April 10, 2017
by Todd Shaver | Apr 10, 2017 | 1pm News Flash
By Michael Foster
(Michael was under the weather yesterday but has made a remarkable recovery!)
Let’s start our retrospective with junk bonds. The SPDR Barclays High Yield Bond ETF (JNK: $37, 6% yield) ended the week mostly flat after going ex-dividend (17 cents each month) last Monday, showing another period of surprising restraint from a tightly-wound up market. Back in early 2016 when we were recommending junk bonds most aggressively, funds like this started a bull run that was steep and long lasting, hindered only by a correction at the end of the election cycle that reversed course shortly after Trump won. Junk bonds returned to their 52-week high by February, and since then have reversed course slightly. The market is about 2% off its recent high, with the correction happening mostly over the last month or so.
This is good news for the junk bond market because of two big pressures happening to the market. First is the yield spread issue. U.S. Treasury yields have been climbing higher although recently stalling, and yields on junk bonds needed to either go higher or stay where they were lest the spread between Treasury and junk bond yields get too small and thus disincentivize investors from buying junk bonds. Since bond yields and prices are inversely related, this meant junk bond prices had to go down a little or a lot. The market decided on a little, and spread the pain out over several weeks. This is a restrained move, indicating a market awareness that junk bonds can’t go up in price significantly, but there’s no justification for a crash either.
This conclusion is particularly surprising because of the second big pressure on the market: Retail. You may have read the news of Retail giants going bankrupt and closing stores. Go to your neighborhood mall and you’ll see it yourself. If you’re old enough to remember the mall’s heyday, going to one of these shopping centers today is cripplingly sad. But don’t feel bad for the retailers - feel bad for their creditors. Retail shops rely on junk bonds and middle market lenders to give them liquidity, so the crash in this market impacts the bond and debt markets too. Yet the intense store closings have done some damage to the bond market without causing them to implode like oil’s crash in 2014 did. This again indicates an awareness of building risks and a restrained response. It’s a laudable market response.
These kinds of risks should hit BDCs as well, which arguably are exposed to lower quality mall retailers. We’re still waiting for the bottom to fall out in the BDC universe. The UBS BDC ETF (BDCS: $24) was mostly flat this past week on little news, although we were disturbed to see insider selling at Main Street Capital Corporation (MAIN: $38), one of BMR’s former favorites. COO Jason Beauvais sold 4,300 shares, or 5% of his pre-sales stake, for six-figure proceeds. While share compensation meant he was a net buyer of stock, Beauvais’s sale of already-owned shares rings claxons in our ears, especially since Main Street still sells at its highest premium in history - a premium of 75%. That’s just too much for us no matter how attractive the stock is, and one can’t help but wonder if it’s too high for Beauvais too.
Triangle Capital Corporation (TCAP: $18.70) is another big BDC with a solid track record and insider selling. Director McComb Dunwoody sold 32% of his stake for $930,000 in cash. Of course, Triangle Capital is one of those paradoxes that portends safety with a steady portfolio of debts to reliable middle market companies. Not that that has resulted in reliable income to cover growing expenses, which is partly why the firm cut its dividend in 2016. That wasn’t enough reason for us to be cautious of the company back then, and there are fundamental strengths in the portfolio. But that’s not enough to justify buying in where dividend coverage remains uncertain. Dunwoody’s sale makes sense and, coupled with Beauvais’s, indicates something particularly distressing about BDCs: Insiders are getting less confident of the industry. This leads us to continue our caution about BDCs.
What’s more, we think investors need to try to understand what exactly BDCs are. They are an alternative investment, and that means risk. Alternative investments serve two purposes, both equally important. The first is to provide a diversified portfolio so that you get exposure to different asset classes in case one of those asset classes really does well one year. The other, arguably more common, raison d’etre for alternative investments is non-correlated returns. This is a complex concept but the basic idea is that you want to try to invest in things that don’t necessarily track your main equity investments, so in case that tanks you have something else going up while you wait for your main investments to recover.
The problem is that BDCs fail miserably on that measure for retail investors - their prime target investor group. Triangle Capital has a beta of 0.87 and Main Street has one of 1.1 - both suggest a close correlation to the S&P 500, versus the -0.38 beta of the iShares 20+ Year Treasury Bond Fund (TLT: $121), a fund that is truly non-correlated with the S&P 500. Investors get duped into BDCs because they think this isn’t correlated to the S&P 500 because it’s such a different kind of investment vehicle. That’s sadly not the case. That doesn’t mean this alternative investment should never be bought - it should, but only when it’s undervalued. And with massive premiums like Main Street’s, this is hardly an asset class that’s gone undervalued in recent months.
So what has? In all honesty, the most undervalued asset class right now may still be municipal bonds. We have been pounding the table on munis since December and we get more emphatic with this recommendation every week that we see the S&P 500 climb and junk bond values go higher. Muni bonds are one of the safest income producing asset classes on Earth, yet they’re priced as if they had a much higher risk than they really do. Yet the biggest risks facing munis - rate hikes in particular - are much bigger risks to BDCs and junk bonds, yet those asset classes are doing much better than munis. Why? Muni investors are an easily frightened bunch, and they’re still terrified about a rate hike that they don’t realize won’t hurt them. That makes for viciously underpriced bonds and a buyer’s market.
How to get into munis? Bull Market Report’s two picks - Invesco Municipal Trust (VKQ: $12.60) and Nuveen AMT-Free Fund (NVG: $14.78) - remain solid choices for getting into this market. You’re getting a near 6% tax free yield and we’ve already seen 4% capital gains since the start of December. There’s still room for these funds to climb as the risk-averse tiptoe back in. It’s a very easy cyclical price trend to follow, and we’re happy to ride it for the short term.
April 2, 2017
by Todd Shaver | Apr 2, 2017 | Weekly Newsletter 7pm Sunday
The Week Ahead
This past week was more of the same calm and collected march higher for the stock market. Optimism is at record highs for business and consumers. There are pockets of softness in the economy, like historically low labor force participation and declining commercial and industrial loan activity at banks, but with the credit market dealing with the stresses of low interest rates the stock market just keeps drawing interest from investors. We now head into April after what was a strong 1Q 2017. The consensus estimate for 2017 S&P 500 EPS is currently $129 revealing a reasonable 18x P/E multiple for today’s overall stock market.
The first quarter closed Friday with the S&P 500 notching its best quarter since 2015, up 5.5%. The Nasdaq had its best quarter since 2013, up 10%. The Volatility Index (^VIX), the fear gauge, posted its second lowest quarterly average in history at 12.37. And listen to this, the average daily percentage change for the Dow Jones during the quarter was the lowest since 1965. Things are CALM out there!
Apple (AAPL: $144, up 2%. All changes in this report are for the WEEK), a component in all three major indexes, jumped 24% during the quarter, nestled next to an all-time high set again this week. The company added $145 billion to its market cap in the quarter, besting its own record set in 2012 of adding more market cap in a quarter than any other company. It was the biggest gainer in the Dow Jones 30. Facebook, Amazon and Netflix all added 18%.
There is always a bull market right here at The Bull Market Report! This week we highlight the following securities: Visa, Amazon, Microsoft, Tesla, Splunk, and Shopify.
Highlights From The Past Week
Trump Talks Tough on U.S.-China Trade. President Trump appeared to follow through Friday on his promises to get tough on trade with China, less than a week before he is to meet with President Xi Jinping of China. In two executive orders, Mr. Trump called for tighter enforcement of tariffs imposed in anti-dumping and anti-subsidy trade cases, as well as a comprehensive review of the United States trade deficits - measures that reflect America’s economic tensions with China. Straightening out the US trade balance with China would be a major positive for US GDP growth, if Trump can accomplish the goal.
Why the Urge to Merge Could Return to Wall Street. Nothing appears to be off the table for the Trump administration as it seeks to pare back the regulations imposed on Wall Street and banks after the financial crisis. There has already been considerable talk about rolling back much of the Dodd-Frank Act of 2010, as well as the Volcker Rule that is intended to prevent Wall Street firms from engaging in proprietary trading. Already, the acting chairman of the Securities and Exchange Commission, Michael Piwowar, says his agency has stopped writing the rules and regulations mandated by Dodd-Frank - more than 20,000 pages so far - in anticipation of the confirmation of Jay Clayton as the commission’s new chairman. There is little doubt change is coming. But no one seems to be talking about whether Wall Street banks will again be able to engage in what has historically been one of their favorite pastimes: getting bigger through mergers and acquisitions. We could be in for an M&A boom across sectors not just Financials.
"Valeant Bet Was a ‘Huge Mistake," Hedge Fund Chief Ackman Says. It is rare that William Ackman, the brash activist investor, apologizes for anything. As a successful hedge fund manager, Mr. Ackman has made billions of dollars for himself and his investors with bold and counterintuitive bets. But this week he conceded that his firm’s biggest wager yet - on Valeant Pharmaceuticals International - was “a huge mistake” that has cost his hedge fund firm, Pershing Square Capital Management, “a tremendous amount.” “I deeply and profoundly apologize,” Mr. Ackman added in an annual letter to investors. It was an unusual moment of contrition for Mr. Ackman and a stark contrast to his emphatic support of Valeant in recent years. In the bigger picture, this event is just the latest of many recent developments pointing to troubling times for hedge fund managers as more and more investors turn to do-it-yourself and/or ETF investing.
BMR Companies and Commentary
Visa (V: $89, flat)
Samsung Electronics announced a strategic partnership with Visa to help bring Samsung Pay to online merchants. Starting later this year, Samsung Pay users will be able to shop online at hundreds of thousands of merchants around the world where Visa Checkout is accepted. The partnership just goes to show everybody in payments relies heavily on Visa.
Samsung Pay’s simple, secure checkout experience using fingerprint authentication gives users a more streamlined online shopping experience, eliminating the lengthy process of adding their payment card data, billing or shipping details each time they shop. Users with fingerprint authentication-enabled Samsung devices will be able to click the Visa Checkout/Samsung Pay co-branded button and touch the fingerprint sensor and the payment will proceed instantly, without needing to enter a user name and password for each purchase.
How cool! The days of filling out long forms or remembering usernames and passwords to make online purchases are continuing to wind down, as options like Visa Checkout’s open platform become accessible on hundreds of thousands of merchant sites, and companies like Samsung see the value in simplifying the process for both consumers and merchants.
BMR Take: Visa trades at 26x the consensus estimate for this year’s fiscal EPS of $3.45. Take a look at this 5-year chart from Yahoo. Where do you think they are headed in 2017/8 and beyond?
Amazon (AMZN: $887, +5%)
Amazon is expected to enter the Australian market soon. Estimates call for this region to eventually contribute upward to $15 billion of sales to Amazon’s top line, which compares to this year’s sales tracking to be around $165 billion for the company.
What is great about Australia for Amazon? Online sales will account for just 12.5% of Australian retail sales by 2025, up from only 7% in 2016. In other words, Australia is just barely into the online sales phenomenon. We are likely heading to online sales being greater than 25% so there is just much growth runway ahead for Amazon in Australia.
What will be interesting to watch is what Amazon’s entry into Australia means for local retailers. Could it be an imminent disaster? Certainly, many local players will have to adjust to smaller store footprints, change pricing, and improve their customer engagement.
BMR Take: Amazon trades at 125x the consensus estimate for this year’s fiscal EPS of $7.09. It’s a big valuation, but growth is exceptional. EPS was a loss in 2014, $1.25 in 2015, and $4.90 in 2016 and now we see estimates for $7.10 in 2017, $12.35 in 2018, and almost $20 in 2019.
Consensus Ratings for Amazon
4 Hold Ratings, 45 Buy Ratings
Targets:
3/30/2017 Loop Capital $1,100
3/29/2017 Cantor Fitzgerald $970
3/28/2017 Stifel Nicolaus $1,025
3/17/2017 Pacific Crest $895
Apple (AAPL: $144, +2%)
In January, Forbes reported that a White House advisory panel issued a report recommending that the U.S. strengthen protection of the Semiconductor industry, especially against threats posed by Chinese policies to dominate the sector.
Then in March, Apple discussed publicly that the Japanese government is likely to ensure Toshiba is acquired. Prime Minister Shinzo Abe recently met with President Trump to discuss among other topics this one. There are now swirling talks that Apple is going to buy part of Toshiba. The deal could be executed for as much as $18 billion.
What does it all mean? Apple farms out their production for Macs, iDevices and accessories so that they can focus the bulk of their investments on software and engineering companies, setting up R&D centers around the world and building out new flagship Apple stores. We very well might be looking at the early signs of Apple soon making many of their products in the United States. Exciting.
BMR Take: Apple is again setting new all-time highs this week. The stock trades for just 15.5x this year’s consensus EPS estimate of $9.25. We are still seeing healthy EPS growth from Apple, as seen in the consensus forecast for EPS of $10.35 in 2018 and almost $11 in 2019.
Microsoft (MSFT: $66, +1%)
Last October Microsoft released the preview of Azure Analysis Services, which is built on the proven analytics engine in Microsoft SQL Server Analysis Services. With Azure Analysis Services, you can host data in the cloud. Users in your organization can then connect to your data models using tools like Excel, Power BI, and many others to create reports and perform ad-hoc data analysis. This is exciting stuff for the business community. You no longer need to run a big back office. You have Microsoft Azure!
Well, just this week, Microsoft announced that Azure Analysis Services is now available in two additional regions: Japan and the UK. This means that Azure Analysis Services is now available in the following regions: Australia, Canada, Brazil, Southeast Asia, North Europe, West Europe, the US, Japan and the UK.
BMR Take: Again a new all-time high for Microsoft this week as the cloud is taking over and Microsoft Azure is one of the top players. The stock trades at 21x this year’s EPS estimate of $3.10 though estimates call for EPS of $3.50 in 2018 and $4 in 2019.
Tesla (TSLA: $278, +6%)
Earlier this week, Tesla announced that Chinese Internet firm Tencent had acquired a 5% stake in the company for $1.8 billion. The cash infusion is good news for Tesla’s financial health, and the company’s growth prospects in the region.
In a recent filing, Tesla said that 2016 sales in China were $1.06 billion. That’s roughly a quarter of what the company made in the U.S. last year. And while the China figures represent significant growth from 2015, it’s still well below what CEO Elon Musk once imagined. In a 2014 interview with Bloomberg, Musk projected that China could eventually become the electric-car maker’s largest market. Admittedly, that day is a long way off, but we are moving closer and closer.
One big hurdle left to clear in China for Tesla is market share. According to CleanTechnica, 352,000 electric car sales were registered in China last year, which is nearly half of all plug-ins sold worldwide. Tesla, however, is the underdog. Despite being the best-selling foreign electric vehicle manufacturer to crack the Chinese market, the company only had a 3% share in 2016. Plenty of room left for improvement to drive more growth.
BMR Take: Tesla is selling cars in China like hotcakes. China LOVES Tesla and Elon Musk. We are excited to see the company make some progress in the attractive China market. The company is still losing money, basically because they are not making cars in mass quantities yet, so the extra money raised from the 5% stake sold is a welcomed boost of cash on the balance sheet. Tesla ended last quarter with over $8 billion in debt on total assets of $23 billion, a definitely elevated level.
Splunk (SPLK: $62, +2%)
An activist may have just shown up at the Splunk table. A notable language change in Splunk’s 10k filing was noticed this week. The new disclosure alerted investors to possible activist involvement in company operations.
The 2017 10-K included following phrasing absent from the previous year’s filing: "From time to time, public companies are subject to campaigns by investors seeking to increase short-term stockholder value through actions such as financial restructuring, increased debt, special dividends, stock repurchases or sales of assets or the entire company. If stockholders attempt to effect such changes or acquire control over us, responding to such actions would be costly, time-consuming and disruptive, which could adversely affect our results of operations, financial results and the value of our common stock. These factors could also make it more difficult for us to attract and retain qualified employees, executive officers and members of our board of directors."
BMR Take: The added language essentially fulfills the company’s legal obligation to warn investors of activist interference. So we would be in a for a nice catalyst here. We really like Splunk. All anybody ever talks about now is cybersecurity. The company has $1 billion in cash and just $100 million in debt. Consensus estimates call for meaningful growth from $0.40 of EPS last year to $0.60 this year and $0.90 next year.
Shopify (SHOP: $68, -1%)
There was a whirlwind of poor press circulating on the company this week. First of all, a research firm downgraded Shopify to a strong sell to reflect negative estimate revisions following an unimpressive full-year 2017 outlook and growing near-term headwinds. This is just near-term noise. We are focused on the longer term big picture, which is very attractive for Shopify. In particular, many investors are asking the question if it would make sense for Amazon to acquire Shopify. After all, the market cap is only $6 billion. This would be a rounding error on Amazon’s balance sheet.
Shopify offers an easy-to-use multi-channel commerce platform that targets small and medium-sized businesses. Its 2016 revenue was $390 million. This would be a bolt-on acquisition for the Amazon Web Services (AWS) business if the rumor is true. As far as what Amazon or another buyer might get for a bid of $7-8 billion or so, the Shopify website showed that more than 380,000 people have sold over $29 billion using Shopify. The service allows small and mid-sized businesses to fully customize their online stores and to add new sales channels, while managing unlimited products and inventory and tracking sales.
BMR Take: We are not worried that the stock took a few points of pullback this past week. This is a long-term investment that will pay off big in five years. EPS is expected to go from a slight loss this year of $0.18 to something like $1.25 by 2020. Given all the potential of Shopify’s technology and the earnings ramp set to occur, we remain excited about the future for this company.
Upcoming Economic News
It is a very quiet week ahead for economics news. Stay tuned for more economic news next week.
A Letter from a Reader
To: The Bull Market Report
From: Arthur Weed
Twilio, First Solar and Ferrellgas were all recommended at the high end of the price range. Shopify also is at the high end of the range in this market. Sometimes riding the market out for lower prices is a good option. I just prefer to watch for weakness and then go for it.
Hi Art –
OK, I understand. We all have our personal philosophies. I like to shoot for the fences with some of my assets. I missed Microsoft at 3 cents. And Apple at 11 cents . But I got AOL at $1 in the 90s and it went to $71. And I got Iomega at $17 even though the low was $3 for the year and it went to $330.
The facts:
Twilio was added after it dropped from its high of $71, and in fact, it had a fairly sharp drop from that level to $52 where we added it.
First Solar was added at $63 and a month later was $73. Revenues have fallen sharply.
The average price of Ferrellgas for the last 23 years is around $20. At $17 we thought we had a nice discount and an opportunity for it to go to $20 and then $25.
Our thoughts:
--- We believe Twilio will be a huge player in the internet communications marketplace. And we believe the stock can triple or more from $50.
--- First Solar has been a leader in this business for decades and until recently has the revenue to go with it. Unfortunately, we have to wait until 2019 for this one to play out. And that is not guaranteed, but we believe management can do it.
Note: First Solar was given a hold rating at JPMorgan Chase. They now have a $38.00 price target on the stock.
--- Ferrellgas has been a leader in the natural gas business forever. We didn’t know their big acquisition would go down as one of the worst in Wall Street history.
--- Shopify is the leader in e-Commerce by a wide margin and has big growth ahead of it. It is a potential Microsoft-like opportunity as the world is moving to mobile every single day, every week, every month, every year. We wish we had discovered it at $25 or $50. But if the stock goes to $100 and then $150-200 we won’t mind too much. We think this is quite possible over time.
Todd Shaver
A Letter from a Reader
From: Chet Malek
Sent: Thursday, March 30, 2017 9:07 AM
To: info@bullmarket.com
Subject: SNAP and Twitter
Todd – Do you have any thoughts on SNAP? Do you like Twitter better (I assume you do)?
Hi Chet –
We do not like Snap. They may surprise me and go to $50 and $100 but at the moment they are WAY behind where Facebook was when Facebook went public. And if you remember, they went public at $37, hit $43 that day, closed at $37 and then proceeded to go down to $16 in the next few months. Now the stock is at $142. BUT Facebook had big revenues and big profits at that time. Snap has good revenues but super negative earnings – They lost $515 million last year and $380 million in 2015! And they are a niche business unlike Facebook which covers it all.
We do like Twitter. One day they will figure it out. And one day someone will buy them at a 40% premium. If I were a gambling man I would buy 2-year LEAP options with a strike price of $25 or $30, cheap. [This is not for all. Consult your broker. High risk here.]
We really like Twilio – good business concept; strong revenues last quarter. No profits yet. But profits will come if the revenue is there, and it is.
Todd Shaver, Founder and Editor in Chief
Twilio Extends Relationship with Amazon
Twilio (TWLO: $29, flat) announced a further step in their relationship with Amazon. They said: Amazon Connect will use Twilio's programmable APIs to provide enhanced capabilities for customers.
(What are APIs? An Application Programming Interface is a set of subroutine definitions, protocols, and tools for building application software. In general terms, it is a set of clearly defined methods of communication between various software components. A good API makes it easier to develop a computer program by providing all the building blocks, which are then put together by the programmer. An API may be for a web-based system, operating system, database system, computer hardware or software library.)
From their public announcement Tuesday: Twilio, the leading cloud communications platform company, today announced support for Amazon Connect, the newly announced cloud-based contact center service from Amazon Web Services (AWS). Twilio's Programmable APIs will enable a range of new capabilities, including integrating phone intelligence lookup to personalize Amazon Connect contact flows, enhance customer contact details, and follow up with post-call surveys via text.
"We're pleased to further extend our work with Amazon Web Services by helping to power and further enhancing the capabilities of Amazon Connect," said Twilio CEO and co-founder Jeff Lawson. "Supporting the continued advancement of the contact center to its more agile future in software, frees developers and businesses from the legacy approach to contact centers -- an approach that simply can't keep pace with customer expectations today."
The announcement furthers the long-standing relationship between the two companies. Note that Twilio is built and globally deployed on the highly scalable AWS Cloud. Some say that Amazon can do what Twilio does and that all this hype is bad news for Twilio. We say the opposite. We think there is a symbiotic relationship here that appears to grow stronger and stronger each month.
Here’s what the company includes in their press releases:
About Twilio
Twilio's mission is to fuel the future of communications. Developers and businesses use Twilio to make communications relevant and contextual by embedding messaging, voice and video capabilities directly into their software applications. Founded in 2008, Twilio has over 650 employees, with headquarters in San Francisco and other offices in Bogotá, Dublin, Hong Kong, London, Madrid, Mountain View, Munich, Sweden, New York City, Singapore, and Tallinn [the capital of Estonia.]
Alphabet (GOOG: $830) is now covered by Barclays. They set an "overweight" rating and a target of $1,065. Our target is $900 but when that level is hit we fully expect to raise it to at least $1100. The only question is when.
The High Yield Corner
By Michael Foster, Special to The Bull Market Report
We start this week’s high yield summary with the GDP report. The headline news looks good: GDP grew at 2.1% versus 2% in the fourth quarter. Politically-minded Americans may want to dismiss this (and who isn’t politically minded these days?), arguing either things will get better or worse under Trump, depending on the flag they bear. We would suggest resisting the urge to devolve the topic to partisan bickering, because the details under this report are very important because they signal where exactly we are in the credit cycle. This, in turn, is important for one of the world’s biggest credit markets: U.S. corporate bonds.
The mainstream press focused on a couple of dynamics under the headline number, although both are relatively unimportant. A big theme, according to journalists, was consumer spending. This rose 3.5%, a sharp upwards revision from 3% previously. Since consumer consumption is the biggest driver of demand in the U.S., which in turn drives demand for the big industries abroad (manufacturing in China and Germany, exporting in Hong Kong and Singapore, commodities in Latin America, and so on), this is good news.
But it’s actually not the most important bit of good news from the report. The National Income and Product Accounts (NIPA) data, which makes up part of the GDP, gave significant and good surprises that have much more predictive power than consumer activity. According to the NIPA release, corporate profits rose after declining for three years. The “corporate profits” metric, jumped over 9% on a year-over-year basis in the 4th quarter of 2016, a sharp acceleration from the 2% increase seen in the 3rd quarter. Some economists have already said the so-called “corporate profit recession” has ended.
This decline, which was partly a result of the crash in commodity prices and partly the result of cash-strapped consumers pulling back, was a primary reason why the S&P 500 got more expensive. Because stock values are measured by dividing their current price by their earnings over a one-year period (the “price-to-earnings” ratio), stock values climbed higher and higher because profits were falling lower even as stock prices were going up. This caused the S&P 500 P/E ratio to shoot up to over 26 by the end of March, about 50% higher than its historical average. That definitely looked and smelled like an overbought market, but investors held their noses and bought stocks anyway.
We’re here to tell you that you can stop holding your nose. While the corporate profits measurement is not identical to the way S&P 500 companies report their earnings, they’re close enough. And with a 9% jump, that means the S&P 500’s one-year forward P/E ratio is less than 20, a very reasonable level.
At the same time, this increase in earnings is extremely good for corporate bonds, BDCs, and REITs for similar reasons. Let us go through these one by one to explain why.
Firstly, corporate bonds. The SPDR Barclays High Yield Bond ETF (JNK: $37) had a good week (up 1%) thanks in no small part to the GDP data, although investors are continuing to recognize what we have been saying for a long time: the default risks are over and will decline significantly because corporate profits are going up, meaning firms will have enough cash to pay their debts. What does this mean? All the risks that were priced into junk bonds back in 2015 are evaporating but the price hasn’t fully recovered on a real adjusted basis. Great news - this means we can buy junk bonds. But we can’t be indiscriminate about it. Well-managed funds like the PIMCO Dynamic Income Fund (PDI: $29) are ideally positioned to outperform. Last year PDI paid out a special dividend well over 4% of the fund’s value, bringing the annualized yield to over 13%. With the strength in junk bonds this type of return will be even easier for this fund to do this year, making it an obvious strong hold even though it is priced at a premium.
A similar rationale exists for why BDCs shot up this week: more corporate profits mean less concern companies will default on their debts. The UBS BDC ETF (BDCS: $24, up 2%) had an incredibly strong week as a result. However, we do not see this as a good enough reason to buy BDCs, especially the larger cap ones that are facing growing competition from banks that are increasing their middle market business lending practices. The market is cheering the macro conditions for BDCs, which are clearly much better than a year or two ago. However, the market is not taking into account the industry conditions for BDCs, which is more competitive and thus will force some BDCs to look for lower yielding or higher risk loans. This makes us cautious on BDCs just as we are more positive about their lower yielding competitors - namely, financial stocks.
Finally, let’s talk REITs. In the simplest sense, higher corporate profits mean more room to raise rents for industrial, commercial, and infrastructural tenants. Retail and commercial REITs make up a healthy chunk of the SPDR Dow Jones REIT ETF (RWR: $92, up 1%), but it also plays into the wheelhouse of The Bull Market Report’s favorite REITs.
Digital Realty Trust (DLR: $105, up 2.5%), Omega Healthcare Investors (OHI: $33, up 2%), Kimco Realty (KIM: $22, down 2%), Government Properties Trust (GOV: $21, up 2%), and Care Capital Properties (CCP: $27, up 6%) are all exposed to corporate and government tenants whose ability to tolerate raising rents is going up as corporate profits rise. This doesn’t mean the market is irrationally exuberant about the sector like they were in mid-2016, which again makes this a good sector to be into, especially if you’re choosing firms relying on commercial rents.
The market is stronger than the fearmongers would have you expect, and that strength is particularly acute in the high yield universe. It’s a great time to buy income.
Funny – as we write this last sentence above we think of all the folks out there who are thinking: How can I buy yield when interest rates are going to go up which means prices will go down? Well, we at The Bull Market Report don’t believe rates are going that much higher. In fact, if anything, we think rates could go lower, despite the Fed’s best wishes. Besides, as noted above and every week that we write this report, you surely notice that we are writing about strong companies with strong management who are well-aware of the world of interest rate risk. We believe in management of the companies we follow. Look at Annaly (NLY:$11.11). They paid a 30 cent divided this week (11% annualized), and the stock was flat. That’s a 2.7% gain for the week in our book. The stock is up over 10% from its low in December! And they’ve been doing this for 20 years.
Good Investing,
Todd Shaver
Founder and Editor in Chief
The Bull Market Report
Since 1998
March 26, 2017
by Todd Shaver | Mar 26, 2017 | Weekly Newsletter 7pm Sunday
Highlights From the Past Week
The markets were a bit weaker last week. Friday’s close ended with uncertainty over Healthcare reform. Regardless of the outcome, some people are starting to ask tough questions. Is this Congress going to be able to deliver on the aggressive Trump agenda? Across the board, we are not just talking simply healthcare, but taxes, trade, regulations, the wall, and so on. This very first test for the new Congress will set the tone for the years ahead. And we are sure you heard what happened on Friday. No healthcare deal. Now what?
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. We currently see a bull market across many parts of the stock market. This week we highlight the following securities: Mazor Robotics, Apple, Google, Facebook, Home Depot, Celgene, and VMware.
Keystone XL Pipeline To Start Construction. The Trump administration announced on Friday that it would issue a permit for the construction of the Keystone XL pipeline, a long-disputed project that would link oil producers in Canada and North Dakota with refiners and export terminals on the Gulf Coast. The announcement by the State Department, reversed the position of the Obama administration. The pipeline has been the focus of a long fight between environmentalists and the project’s advocates, who say it would further the goals of energy independence and economic growth. The event marks a key inflection point for American’s refocusing on business.
The Markets Don't Care About Healthcare As Long As They Get Their Tax Cut. For the stock market, the drawn out effort to pass the healthcare bill may not matter after all. Regardless of whether Republicans can push the bill through (they didn’t), pro-growth and economic policies are next on the agenda. If so, markets win either way. They are not willing to hold economic growth/tax reform hostage to the Affordable Care Act reform any longer. This is a broad market-positive signal that bolsters the case for 2017 tax reform. Tax reform will start to take center stage this Spring.
Optimism Sweeps the Nation and Pulls Money Into Stocks. The surge in business and consumer sentiment reflects an assumption that is deeply rooted in the American psyche: that deregulation and tax cuts always unleash transformative pro-growth entrepreneurship. That is what we are seeing since late last year. Money has been flowing into exchange-traded funds like never before, helping to propel stocks higher. $130 billion has flowed into these index-tracking funds in the first two months of 2017. This follows a record-breaking year in 2016, when ETF managers gathered more than $390 billion in new cash. Moreover, the CBOE Volatility Index, the VIX, a popular gauge of market fear, is trading near historic lows. Even the somewhat pretentious term -- “animal spirits” -- has come back with a vengeance in the financial media.*
*People say "animal spirits" as in reference to optimism and capitalistic mentality. Additionally they mean there is business opportunity out there that is obvious, management has that and is going for it.
BMR Companies and Commentary
Mazor Robotics (MZOR: $29, +24% - all percentages in this letter are for the last week)
Mazor had a big week. Honestly, there was no specific news on the company. There doesn’t always have to be a “new” story. Sometime, people just get more comfortable with what’s happening at a business, and they start to accumulate the stock.
The latest public development at Mazor was the Hartford HealthCare news. Hartford HealthCare is Connecticut's most comprehensive healthcare network. A week or so ago Hartford announced it was joining forces with Mazor. The new partnership will bring unprecedented precision to surgeons performing spine surgery and the patients they serve. The Mazor X system was developed to enhance predictability and improve patient outcomes. It enables surgeons to be more precise, more efficient, and reduce the overall risk rate of spinal surgery.
Hartford is the first healthcare system in the state of Connecticut and throughout the Northeast to debut this technique. Physicians performed surgeries this week at the Bone & Joint Institute at Hartford Hospital and at MidState Medical Center.
BMR Take: Mazor is serving quite the niche - spine surgery - and doing a great job. We continue to like this stock pick. This week’s healthy stock performance reaffirms our conviction. The stock reached our Target Price of $29, and we are now up 70% since June when we added the stock at $16. What should you do? Obviously you could sell or you could hold from here. We are raising our Target to $36 and raising our Sell Price from $18 to $26.
Apple (AAPL: $141, +1%)
With Apple once again moving to record highs, it seems that all anyone talks about is the next big iPhone launch. Buzz surrounding the coming 10-year anniversary iPhone is growing ever louder. Sales of the iPhone 8 debut later this year will shatter expectations and help fuel estimate-beating profit growth.
Yet high hopes for the iPhone 8 aren’t the only reason to take a bigger bite out of Apple. Let’s not forget, it is one of the few technology companies that pays a cash dividend to shareholders. There is talk that the iPhone maker is poised to announce next month plans to significantly increase the capital it returns to shareholders with a $35 billion boost to its existing share buyback plan and a 15% dividend hike. (AND WAIT UNTIL TRUMP starts his tax reform plan with the cash repatriation proposal.)
Apple is a great value proposition. Warren Buffett’s Berkshire Hathaway became one of the company’s biggest shareholders late last year when it added the stock to its portfolio.
BMR Take: With the iPhone continuing to blow away its competition, and Apple’s high-margin services business continuing to race higher, there is just so much to like here.
Google (GOOG: $814, -4%)
Google has run into a bit of a rough patch here. We like it even more down here at this level.
Major advertisers are halting advertising on YouTube after Google said it was taking steps to protect its clients from inadvertently supporting hate. The controversy over ad placement, is now in its second week. We believe it to be way overblown. Chairman Eric Schmidt said Google could "get pretty close" to guaranteeing companies' ads won't be placed near hateful material.
Range Rover it was suspending its YouTube campaign in South Africa while it investigates. Nissan said it was "urgently reviewing" its campaign with Google. JP Morgan Chase and Ford suspended their YouTube ads on Thursday. AT&T, Johnson & Johnson, GlaxoSmithKline and Verizon Communications have joined the boycott in recent days, after the BBC, Volkswagen and Toyota said they had pulled ads in the UK.
BMR Take: We reiterate that we believe this is a good opportunity to buy more of one of the best technology companies on the planet. Admittedly, Google isn't yet fully addressing advertisers' concerns and needs to take stronger steps to regain the trust of brands. However, they will get it right, and when they do, it’s back to the great story we know - and a much higher stock price.
Facebook (FB: $141, flat)
According to one Wall Street analyst’s recent due diligence, they observed Facebook advertising spend volume growing 85% so far this year, from a year ago, across its client base and ahead of the company’s internal forecasts.
Why the strength? Facebook’s customer match offerings and the return on investment benefits of lower cost per click are driving demand strength. Remember, they have 1.9 billion customers. 1.9 billion customers!
Separately, Instagram continues to represent a larger share of Facebook’s overall revenue and is a key driver of growth. Higher engagement is being driven by increased video content. What does this mean? Very good things. Higher engagement means more opportunity to sell advertising. With ad pricing stable, this trend adds up to more and more revenue. You get it. More engagement doesn't just mean people are happier on the platform. More engagement triggers more advertising opportunities for the business model.
BMR Take: It always nice to hear about how the current quarter is going before the current quarter is reported. We sleep well at night thinking about the future for Facebook’s advertising revenue.
Home Depot (HD: $148, -1%)
The remodeling boom continues. Remodeling is so popular right now that homeowners are expected to spend nearly $325 billion dollars on remodeling and repairs this year, according to Harvard. Wow!
Usually you decide to remodel or renovate your home when you're ready to upgrade worn-out areas, want to add new features, or simply because you're ready for a change. But like any good investment, there are a few areas where you can make a nice return on the money you're spending.
The number one interior improvement that ups the value of a home is a kitchen remodel. This can run $20,000 to $50,000 and even much more.
When it comes to the outside of the home, buyers apparently value structural upgrades over decorative improvements to the interior. New roofs lately have been growing fast.
BMR Take: Home Depot is benefiting from this remodeling boom. Retailers like Sears and Macys may be coming under increased pressure from online retailers, but Home Depot is trucking along just fine.
VMware (VMW: $92, -1%)
VMware is in a unique situation in the escalating hybrid cloud war. The company has a strong presence in datacenters but needs large public cloud providers as partners, given the high capital requirements to offer these services in scale. In February 2016, VMware entered into a partnership with IBM to offer hybrid cloud products. In October, VMware announced an alliance with Amazon, the largest public cloud provider, to do the same.
Recent quarterly results from VMware showed rising interest by customers in these partnerships. Lately we’ve seen rising customer confidence in VMware's long-term cloud strategy and its future position in the technology industry.
IBM's large client base in IT outsourcing gives it a novel edge as the adoption of hybrid cloud grows. It also has the entire breadth of services required to move clients at their pace from a legacy architecture to the cloud. IBM is also the world's largest IT services vendor with expertise in design, consulting and re-engineering of legacy IT to cloud. IBM is a leading vendor of both software and IT services, unlike other major cloud providers that historically focused more on software. Its early move into cognitive products through Watson should also help it drive additional growth in hybrid cloud.
BMR Take: We continue to like this core story around the “hybrid” cloud for VMware. Amazon and IBM - what great companies to call your partners! We expect more good news about this business in the near-future.
Celgene (CELG: $123, -2%)
The Affordable Care Act saga in Washington has created a buying opportunity for Celgene. We describe the situation below. The bottom line is that Celgene is lumped into the conversation with other bad actors. The reality is Celgene will do just fine if drug prices come down. It’s the real bad actors like Mylan that will be hurt.
The ACA saga in Washington has created a buying opportunity for Celgene. We describe the situation below. The perception is that Celgene is lumped into the conversation with other bad actors. The reality is that Celgene will do just fine if drug prices come down. It’s the bad actors like Mylan that will be hurt.
When you rush any kind of massive project, you raise the risk that people get hurt. That's certainly the case with healthcare reform. As President Donald Trump and congressional Republicans have scrambled (and lost) to save their troubled attempt to repeal and replace the Affordable Care Act, they addressed Trump’s repeated rhetoric that drug pricing needs to be rationalized. This is such a broad statement; there is a lot of uncertainty about how lower drug prices will impact each player in the healthcare space. So many medicines carry massive price tags because most patients typically pay just a small fraction of those list prices, while insurers handle the rest. We are all in wait-and-see mode as to how the new insurance schemes will influence drug pricing.
BMR Take: Lower drug pricing does not ruin Celgene. This is actually an opportunity for you, with this lower stock price. Celgene is widely cited by Street analysts as a top pick in the space as the franchise is best in class. The company has a stacked pipeline of new drugs creating strong financial prospects.
Consensus Ratings for Celgene
Ratings Breakdown: 1 Sell Rating, 4 Hold Ratings, 23 Buy Ratings
Price Targets:
3/8/2017 Cowen and Company $150
3/6/2017 Oppenheimer Holdings $148
3/2/2017 Cann $148
2/28/2017 Jefferies Group $155
2/25/2017 Canaccord Genuity $156
2/18/2017 Cantor Fitzgerald $159
2/18/2017 Credit Suisse Group $148
2/17/2017 Robert W. Baird $162
Must be something the Street likes about Celgene!
Upcoming Economic News
TUESDAY, MARCH 28
S&P CoreLogic Case-Shiller Home Price Index – January
Time: 9:00 am
Forecast: 5.7% yearly change of 20-city index
Gains in home sales over the long-term amid tight supply can keep the Case-Shiller home price index rising in excess of 5% annually in January. Nationally home prices now lag their pre-crisis peak by 7%, as certain local markets are considered overvalued. Yet broadly, consistent price gains have greatly reduced the share of homeowners underwater on their mortgages, which allows the housing market to function more smoothly.
Conference Board Consumer Confidence – March
Time: 10:00 am
Forecast: 113.0
Consumer confidence as measured by the March Conference Board survey is forecast to remain strong, even if the index slips a bit from February’s 15-year high. In February, the share of survey participants anticipating rising incomes exceeded the share expecting their incomes to decline by 10% for only the second time in the past decade. That gap points to persistent wage gains and an upward bias to price growth.
WEDNESDAY, MARCH 29
Pending Home Sales Index – February
Time: 10:00 am
Forecast: 2.4%
The Pending Home Sales Index is expected to rise in February after sliding to the 12-month low in January. Though sales and home lending are on a long-term uptrend, the pace of gains has not been consistent. Those uneven results imply that further gains in mortgage rates can weigh negatively on housing activity after borrowing costs rose in recent weeks to the highest levels since 2014.
THURSDAY, MARCH 30
GDP – Fourth Quarter (Third Estimate)
Time: 8:30 am
Forecast: 2.0%
Though overall GDP growth slipped in the fourth quarter, output still found support from a hearty pace of consumer spending. That may not be the case in the current quarter after January’s 0.3% decline in real consumer spending equaled the largest shortfall since 2009. Though GDP growth may once again disappoint in the early months of the year, healthy gains in jobs and improved industrial production trends signal stronger underlying economic progress.
FRIDAY, MARCH 31
Personal Income & Spending – February
Time: 8:30 am
Forecast: 0.4% income, 0.2% spending
Personal income is projected to rise 0.4% for the second straight month in February, aided by somewhat faster wage growth. Annual income growth touched 4% in January for the first time in over a year, partly signaling increased labor market tightness. Further gains must be registered in order for real spending to keep ahead of the recent uptick in inflation.
University of Michigan Consumer Sentiment – March
Final Time: 10:00am
Forecast: 98.0
Sentiment in the final March reading of the Michigan survey is likely to continue to display the strong post-election bounce. The reading on current economic conditions reached the highest level in 17 years in the preliminary March survey. That points to ample consumer resources that can keep the aged economic expansion chugging along.
Apple Hits New High This Week at $142.80
Pacific Crest raised their bullish price target for Apple to $175 based on the prospect of a cash repatriation holiday. This is a common song on Wall Street these days, and as you know we have been pounding the table about this for some time now. There is $2.5 trillion of cash overseas. Bring a little more than half of that back and you have $1.5 trillion that would be set to go to work creating jobs and benefitting stockholders. We might see a huge increase in the dividend. Maybe even a large, special distribution of $10-20 a share.
Goldman Sachs reiterated their Buy rating and $150 price target on Apple, saying the iPhone 8 supply chain data points to higher-than-usual seasonality in February based on average sales from six of the company’s suppliers.
And note that Apple was upgraded to Buy by one of the biggest bears on the stock on Wall Street. Bernstein now has a price target of $175. Now THAT’S saying something.
You heard it here first. What price would Apple have to hit to be the first* trillion dollar company? $190. Sounds like it's pretty far away, doesn’t it? But when Apple hits $160, it will be a hop skip and a jump away. Food for thought...
*Alas, PetroChina (PTR) was the first trillion dollar company, hitting that number in 2007. It’s worth just $200 billion now. (So we’re not counting it!) Apple will be the first. Or maybe Google or Amazon or Tesla. The race is on!
Number of monthly active Facebook users worldwide as 4Q16
This statistic shows a timeline with the worldwide number of monthly active Facebook users from 2008 to 2016 in millions. As of the fourth quarter of 2016, Facebook had 1.86 billion monthly active users. Extrapolating, we'd say they are well over 1.9 billion. 2 billion look out!
Consensus Ratings for Facebook
Ratings Breakdown: 1 Sell Rating, 4 Hold Ratings, 39 Buy Ratings, 4 Strong Buy Ratings
Price Targets:
3/21/2017 BTIG Research $175
3/13/2017 Cantor Fitzgerald $175
3/6/2017 Royal Bank of Canada $170
3/3/2017 Nomura $155
3/3/2017 Citigroup $165
High Yield Corner
By Michael Foster
This was a particularly good week for many Bull Market Report picks even though the high yield markets were rather dull.
The SPDR Barclays High Yield Bond ETF (JNK: $37) ended the week flat despite some interesting excitement in the Treasury markets. The 10-year yield retreated throughout the week to 2.42%, a drop of over 8 bp from the start of the week. This is significant because that yield is a combination of economic growth and inflation expectations, and the yield has been driven higher by the Federal Reserve’s rate hike and forward guidance of more rate hikes throughout the year. With the 3-month Treasury yield up to 0.75% and market expectations of an end-of-year yield of 1.5%, the spread between short-term and long-term bonds has shrunk considerably in the last few months. This means the market does not believe rate hikes from the Fed will come hard and fast, but will happen very gradually over a longer time period.
Why does this matter? Rate hikes intrinsically sound like monetary tightening, which is particularly bad for bonds and other debt instruments. For high yield bonds, it’s especially bad because it suggests that yields need to go up to compensate for the risk as yields on Treasuries get bigger. Since yields and price are inverted, it also means high yield bonds currently issued will go down in price. That, in turn, would hit funds like the SPDR High Yield fund
However, the Federal Reserve is not tightening relative to expectations. That “relative” clause is key here. The Fed is making borrowing more expensive, but everyone in the market expects the Fed to do this. The real question is how fast and how often they do it. The market now thinks that the Fed will raise rates at a slower pace than the market used to think, which means the Fed is tightening less than expectations. This, paradoxically, is good for high yield bonds because it indicates the downside of a tight policy is already priced in.
Extraordinarily, that “priced in” moment came in 2015. We’re getting near the 2-year anniversary to that cycle of discounting corporate bonds for future rate hike action. And keep in mind that is after junk bonds were discounted for future rate hike action back in 2013. If you look at the price return for the SPDR fund over the last five years, the fund is down over 7%. In other words, junk bonds have been discounting the Fed’s future rate hikes for several years, and every time the rate hike schedule is delayed, it bolsters junk bonds’ value even further.
That doesn’t mean junk bonds have fully recovered, though. The market is still very cautious because of a lot of misunderstanding about what the rate hike really means for corporate bonds, causing money to be left on the sidelines. That makes junk still a good opportunity, although you can’t expect the 10% price returns on junk bonds that were so easy to get a year ago.
So with that in mind, there remain valuable funds with high yield and corporate bonds in them. BMR picks AGIC Equity and Convertible Income Fund (NIE: $19.11, down -1%) and the PIMCO Dynamic Income Fund (PDI: $29, flat) remain solid picks that are earning their dividends and have capital gains potential. Impressively, Pimco has already seen a 5% return in 2017 although we haven’t even gotten to spring yet! That doesn’t mean the performance will annualize at that rate by the end of the year, but it may. What it does mean is that the fund remains a market outperformer that can continue to pay out its current dividend in a market where many funds are cutting distributions.
The AGIC fund has not been as solid of a performer largely because of its equity holdings. The fund had a bad week, but has a 4% year-to-date performance when looking at its NAV. That lags the S&P 500, which is up 4.6% over the same period. That underperformance does not bother us for two reasons. Firstly, the fund has tremendous liquidity thanks to its high 8% yield. It also has maintained its 10%+ discount to NAV throughout the year because the market simply underappreciates this fund. Thanks to that discount, the fund’s management needs to get just a 7.1% return annualized to maintain payouts and not see NAV go down. Thanks to the market’s growth and high yields on convertible bonds, this not difficult for AGIC Equity to earn in the current market. While there are some other risk factors at hand, they aren’t significant enough at the moment for investors to be concerned with.
Elsewhere in the high yield world, things were quiet this week. The SPDR Dow Jones REIT ETF (RWR: $92, flat) saw little movement, but BMR picks fared far better. Digital Realty Trust (DLR: $104) and Kimco Realty (KIM: $23) ended the week flat alongside the broader market, but Omega Healthcare Investors (OHI: $32, up 3%), Government Properties Trust (GOV: $21, up 1%), and Care Capital Properties (CCP: $25, up 2%) fared significantly better than the index. We’re nowhere near overbought territory for these REITs, but we may get there if further price appreciation comes to these stocks.
One asset class was particularly hard hit this week, and it’s one that readers know we have been cautious about for several weeks now: BDCs. The UBS BDC ETF (BDCS: $23, down -1%) was one of the worst performers in the high yield world, but former BMR favorite Main Street Capital (MAIN: $37) did much worse, losing over 1% for the week. Now Main Street’s price is up only 1% for 2017, making it a market laggard. Nothing fundamentally has changed with Main Street, but the market has finally warmed up to this stock so much that it’s gotten far overpriced and thus is now a bad value. It trades at a tremendous premium to its NAV, as we’ve mentioned several times since The Bull Market Report pulled it from its High Yield portfolio. It remains a very high quality BDC with market dominance, but at a 6% yield excluding special dividends, it just doesn’t provide the income worth the risk of paying for such a high premium. We are happy for management to have earned a deserved price premium for the value they add for investors, but we are not willing to pay that premium. Main Street is fairly to slightly overvalued, which is what you would expect for a good company in a healthy stock market. We will wait to buy Main Street again if and when the market gets unhealthy.
Finally, a word on municipal bonds. In 2016 we were pounding the table aggressively on almost all high yield assets, but were tentative about municipal bonds. The asset class was overbought throughout 2016 and undersold before that run up, especially when compared to the more ridiculous panic selling elsewhere in REITs, junk bonds, and especially corporate bonds. We didn’t see muni bonds fairly priced until late 2016, and then they became near bargains a short time later. That is when we started to dip our toes in the asset class and see tremendous value in the market.
Slowly, the market is beginning to come our way. The iShares S&P National AMT-Free Municipal Bond Fund (MUB: $109, up 1%) had a very strong week, and that’s helped the fund return again to positive territory for 2017. BMR pick Nuveen AMT-Free Fund (NVG: $14.53, up 1%) had a similarly strong week and has a similar year-to-date performance. Yet its dividend yield is over twice the iShares fund and its capital gains potential is much greater as well. There is no reason to shy away from municipal bonds now, and we can only hope that the trend we saw last week will continue over the coming weeks. Muni bonds deserve more market demand - it’s only a question of when that market demand materializes.
Good Investing,
Todd Shaver
CEO, Editor and Founder
The Bull Market Report
Since 1998
March 20, 2017
by Todd Shaver | Mar 20, 2017 | Monthly Newsletter Daily 6am if new
What a week. Another interest rate hike has come. The entire market and all the Fed officials, except one dissenting opinion, wanted the March rate hike. Who dissented? Minneapolis Fed President Neel Kashkari. Why? Kashkari said the announcement of the Fed’s balance sheet plan could trigger somewhat tighter monetary conditions resulting in the equivalent of a rate hike of unknown size. After it has been published and the market response is understood, then he says the Fed can return to using the federal funds rate as a primary policy tool, with the balance sheet normalization under way in the background. Understanding Kashkari’s lone wolf dissenting opinion is something to take note of. We need to keep an eye on the rising interest rate cycle and how it impacts the bull market going forward. For the time being, the bull market continues to break new highs.
No matter what, there is always a bull market here! Week in and week out, you can find it right here at The Bull Market Report. We currently see a bull market across many parts of the stock market. This week we highlight the following securities: Tesla, Visa, Apple, Google, and PayPal.
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Highlights From The Past Week
Another Week of Huge Cash Inflows! According to industry data, overall cash continued to flood into equities for a total of $14.5 billion, the 11th consecutive week of inflows. Most of this was due to allocations to ETFs, which saw $19.7 billion in inflows, the highest weekly amount YTD, offset by $5.1 billion in outflows from actively managed funds. Looking at what its private clients are doing, an investment bank notes that the top 3 ETF inflows in the past 4 weeks were Financials, Bank Loans, and MLPs.
Has OPEC Underestimated US Oil Production Once Again? The U.S. crude cowboys are back on their horses and leading a strong recovery in the oil patch that is not expected to falter. With lessons learned from the oil price crash, companies have streamlined their budgets and are focused on the most prolific shale plays. U.S. drillers are giving OPEC a hard time by raising output and hedging future production. This is all good things for US energy independence and stability.
Refreshed Fed Forecast Leaves Long-Run Rate Outlook Unchanged. For those curious what the Fed's latest Fed Funds rate forecast reveals, here is the summary: (i) median target for end-2017 is 1.375%, unchanged; (ii) median target for end-2018 is 2.125%, unchanged; (iii) median target for end-2019 is 3% vs. 2.875% in December; and (iv) long-run target is 3%, unchanged. Given that the long-run expectations of 3% is unchanged, some say we could see a more gradual rising interest rate cycle than some had thought. Good thing for equities!
Homebuilders: Not Been This Confident Since The Peak Of The Last Housing Bubble. Builder confidence in the market for newly-built single-family homes jumped six points to a level of 71 on the National Association of Home Builders/Wells Fargo Housing Market Index (HMI). This is the highest reading since 2005 - the ultimate peak of the last housing bubble. This record confidence level is welcomed for the current bull market.
BMR Companies and Commentary
Tesla (TSLA: $262, +7% - all prices are for the previous week)
Tesla’s $170 million battery play is just the beginning. Tesla is ready to power some grids. And not just in California or Australia. Last week, Elon Musk wagered he could address South Australia’s energy crisis with 100 megawatts (MW) of batteries installed in 100 days or less – “or it’s free.” The exchange blew up on Twitter and led to phone calls between Musk and leading Australian politicians, including Prime Minister Malcolm Turnbull. (Ukraine Prime Minister Hroisman later chimed in that he’s interested, too.)
An analysis finds that such a deal wouldn’t only alleviate South Australia’s blackouts, but would also be profitable - at an anticipated cost of roughly $170 million. Battery prices are tumbling fast - by almost half since 2014 - and such mega projects are increasingly popping up around the world.
Megawatts measure the amount of power a battery can provide at any given time. Tesla’s battery projects typically supply a four-hour duration for each megawatt, so it’s reasonable to assume that South Australia’s 100 MW project would entail a 400- megawatt-hour battery installation. That would make it Australia’s biggest battery-capacity project, and one of the biggest on Earth.
BMR Take: Tesla led by Elon Musk has time and time again been at the front of the pack doing innovating things in the world. This battery event is just yet another example of the value of Tesla and Elon Musk to the world and why we favor the stock of Tesla.
Consensus Ratings for Tesla
Ratings Breakdown: 1 Sell Rating, 2 Hold Ratings, 1 Buy Rating
Consensus Price Target: $280
3/17/2017 Goldman Sachs Group Target: $187
3/9/2017 Sanford C. Bernstein Target: $250
2/23/2017 Dougherty & Co Target: $375
2/23/2017 Royal Bank of Canada Target: $314
Visa (V: $90, +1%)
Visa took the microphone at a major investment banking conference this week. What did management have to say? Here are a few tidbits of color on the business and market environment from Visa management:
“We certainly have seen a tick-up in what I would call the drivers of the business, which is what we like because that is, in the end, what counts.”
“We saw, a step-up in payment volumes almost everywhere except a couple of places like Brazil; we saw a nice step-up in Europe. Certainly, in the U.S., we were helped by gas, and also, we were helped by the portfolio wins we've had like Costco and USAA.”
“What really helped was cross-border volume growth getting to double-digits. It's been a long time since we've had double-digit cross-border volume growth. I think you have to go back three or four years. In fact, I think the U.S. cross-border volume growth was double-digit for the first time since early 2014.”
BMR Take: Visa is a powerhouse in payments. Fundamental trends are strong. A new all-time high this week. Stay the course!
Apple (AAPL: $140, +1%)
Taking a look back at another week of news from Apple, this week’s developments include: the high price of the IPhone 8, the sneaky MacBook Pro price cut, details on the new iPad, the AirPods health-focused future, price fixing in Russia, the challenge from the Galaxy S8, and running Windows XP on your iPhone.
The key to watch is how expensive will the new iPhone 8 be, in our view. One of the major big picture trends in the smartphone market is the proliferation of competition and how, if at all, will it impact Apple. Will Apple be able to sell expensive phones for a long time to come? We are keenly focused on this question.
One way to keep up the price of the iPhone for Apple is constant innovation and great features. Leaks about iPhone 8 say that Apple’s decision to switch the redesigned iPhone from LCD (Liquid Crystal Display) to OLED (Organic Light Emitting Diode) improves screen visualization. We hope to hear more about new improvements. Apply customers are as loyal as they come and are likely to dig deep into their wallets for the latest and greatest.
BMR Take: Expectations for iPhone sales are a key driver of the business. We continue to monitor developments closely. All is checking out okay so far this year. And Apple sets a new all-time high this week. The market cap is now $735 billion, on the way to $750 billion and then $800 billion.
Google (GOOG: $852, +1%)
Google had to apologize to the UK government over some YouTube ads. Google apologized to senior officials representing the government and pledged a review of their advertising systems.
Google advertising revenues were $60 billion in 2014, $67 billion in 2015, and $79 billion in 2016. The acquisition cost of this revenue is just 20% leaving 80% going to gross profit. What a hugely profitable business this is! We see continued growth ahead. Google AdWords remains a world class place for performance-based advertising. Admittedly, like the UK situation, there are sometimes kinks in the armor though they are minor in the overall picture.
BMR Take: Google is fighting to hold onto a top spot in the advertising world. This UK news is just one of many examples of some of the challenges the company is facing. The good news is that as Google’s YouTube irons out its business model, we think YouTube could be one of the top assets in all of media in 10 years.
PayPal (PYPL: $43, flat)
Big news out this week was that Google’s gmail can now send payments. There is a lot of debate about what this means for PayPal. Some believe it’s a competitive threat, but for right now it just looks like more fear than reality. Why?
Being an independent platform like Paypal is so important in payments. All PayPal does is sit at the center of commerce as an exchange for trading goods and services. In contrast, Google and so many other playing in the mobile payments space have alternative interests. Obviously, Google is big in advertising.
Merchants have been very clear they want an independent platform as a partner not a potential competitor. This is why Home Depot works with PayPal and not Apple for mobile/online payments.
BMR Take: If you own PayPal, don’t be frightened by the Google gmail news out this week. You already own the best asset in the space. Don’t doubt it.
Upcoming Economic News
WEDNESDAY, MARCH 22
Existing Home Sales – February
Time: 10:00 am
Forecast: 5.58 million
February existing home sales are expected to slip from January’s decade-long high, but still contribute to steady long-term growth. Sales rose 6.4% year-over-year in January, an admirable pace given the limited inventory. Home prices rose at the yearly rate of 5.6% in the December 20-city Case-Shiller index, part of a consistent path of gains that can draw more sellers to the market.
THURSDAY, MARCH 23
New Home Sales - February
Time: 10:00 am
Forecast: 560,000
February new home sales are projected to rise marginally from January’s level. Sales of new homes have cooled a bit, rising 6% year-over-year in the three months ending January after soaring by 20% in Q3. Yet if last year’s highs proved unsustainable, the rising number of new household units amid the continued economic expansion will keep new home sales and construction on an uptrend.
FRIDAY, MARCH 24
Durable Goods Orders – February
Time: 8:30 am
Forecast: 1.0% overall, 0.5% ex transportation
Core durable goods orders figure to rise in February after falling for the first time in seven months in January. Even with the January dip, orders rose 10% annualized in the past three months, the best such result in three years. That upturn in demand reflects rising domestic confidence and improved economic prospects across the globe.
The Glamour of Dividend Stocks Has Lessened [THEY SAY]
[Who’s “They”?]
So says RBC Capital, as the premium investors earn from glamour dividend stocks over the benchmark Treasury rate has narrowed.
Really we say?
They say: "The average dividend spread in our coverage is 1.9% currently, compared to 2.1% in the past 5 and 10 years." Narrower spreads were caused by fluctuations in the 10-year Treasury rate and changes in dividend policies, RBC said. "Although average dividend yields did not change much, the spreads vs. 10Y T-bond are narrower today vs. the 10-year average.”
OK – Go on…. We’re not buying this argument yet. [Nor ever for that matter.]
“Meanwhile, some peculiar changes have come about in the consumer staples sector. First, while the dividend yield for the consumer staples index remains constant at 2.6%, the spread over the Treasury rate has changed from negative to positive.”
“Secondly, tobacco stocks no longer earn the highest dividend yield among consumer staples.”
OK – Who would want to own tobacco stocks anyway?
In fact, they noted, "At present, Coca Cola has a higher dividend than Altria Group. This compares to MO carrying a dividend yield that has historically been 200 bps-plus higher than KO. This could be due to investor concerns over Coca Cola's core business, combined with investor excitement over consolidation in the tobacco industry.”
BMR Take: All in all, a very boring report. It’s typical of the big research firms always talking about the “high dividend paying stocks” like Coca-Cola and Altria. Coke pays 3.5%. And Altria pays 3.25%. Big deal we say. Why? See our High Yield Portfolio discussed below and on the website where the average stock pays 6-8%, with Annaly (NLY) still paying 11%!
The Bull Market High Yield Report
By Michael Foster
Special to The Bull Market Report
Of course, we need to start with the rate hike.
Last week we said that Janet Yellen would almost certainly raise interest rates. Now it has happened. The rate hike itself was exactly as markets expected: 25 basis points, with forward guidance of two more rate hikes this year. So we’re in a tightening part of the credit cycle.
Yet everything went up. A lot. This caused a great deal of consternation in the financial press. We saw three common responses:
1. The rate hike is the beginning of more, and the bond and stock markets should go down but they didn’t.
2. The rate hike was too small and should be bigger - 50 bp rate hikes might be coming soon, and the stock and bond markets should go down to factor this into account.
3. The rate hike was a bad idea and will cause financial/economic mayhem, so the stock and bond markets should go down but they didn’t.
This is very gloomy, negative, cautious sentiment about the rate hike all around, with even more negativity about the market’s strong response following the move.
If you have been reading this column with any regularity, you know that we have little respect for much of the financial press. They just get things wrong too often, and their incentives for more page views, clicks, ratings and so on, actively encourages hysteria and overly positive or negative responses to markets that are on the whole quite rational. This week’s move is case in point; the S&P 500 ended the week up a whopping 0.24%. Big deal. While PE ratios are high at nearly 27, there are many reasons to dismiss this metric, such as: the combination of an unusual monetary policy regime, years of virtually no inflation, repressed corporate earnings, the structural shift towards technology stocks where PE ratios tend to be higher, and the drag from the still mostly unprofitable Energy sector.
More crucially, we saw the markets make a modestly constructive response to a modestly constructive monetary policy. Yellen is slowly and rather gracefully raising interest rates at a time when the economy and the stock market can handle it.
This is why the financial press narratives are wrong.
Stocks and bonds went up following the rate hike for pretty much the same reason: Yellen’s rate hike is actually quite dovish. Let’s listen to the Fed itself speak:
"The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.”
This is the crux of the FOMC’s recent statement, and it’s a pretty simple premise: while the rate hikes sound hawkish on the surface, they are in fact rather dovish. The reality is that, relative to labor, inflation and other financial indicators, the Fed’s 25 basis point hike and plans for another two hikes in 2017 are very dovish. They don’t superficially represent QE* in 2013 or ZIRP* in 2014-2015, but they are pretty much the same thing.
*Qualitative Easing; Zero interest-rate policy
Yet throughout 2013-2015 there were many periods where the market sold off stocks and bonds in anticipation of scheduled rate hikes. But each period turned into a “buy the dip” opportunity. Those who are bearish about higher interest rates and their impact on equities and bonds have pretty much given up. Yet the bulls haven’t fully taken over. The result is a rather measured, moderate response to the Fed’s monetary policy, which is itself quite measured and moderate.
Of course, that doesn’t make for sexy headlines. “The Fed is Competent and the Market is Responding Rationally” doesn’t make for salacious reading. Yet the dynamics at play here, especially in the backdrop of years of QE in the US and ongoing QE in Europe and Japan (as well as the looser monetary policy in China and many, many other dynamics we simply don’t have time to discuss here), indicate that a bearish viewpoint would be a hysterical and irrational one.
However, if you want to find a pocket of irrational exuberance, you can find a bit of it in the high yield world. This bothers us as high yield analysts; We’d like for this pocket to be a bit more fearful than the market as a whole, providing buying opportunities. Alas, animal spirits are heating up more here than elsewhere, which is urging caution and consolidation.
As a result, we are sadly and reluctantly off all BDCs despite our affection for the sector. The UBS BDC ETF (BDCS: $23, up 2%) went up way too much this week, compounding an over 3% year-to-date gain and now 21% year-over-year gain. This is absurd, especially as most BDCs have reported and NAVs have declined in many cases and barely risen in others. We need to see a major correction before this sector gets attractive.
The same could be said, although less stridently, about junk bonds. The SPDR Barclays High Yield Bond ETF (JNK: $37, up 1%) had a strong week and remains up 7% over the past year. Those aren’t stratospheric numbers like BDCs, but it does show a curious disconnect. Often, investors obsess over default rates. And it’s true that middle market defaults at 1.5%, are far less than the 5.8% default rate in junk bonds*. Of course, there’s more to this story than meets the eye. Middle market default rates are going up and junk bond rates are going down - some estimates believe high yield debts could see a 4% default rate by the end of this year. And looking at the price trends over the last two years, these default risks are priced in.
*Remember, BDCs specialize in middle market loans
So we remain bullish on junk bonds to a limited extent, and prefer them over BDCs. But one needs to be selective to avoid those defaults. The PIMCO Dynamic Income Fund (PDI: $29, up 2%) remains a top pick although it is approaching a sell point. We at the Bull Market Report may need to find another junk bond fund to replace this one. This is a great fund, but it’s trading at a hefty 7% premium to net asset value. In such a situation the upside this fund provides may sadly be already priced in.
If you’re looking for deals and high yield, now is still the time to buy municipal bonds. We suspect there will be a lot of time to buy munis - the market continues to discount them based on several irrational fears, and the risk-averse retiree-investor base of these assets means fears tend to be priced into munis longer than other asset classes. Additionally, many municipal bonds are bought in open-end funds where money managers are often forced to sell if they face fund redemptions. With so many people looking to buy other assets and fearing rate hikes, it’s not surprising that they’re pulling cash out of the muni market. But this pressure isn’t due to fundamental weakness in munis, meaning they will come back. But it may take time.
That’s great. That means investors can greedily snap up munis. The iShares S&P National AMT-Free Municipal Bond Fund (MUB: $108, flat) is one option, but you’ll get assets at a discount, a better quality portfolio, and access to cheap leverage with Invesco Municipal Trust (VKQ: $12.23, up 1%) and the Nuveen AMT-Free Fund (NVG: $14.28, up 1%). Note both had a stronger week than the muni index ETF from iShares, and that is likely to be the story for a while to come if the market comes to its senses about munis.
As you can see, the big theme here is that the market is being “mostly” rational: But slightly irrationally bullish in one asset class (BDCs) and irrationally bearish in another (municipal bonds). For investors, this means rotating into the best funds exposed to the sector that’s getting unfairly punished and avoiding the irrational bullishness in the other sector. Sadly, this is not as easy as making money in 2016, when you could just buy junk bonds and REITs at the start of the year and rebalance once or twice later in the year.
It will be harder to make good money in the high yield market in 2017, but it won’t be impossible. We identified REITs as one pocket of potential after the big selloff in the middle of 2016. And now that payoff is really coming to fruition.
The SPDR Dow Jones REIT ETF (RWR: $92, up 2%) had an extremely strong week thanks to the Fed’s dovish position. However, the REIT ETF remains down over 6% over the last six months. So we’re in a good position to add to REIT positions without being back at the top.
But what REITs? Care Capital Properties (CCP: $25, up 3%) is great to hold but the recent run-up exceeds other high-quality REITs such as Digital Realty Trust (DLR: $103, down 1%) and Omega Healthcare Investors (OHI: $32, up 1%). It may make more sense to buy a bit of Digital Realty and Omega Healthcare if you’re looking for REIT exposure right now.
And at the moment, buying a bit of REITs and a bit of municipals makes a lot of sense. We’d like to see more caution in other pockets of the high yield market before betting too big in it, but we aren’t at the point of calling a top either. Now is the time to stick with high yield, reallocate to the underappreciated asset classes, and wait to see if the sentiment changes. And it will. It always does.
Good Investing,
Todd Shaver
Founder, CEO and Editor
The Bull Market Report
Since 1998
March 19, 2017
by Todd Shaver | Mar 19, 2017 | Weekly Newsletter 7pm Sunday
What a week. Another interest rate hike has come. The entire market and all the Fed officials, except one dissenting opinion, wanted the March rate hike. Who dissented? Minneapolis Fed President Neel Kashkari. Why? Kashkari said the announcement of the Fed’s balance sheet plan could trigger somewhat tighter monetary conditions resulting in the equivalent of a rate hike of unknown size. After it has been published and the market response is understood, then he says the Fed can return to using the federal funds rate as a primary policy tool, with the balance sheet normalization under way in the background. Understanding Kashkari’s lone wolf dissenting opinion is something to take note of. We need to keep an eye on the rising interest rate cycle and how it impacts the bull market going forward. For the time being, the bull market continues to break new highs.
No matter what, there is always a bull market here! Week in and week out, you can find it right here at The Bull Market Report. We currently see a bull market across many parts of the stock market. This week we highlight the following securities: Mazor Robotics, Opko Health, Tesla, Visa, Apple, Google, and PayPal.
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Highlights From The Past Week
Another Week of Huge Cash Inflows! According to industry data, overall cash continued to flood into equities for a total of $14.5 billion, the 11th consecutive week of inflows. Most of this was due to allocations to ETFs, which saw $19.7 billion in inflows, the highest weekly amount YTD, offset by $5.1 billion in outflows from actively managed funds. Looking at what its private clients are doing, an investment bank notes that the top 3 ETF inflows in the past 4 weeks were Financials, Bank Loans, and MLPs.
Has OPEC Underestimated US Oil Production Once Again? The U.S. crude cowboys are back on their horses and leading a strong recovery in the oil patch that is not expected to falter. With lessons learned from the oil price crash, companies have streamlined their budgets and are focused on the most prolific shale plays. U.S. drillers are giving OPEC a hard time by raising output and hedging future production. This is all good things for US energy independence and stability.
Refreshed Fed Forecast Leaves Long-Run Rate Outlook Unchanged. For those curious what the Fed's latest Fed Funds rate forecast reveals, here is the summary: (i) median target for end-2017 is 1.375%, unchanged; (ii) median target for end-2018 is 2.125%, unchanged; (iii) median target for end-2019 is 3% vs. 2.875% in December; and (iv) long-run target is 3%, unchanged. Given that the long-run expectations of 3% is unchanged, some say we could see a more gradual rising interest rate cycle than some had thought. Good thing for equities!
Homebuilders: Not Been This Confident Since The Peak Of The Last Housing Bubble. Builder confidence in the market for newly-built single-family homes jumped six points to a level of 71 on the National Association of Home Builders/Wells Fargo Housing Market Index (HMI). This is the highest reading since 2005 - the ultimate peak of the last housing bubble. This record confidence level is welcomed for the current bull market.
BMR Companies and Commentary
Mazor Robotics (MZOR: $24, +5% - all price changes in this report are for the week)
As you know, Israel-based Mazor Robotics has teamed up with Dublin, Ireland-based Medtronic to co-market and promote the Mazor X. Mazor X expands on the company's robotic guidance technology to include analytical tools, multiple-source data, precision guidance, optical tracking, intra-op verification and connectivity technologies. That is a lot of jargon, but we tell you this so that you know that Mazor X is a key technology for spine surgery.
Mazor is at a key inflection point, in our view, having generated record sales in the most recent quarter. Specifically, the 21 systems ordered during the most recent quarter illustrated strong ongoing demand – strong news on the fundamentals.
What is more exciting is that there is a clear and significant shift toward direct orders for the Mazor X system. Importantly, of the 21 systems currently in backlog, 18 are for Mazor X and only six of those are from Medtronic. This indicates significant bottom-up demand from surgeons. The Medtronic partnership is a good starting point, but the business is picking up momentum on its own.
BMR Take: What is harder to do than spine surgery? Mazor is a top player in the space that is delivering on growth. We see compelling value in the stock.
Opko Health (OPK: $8.12, +2%, but the high for the week was $8.54)
After a recent decline after its latest earnings report, Opko seems to be picking up support in the analyst community. Recently, one analyst chimed in reiterating a $12 price target and another came out with a more optimistic $14 target. Then just this week, the most bullish call came in from Guggenheim expecting a whopping $25 price target. The analyst notes belief that Rayaldee sales could hit $700 million by 2021 and the company has several underappreciated assets in its pipeline. Recall that Rayaldee is a new treatment for kidney disease. The FDA's approval of Rayaldee represents an important milestone. It is the first product to receive FDA approval for kidney disease and is one of Opko’s many pharmaceutical products being developed for significant medical problems which will benefit from new treatment options.
BMR Take: Opko remains one of the most exciting stories we see in Biotech. With a $4.5 billion market cap, there is so much room for upside, yet that also carries a bit more volatility with it. For investors looking for big gain potential here, this fits the bill as we continue to like what we see at Opko.
Consensus Ratings for Opko Health
3 Hold Ratings, 6 Buy Ratings
Consensus Price Target: $16
3/14/2017 Guggenheim Price Target: $25
3/5/2017 Standpoint Research Target: $14
1/3/2017 Laidlaw Target: $19
1/3/2017 Ladenburg Thalmann Financial Target: $19.50
Tesla (TSLA: $262, +7%)
Tesla’s $170 million battery play is just the beginning. Tesla is ready to power some grids. And not just in California or Australia. Last week, Elon Musk wagered he could address South Australia’s energy crisis with 100 megawatts (MW) of batteries installed in 100 days or less – “or it’s free.” The exchange blew up on Twitter and led to phone calls between Musk and leading Australian politicians, including Prime Minister Malcolm Turnbull. (Ukraine Prime Minister Hroisman later chimed in that he’s interested, too.)
An analysis finds that such a deal wouldn’t only alleviate South Australia’s blackouts, but would also be profitable - at an anticipated cost of roughly $170 million. Battery prices are tumbling fast - by almost half since 2014 - and such mega projects are increasingly popping up around the world.
Megawatts measure the amount of power a battery can provide at any given time. Tesla’s battery projects typically supply a four-hour duration for each megawatt, so it’s reasonable to assume that South Australia’s 100 MW project would entail a 400- megawatt-hour battery installation. That would make it Australia’s biggest battery-capacity project, and one of the biggest on Earth.
BMR Take: Tesla led by Elon Musk has time and time again been at the front of the pack doing innovating things in the world. This battery event is just yet another example of the value of Tesla and Elon Musk to the world and why we favor the stock of Tesla.
Consensus Ratings for Tesla
Ratings Breakdown: 1 Sell Rating, 2 Hold Ratings, 1 Buy Rating
Consensus Price Target: $280
3/17/2017 Goldman Sachs Group Target: $187
3/9/2017 Sanford C. Bernstein Target: $250
2/23/2017 Dougherty & Co Target: $375
2/23/2017 Royal Bank of Canada Target: $314
Visa (V: $90, +1%)
Visa took the microphone at a major investment banking conference this week. What did management have to say? Here are a few tidbits of color on the business and market environment from Visa management:
“We certainly have seen a tick-up in what I would call the drivers of the business, which is what we like because that is, in the end, what counts.”
“We saw, a step-up in payment volumes almost everywhere except a couple of places like Brazil; we saw a nice step-up in Europe. Certainly, in the U.S., we were helped by gas, and also, we were helped by the portfolio wins we've had like Costco and USAA.”
“What really helped was cross-border volume growth getting to double-digits. It's been a long time since we've had double-digit cross-border volume growth. I think you have to go back three or four years. In fact, I think the U.S. cross-border volume growth was double-digit for the first time since early 2014.”
BMR Take: Visa is a powerhouse in payments. Fundamental trends are strong. A new all-time high this week. Stay the course!
Apple (AAPL: $140, +1%)
Taking a look back at another week of news from Apple, this week’s developments include: the high price of the IPhone 8, the sneaky MacBook Pro price cut, details on the new iPad, the AirPods health-focused future, price fixing in Russia, the challenge from the Galaxy S8, and running Windows XP on your iPhone.
The key to watch is how expensive will the new iPhone 8 be, in our view. One of the major big picture trends in the smartphone market is the proliferation of competition and how, if at all, will it impact Apple. Will Apple be able to sell expensive phones for a long time to come? We are keenly focused on this question.
One way to keep up the price of the iPhone for Apple is constant innovation and great features. Leaks about iPhone 8 say that Apple’s decision to switch the redesigned iPhone from LCD (Liquid Crystal Display) to OLED (Organic Light Emitting Diode) improves screen visualization. We hope to hear more about new improvements. Apply customers are as loyal as they come and are likely to dig deep into their wallets for the latest and greatest.
BMR Take: Expectations for iPhone sales are a key driver of the business. We continue to monitor developments closely. All is checking out okay so far this year. And Apple sets a new all-time high this week. The market cap is now $735 billion, on the way to $750 billion and then $800 billion.
Google (GOOG: $852, +1%)
Google had to apologize to the UK government over some YouTube ads. Google apologized to senior officials representing the government and pledged a review of their advertising systems.
Google advertising revenues were $60 billion in 2014, $67 billion in 2015, and $79 billion in 2016. The acquisition cost of this revenue is just 20% leaving 80% going to gross profit. What a hugely profitable business this is! We see continued growth ahead. Google AdWords remains a world class place for performance-based advertising. Admittedly, like the UK situation, there are sometimes kinks in the armor though they are minor in the overall picture.
BMR Take: Google is fighting to hold onto a top spot in the advertising world. This UK news is just one of many examples of some of the challenges the company is facing. The good news is that as Google’s YouTube irons out its business model, we think YouTube could be one of the top assets in all of media in 10 years.
PayPal (PYPL: $43, flat)
Big news out this week was that Google’s gmail can now send payments. There is a lot of debate about what this means for PayPal. Some believe it’s a competitive threat, but for right now it just looks like more fear than reality. Why?
Being an independent platform like Paypal is so important in payments. All PayPal does is sit at the center of commerce as an exchange for trading goods and services. In contrast, Google and so many other playing in the mobile payments space have alternative interests. Obviously, Google is big in advertising.
Merchants have been very clear they want an independent platform as a partner not a potential competitor. This is why Home Depot works with PayPal and not Apple for mobile/online payments.
BMR Take: If you own PayPal, don’t be frightened by the Google gmail news out this week. You already own the best asset in the space. Don’t doubt it.
Upcoming Economic News
WEDNESDAY, MARCH 22
Existing Home Sales – February
Time: 10:00 am
Forecast: 5.58 million
February existing home sales are expected to slip from January’s decade-long high, but still contribute to steady long-term growth. Sales rose 6.4% year-over-year in January, an admirable pace given the limited inventory. Home prices rose at the yearly rate of 5.6% in the December 20-city Case-Shiller index, part of a consistent path of gains that can draw more sellers to the market.
THURSDAY, MARCH 23
New Home Sales - February
Time: 10:00 am
Forecast: 560,000
February new home sales are projected to rise marginally from January’s level. Sales of new homes have cooled a bit, rising 6% year-over-year in the three months ending January after soaring by 20% in Q3. Yet if last year’s highs proved unsustainable, the rising number of new household units amid the continued economic expansion will keep new home sales and construction on an uptrend.
FRIDAY, MARCH 24
Durable Goods Orders – February
Time: 8:30 am
Forecast: 1.0% overall, 0.5% ex transportation
Core durable goods orders figure to rise in February after falling for the first time in seven months in January. Even with the January dip, orders rose 10% annualized in the past three months, the best such result in three years. That upturn in demand reflects rising domestic confidence and improved economic prospects across the globe.
The Bull Market Report Adds a New Company to Our High Technology Portfolio
A Top Innovator In Payments
Square: (SQ: $17.30)
March 20, 2017
Company Description
Square provides mobile payment solutions. The company develops point-of-sale software that helps in digital receipts, inventory, and sales reports, as well as offering analytics and feedback. Square also provides financial and marketing services.
If your neighborhood bakery now accepts credit cards as well as cash, you might have Square to thank for the convenience. Square provides hardware (a square-shaped card reader) and software to merchants and other service providers that enable them to accept credit card payments. The card readers attach to smartphones and tablets, providing a business with a low-cost point of sale system. Square's software handles the backend of the transaction, making sure accounts square up between the merchant, the card company, the bank, and the consumer. Square charges a per-transaction fee (its standard rate is 2.75%). An early provider of mobile payment equipment and software, Square faces competition from established financial and technology companies.
Investment Thesis
We believe Square - by virtue of its strong brand and cohesive payment and business software platform that addresses the major challenges small merchants face to start, run, and manage their businesses - is well-positioned to capture a significant piece of a large market opportunity. We see potential for strong multi-year growth and improved EBITDA profitability as the business scales.
The large, underserved market opportunity presents a long growth runway. We believe Square offers the most complete and cohesive payments and business software platform for small and mid-market merchants, which addresses many challenges facing small businesses including hardware, software, and payment services from different vendors and pricing that is often complex and opaque. We believe the market is large and underserved with an addressable market opportunity of 30 million merchants in the U.S., representing a “greenfield” opportunity, as 20 million of these merchants currently do not accept electronic payments.
Square’s products offer a cohesive payments platform for merchants. We believe Square has evolved from a payments company to one that offers a full range of products and services to sellers to help them start, run, and grow their businesses. In addition to processing payments on its sellers’ behalf, Square provides analytics, capital, invoicing capabilities, customer engagement services, and payroll services, among other offerings. As sellers grow, Square's business with those customers grows in parallel, both through increased processing volume, complementary services, and the incremental payment volume that those services can generate.
Consensus expectations are modeling 30% and 28% growth in revenue over 2017 and 2018. While the story will evolve, we see Square driving strong revenue growth of 20-25% long-term while balancing improved profitability. Not many people have caught on to just how strong the long term growth tailwinds could be, we believe. We anticipate Square will continue to invest in its platform, but we do not believe it is a “grow at all costs” story. We believe Square is committed to improving profitability
IPO
Square raised $240 million in its initial public offering late in 2015. The company's offering price was $9 a share, which was less than investors had expected. The stock closed out 2015 at around $14.
Operations
Square extends its platform by offering products and services such as Square Cash, a peer-to-peer payment service using debit cards for businesses and consumers; Square Payroll, which helps merchants track employees' hours and wages; and Square Capital, which extends credit to Square customers. Square also has services that help its customers engage with their customers.
Square generates 85% of its revenue from transactions fees charged to its general customers. Transaction fees for Starbucks accounted for as much as 10%. Some 5% of revenue comes from software and data products and hardware.
Geographic Reach
Square began generating revenue outside the US in 2014 and international sales, in Canada and Japan, accounted for 10%% of revenue in 2016.
Sales and Marketing
Square has pitched itself as the company that enables small businesses to accept almost any kind of payment and that seems to work. Small businesses account for most of its sales. Its customers with less than $125,000 in annual revenue account for 62% of sales. Those with revenue between $125,000 and $500,000 generate 27% while those with more than $500,000 account for 11%. The mix has changed over Square's history with the less than $125,000 segment declining from 88% of Square's revenue in 2011; a good thing.
The company advertises through channels that include online, mobile, email, direct mail, and direct response TV. Square's sales and marketing expenses include the costs of making and distributing the Square Reader for magnetic stripe cards. The company offers the reader free on its website. Customers who buy card readers can get a full rebate on the price.
Strategy
From the foundation of its mobile payments customers (which Square calls “sellers”), Square is building an ecosystem of financial and management systems directed mostly at small businesses, the ones who have neither the time, money, nor inclination to install and learn big software systems. The company has added products that help analyze sales, manage a business, track payroll, make appointments, and engage with customers. Square's products work with payment options such as Apple Pay and Android Pay as with near-field communications and card chip systems. It also encourages the creation of apps for its platform by third-party developers.
Since it was founded in 2009 Square has attracted millions of small businesses to its platform, which underscores the value of its brand.
While the company has grown quickly, it has drawn several competitors as the market for mobile payments has grown. Some of them such as Visa, MasterCard, Google (with Google Wallet), Intuit and PayPal are more established companies with deeper resources. Amazon, which launched a Square competitor in 2014, pulled the plug on the service in 2015.
Starbucks transactions accounted for 14% of Square's revenue in 2014. But Square's agreement to provide point-of-sale services for Starbucks came to an end in late 2015, taking a chunk out of Square's revenue. On the other hand, the Starbucks deal was a money loser for Square. Overall, Starbucks was a good deal for Square by boosting brand awareness.
Another widely cited issue for Square is that its CEO, Jack Dorsey also is the CEO of Twitter. He was a co-founder of Twitter and had previously served as its CEO. He founded Square and has been its only CEO. It remains to be seen how the arrangement will affect each company. We don’t think it matters too much at this point.
BMR Take: We see a major bull market in mobile payments and identify Square to be front and center in shaping the future of the industry. The company has a track record of outstanding innovation and a brand that is challenging the likes of big names like Visa, MasterCard, and American Express (what great company to be in!). You know we like PayPal which now has a market cap of over $50 billion. Square at bit of $6 billion has the potential to grow to PayPal size. Now wouldn’t that be nice! We are placing a Price Target of $24 on the stock, an upside of 40%, and a Sell Price of $14.
Consensus Ratings for Square
Ratings Breakdown: 9 Hold Ratings, 20 Buy Ratings
3/06/2017 Instinet Price Target: $21
2/24/2017 Susquehanna Bancshares Target: $20
2/23/2017 Royal Bank of Canada Target: $18
2/23/2017 Wedbush Target: $19
2/23/2017 Goldman Sachs Group Target: $17
2/23/2017 Mizuho Target: $19
A Word from Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
Since World War II the Fed has embarked on 13 tightening cycles. Ten of those cycles led to recessions. If this is going to be one of the three that didn't, we had best begin seeing action and policy sooner than later.
Lower taxes and the repeal of the Dodd-Frank Act were big promises and equally big positives to Wall Street. Almost every financial stock took off, sending the Financial ETF (XLF) up 13% in November.
The promise of over $1 trillion in infrastructure spending also brought buyers into the industrial and material stocks. The Industrial ETF (XLI) was up 9% for the month, while materials ETF (XLB) was up 6%. Some steel stocks have already started backing up, however, as "action and policy" seems to be stuck in the smelter.
As President Trump sets his agenda for his first 100 days in office, one item at the top of his to-do list will be undertaking regulatory reform. Both on the campaign trail and during his transition period, Mr. Trump has reiterated his commitment to relieving the regulatory burden on certain industries in order to create jobs and revitalize the US economy. Many companies stand to benefit from the potential lifting or relaxation of regulatory constraints.
So, with the establishment Congress beginning to ramp up its resistance to the Trump growth agenda we are now in a period we will call "investor fatigue". Top it off with the rate hike, and you have a combination of deterioration in the momentum we enjoyed for the past 12 weeks and a real economic strain as pressure on margins goes up along with the higher interest rates. The remedy is well known, but if it is put off until next year or watered down to the extent that it reportedly may be, then investors could get the opportunity to "buy the dip" sooner than expected.
Consensus Ratings for Kimco Realty (KIM: $23, up 5%)
Ratings Breakdown: 1 Sell Rating, 7 Hold Ratings, 8 Buy Ratings
2/3/2017 Canaccord Genuity Target: $34
1/23/2017 Barclays Target: $27
1/9/2017 Raymond James Financial Target: $28
The Glamour of Dividend Stocks Has Lessened [THEY SAY]
[Who’s “They”?]
So says RBC Capital, as the premium investors earn from glamour dividend stocks over the benchmark Treasury rate has narrowed.
Really we say?
They say: "The average dividend spread in our coverage is 1.9% currently, compared to 2.1% in the past 5 and 10 years." Narrower spreads were caused by fluctuations in the 10-year Treasury rate and changes in dividend policies, RBC said. "Although average dividend yields did not change much, the spreads vs. 10Y T-bond are narrower today vs. the 10-year average.”
OK – Go on…. We’re not buying this argument yet. [Nor ever for that matter.]
“Meanwhile, some peculiar changes have come about in the consumer staples sector. First, while the dividend yield for the consumer staples index remains constant at 2.6%, the spread over the Treasury rate has changed from negative to positive.”
“Secondly, tobacco stocks no longer earn the highest dividend yield among consumer staples.”
OK – Who would want to own tobacco stocks anyway?
In fact, they noted, "At present, Coca Cola has a higher dividend than Altria Group. This compares to MO carrying a dividend yield that has historically been 200 bps-plus higher than KO. This could be due to investor concerns over Coca Cola's core business, combined with investor excitement over consolidation in the tobacco industry.”
BMR Take: All in all, a very boring report. It’s typical of the big research firms always talking about the “high dividend paying stocks” like Coca-Cola and Altria. Coke pays 3.5%. And Altria pays 3.25%. Big deal we say. Why? See our High Yield Portfolio discussed below and on the website where the average stock pays 6-8%, with Annaly (NLY) still paying 11%!
The Bull Market High Yield Report
By Michael Foster
Special to The Bull Market Report
Of course, we need to start with the rate hike.
Last week we said that Janet Yellen would almost certainly raise interest rates. Now it has happened. The rate hike itself was exactly as markets expected: 25 basis points, with forward guidance of two more rate hikes this year. So we’re in a tightening part of the credit cycle.
Yet everything went up. A lot. This caused a great deal of consternation in the financial press. We saw three common responses:
1. The rate hike is the beginning of more, and the bond and stock markets should go down but they didn’t.
2. The rate hike was too small and should be bigger - 50 bp rate hikes might be coming soon, and the stock and bond markets should go down to factor this into account.
3. The rate hike was a bad idea and will cause financial/economic mayhem, so the stock and bond markets should go down but they didn’t.
This is very gloomy, negative, cautious sentiment about the rate hike all around, with even more negativity about the market’s strong response following the move.
If you have been reading this column with any regularity, you know that we have little respect for much of the financial press. They just get things wrong too often, and their incentives for more page views, clicks, ratings and so on, actively encourages hysteria and overly positive or negative responses to markets that are on the whole quite rational. This week’s move is case in point; the S&P 500 ended the week up a whopping 0.24%. Big deal. While PE ratios are high at nearly 27, there are many reasons to dismiss this metric, such as: the combination of an unusual monetary policy regime, years of virtually no inflation, repressed corporate earnings, the structural shift towards technology stocks where PE ratios tend to be higher, and the drag from the still mostly unprofitable Energy sector.
More crucially, we saw the markets make a modestly constructive response to a modestly constructive monetary policy. Yellen is slowly and rather gracefully raising interest rates at a time when the economy and the stock market can handle it.
This is why the financial press narratives are wrong.
Stocks and bonds went up following the rate hike for pretty much the same reason: Yellen’s rate hike is actually quite dovish. Let’s listen to the Fed itself speak:
"The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.”
This is the crux of the FOMC’s recent statement, and it’s a pretty simple premise: while the rate hikes sound hawkish on the surface, they are in fact rather dovish. The reality is that, relative to labor, inflation and other financial indicators, the Fed’s 25 basis point hike and plans for another two hikes in 2017 are very dovish. They don’t superficially represent QE* in 2013 or ZIRP* in 2014-2015, but they are pretty much the same thing.
*Qualitative Easing; Zero interest-rate policy
Yet throughout 2013-2015 there were many periods where the market sold off stocks and bonds in anticipation of scheduled rate hikes. But each period turned into a “buy the dip” opportunity. Those who are bearish about higher interest rates and their impact on equities and bonds have pretty much given up. Yet the bulls haven’t fully taken over. The result is a rather measured, moderate response to the Fed’s monetary policy, which is itself quite measured and moderate.
Of course, that doesn’t make for sexy headlines. “The Fed is Competent and the Market is Responding Rationally” doesn’t make for salacious reading. Yet the dynamics at play here, especially in the backdrop of years of QE in the US and ongoing QE in Europe and Japan (as well as the looser monetary policy in China and many, many other dynamics we simply don’t have time to discuss here), indicate that a bearish viewpoint would be a hysterical and irrational one.
However, if you want to find a pocket of irrational exuberance, you can find a bit of it in the high yield world. This bothers us as high yield analysts; We’d like for this pocket to be a bit more fearful than the market as a whole, providing buying opportunities. Alas, animal spirits are heating up more here than elsewhere, which is urging caution and consolidation.
As a result, we are sadly and reluctantly off all BDCs despite our affection for the sector. The UBS BDC ETF (BDCS: $23, up 2%) went up way too much this week, compounding an over 3% year-to-date gain and now 21% year-over-year gain. This is absurd, especially as most BDCs have reported and NAVs have declined in many cases and barely risen in others. We need to see a major correction before this sector gets attractive.
The same could be said, although less stridently, about junk bonds. The SPDR Barclays High Yield Bond ETF (JNK: $37, up 1%) had a strong week and remains up 7% over the past year. Those aren’t stratospheric numbers like BDCs, but it does show a curious disconnect. Often, investors obsess over default rates. And it’s true that middle market defaults at 1.5%, are far less than the 5.8% default rate in junk bonds*. Of course, there’s more to this story than meets the eye. Middle market default rates are going up and junk bond rates are going down - some estimates believe high yield debts could see a 4% default rate by the end of this year. And looking at the price trends over the last two years, these default risks are priced in.
*Remember, BDCs specialize in middle market loans
So we remain bullish on junk bonds to a limited extent, and prefer them over BDCs. But one needs to be selective to avoid those defaults. The PIMCO Dynamic Income Fund (PDI: $29, up 2%) remains a top pick although it is approaching a sell point. We at the Bull Market Report may need to find another junk bond fund to replace this one. This is a great fund, but it’s trading at a hefty 7% premium to net asset value. In such a situation the upside this fund provides may sadly be already priced in.
If you’re looking for deals and high yield, now is still the time to buy municipal bonds. We suspect there will be a lot of time to buy munis - the market continues to discount them based on several irrational fears, and the risk-averse retiree-investor base of these assets means fears tend to be priced into munis longer than other asset classes. Additionally, many municipal bonds are bought in open-end funds where money managers are often forced to sell if they face fund redemptions. With so many people looking to buy other assets and fearing rate hikes, it’s not surprising that they’re pulling cash out of the muni market. But this pressure isn’t due to fundamental weakness in munis, meaning they will come back. But it may take time.
That’s great. That means investors can greedily snap up munis. The iShares S&P National AMT-Free Municipal Bond Fund (MUB: $108, flat) is one option, but you’ll get assets at a discount, a better quality portfolio, and access to cheap leverage with Invesco Municipal Trust (VKQ: $12.23, up 1%) and the Nuveen AMT-Free Fund (NVG: $14.28, up 1%). Note both had a stronger week than the muni index ETF from iShares, and that is likely to be the story for a while to come if the market comes to its senses about munis.
As you can see, the big theme here is that the market is being “mostly” rational: But slightly irrationally bullish in one asset class (BDCs) and irrationally bearish in another (municipal bonds). For investors, this means rotating into the best funds exposed to the sector that’s getting unfairly punished and avoiding the irrational bullishness in the other sector. Sadly, this is not as easy as making money in 2016, when you could just buy junk bonds and REITs at the start of the year and rebalance once or twice later in the year.
It will be harder to make good money in the high yield market in 2017, but it won’t be impossible. We identified REITs as one pocket of potential after the big selloff in the middle of 2016. And now that payoff is really coming to fruition.
The SPDR Dow Jones REIT ETF (RWR: $92, up 2%) had an extremely strong week thanks to the Fed’s dovish position. However, the REIT ETF remains down over 6% over the last six months. So we’re in a good position to add to REIT positions without being back at the top.
But what REITs? Care Capital Properties (CCP: $25, up 3%) is great to hold but the recent run-up exceeds other high-quality REITs such as Digital Realty Trust (DLR: $103, down 1%) and Omega Healthcare Investors (OHI: $32, up 1%). It may make more sense to buy a bit of Digital Realty and Omega Healthcare if you’re looking for REIT exposure right now.
And at the moment, buying a bit of REITs and a bit of municipals makes a lot of sense. We’d like to see more caution in other pockets of the high yield market before betting too big in it, but we aren’t at the point of calling a top either. Now is the time to stick with high yield, reallocate to the underappreciated asset classes, and wait to see if the sentiment changes. And it will. It always does.
Good Investing,
Todd Shaver
Founder, CEO and Editor
The Bull Market Report
Since 1998
