sells the imagery, is acquiring the Terra Bella satellite business of Alphabet in a bid to take on larger industry incumbents. In return, Alphabet’s Google is taking a stake in the startup. Google has agreed to purchase satellite images captured by Planet in a multiyear deal.
"It’s a big deal," said Will Marshall, Planet’s chief executive officer. "What this enables us to do is tap into new markets, like certain aspects of the financial markets, insurance and disaster relief." With the deal, Planet will receive seven high-resolution satellites that Terra Bella currently has in orbit. Planet plans to launch an additional six of Terra Bella’s satellites. They are larger than Planet’s existing satellites and offer up to six times better imagery resolution.
Google acquired its satellite division, then called Skybox Imaging, for $500 million in 2014. About 80 Google employees are heading to the startup which has raised more than $180 million. Marshall said the company does not plan to raise additional funds despite the influx of employees and equipment.
BMR Take: Google is at it again. The company is just doing things nobody else is doing. Through innovation, the company is creating its own growth path thereby controlling their own destiny. To re-visit the latest numbers, which were great, Google reported 4Q16 revenue of $26.1 billion, which grew 22% from a year ago and came in about 3% above the consensus. EPS of $8.81 also grew nicely from $7.06 a year ago and was about 7% above the consensus. There was much to like about the quarter - we can't highlight it all, but we will highlight this: Google demonstrated commitment to being an AI-first (Artificial Intelligence) organization with 350+ product launches enabled by AI in 2016. This is just great to see as we believe long term, AI is a mega-trend. All in all, the business is firing on all cylinders, we see compelling long term prospects ahead, and our $900 target is in reach as long as Trump doesn’t derail the stock market. If we hit that target we are raising it to $1000.
Visa (V: $86, +3%)
Visa climbed the most in the Dow Jones Industrial Average on Friday after fiscal first-quarter profit beat analysts’ estimates and the payments network said it expects to meet 2017 revenue forecasts even as a stronger U.S. dollar weighs more heavily on its business.
Revenue will probably increase 16-18% for the full year, the firm reiterated, even accounting for a bigger drag from currency swings. “I feel great about the future of Visa,” CEO Al Kelly told the Street. “We’re on track to meet our financial goals.”
Visa went on to discuss how it completed its roughly $20 billion purchase of Visa Europe, bringing the two firms together after eight years as separate companies. The deal is part of Visa’s strategy to increase its presence in the region and improve global digital offerings to better compete against Mastercard. Getting the event out of the way has been long awaited for.
BMR Take: We are very encouraged to see the stock performance and business results overcome foreign currency risks. The outlook for a stronger dollar could really hurt an international company like Visa. This week was very relieving. For example, foreign exchange effects weighed on growth by 3% this quarter. This figure could easily be greater than 10% in a more tough currency environment.
Upcoming Economic News
TUESDAY, FEBRUARY 7
Trade Balance – December
Time: 8:30 am
Forecast: -$45 billion
The advance report on trade in goods showed solid gains for both imports and exports in December, likely leaving the overall trade deficit little changed. Higher commodity costs and dollar strength helped turn trade into a major drag on last quarter’s GDP, subtracting 1.7% from the real growth rate.
FRIDAY, FEBRUARY 10
Import Price Index – January
Time: 8:30 am
Forecast: 0.2%
Gains in raw materials costs are projected to lift the Import Price Index in January for the fourth time in the past five months. Import prices have not been a major drag on broad price trends of late; the 1.8% yearly rise of the Import Index through December is the quickest pace in four years. While improved prospects for the commodities sector are lifting inflation pressures, renewed dollar strength can moderate the ongoing acceleration in prices.
University of Michigan Consumer Sentiment – February
Preliminary Time: 10:00 am
Forecast: 97.9
Sentiment in the February Michigan survey is expected to dip after ascending to the 13-year high in January. Continued strong jobs gains and quicker income growth can keep confidence above the average level seen during the current recovery. Yet elevated expectations can be curbed a bit as some of the more overly optimistic projections for economic growth may fall short of the mark.
A Letter from a Reader
From: John Tennant [mailto:jotenn@xxxxx.com]
Sent: Sunday, January 29, 2017 5:10 PM
To: Info@BullMarket.com
Subject: OPKO (OPK: $8.61)
Great Forbes article on CEO Frost of Opko. He just keeps buying his stock too, showing the tenacity cited in the article. I sure hope he continues his successful ways, as I am also a firm believer in OPKO and just bought more as the stock drifted below $8.50.
Regards, John
Our thoughts: John was referring to the Forbes article we told you about last week, which blew our mind. Here’s what we said last week:
“Frost is the CEO of Opko and after reading this article, if we at The Bull Market Report invested in our stocks, which we don’t, we would take a lot of our pennies and dollars and invest in this man. Read for yourself:
https://www.forbes.com/sites/schifrin/2017/01/03/meet-miamis-renaissance-billionaire/#3912053b7306
“The chart below lists all of Frost’s and Opko’s investments. This list is AMAZING, and we are not exaggerating. We would strongly suggest that some or all of them will pay off in the future.
https://www.forbes.com/sites/schifrin/2017/01/03/the-buffett-of-biotechs-portfolio/#5cd7e7c3a4a3
BMR Take: We have a Sell Price of $8 on the stock, but we are contemplating buying more if it hits this level. Stay tuned. And write us here after you read the article: Info@BullMarket.com. We would love to hear your thoughts.”
Tesla (TSLA: $251, flat) Morgan Stanley upgraded Tesla to $305. We note that the stock held steady last week after rising from $215 at the end of the year.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
What was GDP growth for 2016? It began with 0.8% the first quarter; 0.9% the second; 3.5% the third and then – uh oh – only 1.9% in the 4th quarter. That's well short of the consensus forecasts, and results in a very lackluster 2016 number for annual GDP growth of about 1.4%. Fortunately, earnings guidance for 2017 has been much better than what we saw this time last year. This is important because the market looks ahead, not behind. And, disposable personal income (income after taxes) increased 0.3% in December and is up 3.7% from a year ago.
It appears to us that President Trump is very intent on providing a clear and consistent pro-growth agenda. This should pave the way for the market to continue on a move towards a break above 2300 on the S&P 500 Index. The market reacted negatively to what is being described as "uncertainty" following President Trump's orders to curb travel and immigration from Syria, Iraq, Iran and four other countries on the grounds of national security. This type of "noise" will likely be around for the foreseeable future. Regardless of your political perspectives, moments of change can elicit emotional reactions from even the most rational investors. As always, emotions have no place in investing. Remember that "fear, greed or hope" will get you every time if you let your emotions guide you. That said, we agree with this recent comment from a market maven: "We believe that now is the time to continue focusing on quality U.S. companies with consistent dividend increases, earnings growth and strong fundamentals - not who is in the White House".
The problem we had the past eight years of getting to at least a 3% GDP rate was not so much the private sector, but rather expanding government largess. Before the Panic of 2008, government transfers – Medicare, Medicaid, Social Security, disability, welfare, food stamps, and unemployment insurance – had climbed to roughly 14% of income, which certainly didn't help prevent the recession. Now they're surged even higher to around 17%. Redistribution hurts growth because it shifts resources away from productive ventures and, among those getting the transfers, weakens work incentives. That's why, for the first time we still have a Plow Horse economy, not a Race Horse economy.
The RACE
In which we plot the prices of four of our favorites. Price of course is irrelevant, but fun to watch. So skip this if you think it is silly. But sometimes we like to be a little silly at The Bull Market Report
Google - $801, down $22.
Apple - $129, up $7 – but we have to reverse out the 7-1 split from 2014, so we get $903, up $49. WOW.
Facebook - $130, down 1 (but setting an all-time high Thursday of $135.) Again, we bring Facebook into the race by multiplying by 7, giving us $910. Facebook had its big run from $115 at the end of the year.
Amazon - $810, down $26.
Results: Google and Amazon fell sharply while Apple had an amazing week and almost caught Facebook. The Race heats up!
UPS Got Hit This Week
This $93 billion market cap company had a rough week. UPS (UPS: $107, down 9%) reported earnings this week. The company reported 4Q16 revenues of $16.9 billion against analysts’ estimates of $17.0 billion. Compared with 4Q15’s revenues of $16.0 billion, the company’s 4Q16 revenues rose 5.5%. On a yearly basis, UPS’s revenue increased to an all-time high of $61 billion in 2016. It was up 4.4% compared with the previous year. UPS Ground business segment saw revenue growth of 7.1% in 4Q16. The Cargo business saw revenue growth fall 12% on a year-over-year basis in 4Q16. During the 2016 peak season, UPS delivered more than 710 million packages around the world, representing a 16% growth compared with 2015. It’s all about e-commerce demand fueling the company’s record package volumes.
Management expects total revenues to grow 5%–7% in 2017, surpassing its historical norms. The company expects e-commerce continued growth to drive revenues. And they believe they will have the power to increase prices due to their size and strength.
BMR Take: We think the reaction on Wall Street was unwarranted and would look at the 9% price drop as an opportunity to buy the biggest and best delivery service on the planet. 710 million packages delivered last year? Two and quarter million packages a day for six days a week? This is strength. This is power. This will drive the company to the $150 billion club within 2-3 three years. And they are paying 3% a year to boot.
Apple Sells a Record Number of iPhones, Beating Expectations as Cash Hits $246 Billion
Apple reported Q1 earnings which not only beat on the top and bottom lines, but also sold a record number of iPhones - 78 million, 2 million more than expected. Earnings of $3.36 were higher than the $3.22 expected, on record revenue of $78.4 billion, above the $77.3 billion expected, and 3.3% higher than a year ago. Revenue in China declined by 12% in the quarter, the 4th consecutive quarterly decline in a row.
--- Gross margin: 38.4%
--- iPhone sales generated $54.4 billion in revenue, 69% of total. This compares to 2.5% in Q1 2008
--- iPhone average selling price: $695
--- Cash now at $246 billion, or $46 per share.
--- App store sales increased 40% YoY in the quarter.
Tim Cook had this to say: “We’re thrilled to report that our holiday quarter results generated Apple’s highest quarterly revenue ever, and broke multiple records along the way. We sold more iPhones than ever before and set all-time revenue records for iPhone, Services, Mac and Apple Watch. Revenue from Services grew strongly over last year, led by record customer activity on the App Store, and we are very excited about the products in our pipeline.”
BMR Take: Now that’s EXACTLY what we thought Cook might say! Seriously, we can see no reason why Apple won’t set a new all-time high sometime soon, as long as the market stays above 20,000 and in fact starts a run towards 21,000.
Twilio
JMP Securities upgrades the company less than a week before it steps up for an important earnings report. One of the most encouraging aspects of JMP Securities turning bullish is the timing of the move.
Twilio (TWLO: $31, up 6%) moved higher this week. The provider of cloud-based communications solutions got a boost after JMP Securities upgraded the stock from Market Perform to Outperform.
They show that developer demand remains strong for Twilio's platform that integrates communication features into existing applications. The Twilio sales team is having a hard time keeping up with all of the inbound leads, a good problem to have when it comes to assessing the dot-com darling's near-term growth potential.
They see a scenario where the stock could hit as high $45 if things go really well for Twilio, a call that would result in a pop of 50% if it plays out.
Twilio reports quarterly results Tuesday. An analyst firm jumping into the fray at this point implies a high degree of confidence in the call. They could have just waited six days for the report to confirm or debunk his refreshed thesis.
The stock has nearly doubled since going public at $15 seven months ago, but the shares have fallen sharply since peaking north of $70 in late September. JMP Securities says there is a real company here -- and it's hitting all of the right notes. And we at The Bull Market Report couldn’t agree more.
JMP says that developers behind some of the hottest apps -- from Uber to WhatsApp to Airbnb – have hopped on Twilio's real-time communications solutions. There were 34,000 developers on Twilio at the end of September, a 45% surge over the past year. We can’t be more pleased. Fingers crossed for a strong earnings report on Tuesday.
Letter to the Editor
Todd, Have you ever looked at Verizon (VZ, $49)? Might be good at this level ? Art
From: Art Weed
Our response:
Hi Art –
Yes, down from $54 – looks appealing. For us though, it is just too big. Almost $200 billion in market cap. Not that we don’t like big companies, but Verizon has have never really gone anywhere. It was $60 in 1999!! So, not for us.
Thanks for writing and good investing in 2017.
Todd Shaver, Founder and Editor in Chief
GoPro was down 13% to $9.57
Thursday, GoPro (GPRO) said it earned 29 cents a share on sales of $541 million in Q4. GoPro lost $115 million, or 82 cents a share.
GoPro went public in June 2014 at $24 and rose as high as $98 in October 2014 before flaming out. It hit a low of $8.55 on Dec. 15.
We’re glad we got out of this one in July at $13.
The High Yield Report
By Michael Foster
Special to The Bull Market Report
The biggest move this week was in BDCs. The UBS BDC ETC (BDCS: $23, down 2%) was the weakest of all high yield sectors. This sell-off happened for a very good reason: The industry has gotten far overbought. This overbought situation drove us to remove Main Street Capital (MAIN: $36) from our high yield portfolio and as we see growing risks with the sector as a whole. Main Street continues to be an outperformer in the sector, but we don’t like what we’re seeing in broader terms. The sell-off looks like the beginning of profit taking. This may reverse, but the risks seem much higher for this already risky sector. We want to jump back in and get 8% yields from companies that can provide credit to high quality smaller firms, but it’s going to take a while for this trade to become attractive again.
There is one additional concern to consider before jumping into a BDC: Dodd-Frank. BDCs were an unexpected beneficiary of greater banking regulations and “banker paranoia” about regulators breathing down their necks. Did you know the big banks are now spending roughly 25% of earnings on regulatory compliance? The overhead that regulations have put on banks, combined with the fear of public embarrassment, shame, and fines has driven investment and retail bank management to conservatism to a fault. This was most noticeable in 2009-2010 when it was almost impossible to get a mortgage with less than 25% down; the banks were just too paranoid to lend. Things are laxer now, but in the corporate finance world there is still a relative tightness compared to actual credit demand.
That’s where the BDCs came in; they could lend to firms that got turned down by big banks. Fueled by a clever common stock issuance structure that allowed them to expand when deals were possible, this industry exploded to fill demand. This was also happening when Treasury yields were crashing, so there was more investor demand for BDCs to get higher yields.
What if banks come back to lending to the middle market firms that now rely on BDCs? Surely more competition will be a headwind for the industry. That makes us wonder if paying a high premium to NAV for a company in the sector, even one as well managed as Main Street, is wise. And that keeps us firmly on the sidelines.
In the rest of the high yield universe, things were rather quiet. The SPDR Barclays High Yield Bond ETF (JNK: $37) and the Alerian MLP ETF (AMLP: $13.29) ended the week flat. High yield bonds are in a state of uncertainty at the moment as a result of higher interest rates (which is bad) but stronger economic tailwinds (which is good). On the one hand you have investors who worry that companies will struggle to refinance their debt load given higher servicing costs, but on the other hand you have investors who are certain that higher economic growth will translate into better revenues and profit margins that will counteract the servicing costs. And, of course, you have the issue of tax reform, which will also be a boon to American firms if it manifests itself. That could also give firms a lot more room to pay back loans, thus counteracting the higher interest rate issue even further.
What this tells us is that the interest rate hike paranoia of 2013-2015 is over. We’re now seeing capital flows being driven by new considerations and new developments in the market. This is a good thing. It means we can be less obsessed with Janet Yellen & Co. and focus on fund quality over all else.
That brings us to our favored high yield funds. The AGIC Equity and Convertible Income Fund (NIE: $19.26, down -1%) and the PIMCO Dynamic Income Fund (PDI: $29, up 1%) cancelled each other out and ended the week with relative stable pricing. This no action keeps us in a holding pattern and encourages us to stand pat on these two funds.
Finally, a quick word on municipals. Invesco Municipal Trust (VKQ: $12.67, up 1%) and the Nuveen AMT-Free Municipal Credit Income Fund (NVG: $14.59, up 1%) had a solid week of gains, with Invesco continuing to be a strong performer since our recommendation. We don’t see massive capital appreciation in municipal bonds anytime soon, but we think this sector remains overly ignored by investors looking for 7%-9% yields. This is folly when you can get tax-free yields of 4-5% that effectively becomes the same cash in hand as you’d get from 7% taxable yields. More investors will realize this, probably after they file their taxes. That in turn is going to increase demand for municipals. Fears about their tax treatment and again about interest rates are overly priced into these assets. Investors will come back to munis - and we encourage you to be there first.
Good Investing,
Todd Shaver, Founder, CEO and Editor
The Bull Market Report
Since 1998
