Way Too Quiet For Comfort
The market was so calm this week that by Thursday morning we were considering the use of a blood pressure monitor to check for signs of life. A holiday-shortened trading week ended with an ever-so-modest dollar-driven rally. By the Thursday close all three major US indices were down slightly as CALM was the operative word for the week.
Here is how the week ended:
Key Market Measures (Friday’s Close)
Dow Jones 17,516 -86 -0.5%
S&P 500 2,036 -14 -0.7%
Nasdaq 4,774 -22 -0.5%
Crude Oil $40 +$1 +2.5%
Gold $1,217 $39 -3.1%
Looking at sectors, last week’s loser, Healthcare, was this week’s winner. If you guessed that last week’s winner, Energy, was this week’s loser, you would be right on the money.
This Week’s Winners & Weaklings
Strongest Group: Healthcare up 1.1%
Weakest Group: Energy down 3.0%
Rally Stalls, Market Stands up to Terror
Nothing that goes straight up ever stays up, which is what U.S. equities experienced this past four-day, Easter-shortened trading week. The quick 10% stock market comeback of March, paced by rising crude prices and a dovish Fed interest rate stance, lost steam, ending a five week winning streak. All in all, U.S. equities held up relatively well.
Last Week’s World Events Had Little Effect on the Market
First, it seems imperative to start with the cowardly Brussels ISIS attack. They can kill us with bombs and guns, and we can kill them with drones and bombs, but to what end? Suffice it to say, conventional logic behind rules of warfare and simple respect for life no longer apply. At least for now, however, the message financial markets are sending is “we’re not too worried.”
Even so, you have to wonder when the impacts of security spending, disruptions in transportation services and potential cyber-sabotage will register negatively in markets both domestic and abroad. In Friday’s USA Today, Adam Shell pondered those possibilities, which included the rise of populist/nationalist politicians creating “new laws in the name of security that lean towards isolationism and eventually hurt trade,” essentially an assault on globalization that could be viewed negatively by investors.
None of that mattered much to the U.S. equity complex this week, with Blue Chips opening on Monday at the 17,600 level, closing Friday at 17,515. The S&P 500, which many view as a better barometer of the health of the overall marketplace, closed at 2,036, down 13 points week-over-week. The Nasdaq slipped 25 to 4,773. Trading volume was below average, as market participants got a head start on the holiday weekend.
Taking Stock of 2016: Searching For Excitement
Except for the Nasdaq, the Dow and S&P 500 are hovering near 2016 high levels, meaning the average investor has neither made nor lost money this year. Of course, it’s better here than back in mid-January when hour-to-hour volatility prevailed and most folks were oozing red. The question, as always, where do we go from here?
The opinion of this week’s talking heads linked the current calm to conditions just prior to the 2015 market peak, a point well taken. The major difference is that back then, the economy and corporate profits were slowing. Today both measures are simply slow. Gross Domestic Product growth is under 2% and profits are forecast to increase only 3%. A point worth noting is that market valuations both then and now are high. In mid-2015 the multiple on the S&P 500 was 24 times. Today it is almost 23. You will recall that at the February low, the multiple was in the mid-teens.
Technically, the stock market is forward-looking so it is not completely fair that we are measuring value based on trailing earnings. But since profits are inching up at a slow place, it hardly matters. The conclusion should be clear. The market is vulnerable.
We are not talking about the world coming to an end. Investor psychology remains strong. When you incorporate the tragic events that took place in Brussels, the fact that there was no major market reaction was quite positive. Let’s also consider the political arena where the degree of negativity, uncertainty and disgust is enough to shake investor confidence. But stocks are near a high for 2016, so there is an argument that the market can take a punch in the solar plexus like a heavyweight boxing champ and still be standing. Good stuff.
What we are suggesting is that valuations matter and market psychology can change quickly. Here is what we see as the next test of market strength: The first quarter is long in the tooth and earnings reports will begin to trickle in soon. Generally speaking, the first quarter is the easiest period for CFOs to adjust expenses to match the budget and hit targeted earnings. Revenues are a different matter. There is no fudging possible here. This is where we will be watching closely. Very soon we will be adding an Earnings Alert feature to The Bull Market Report to let you know when to expect quarterly reports for our favored companies and for the most popular market movers.
The FOMC: There is a Family Feud Brewing
The Federal Open Market Committee of the Federal Reserve (FOMC) met in March, left rates unchanged and followed up with just enough doubletalk to leave doubt about their future course. At the post meeting news conference, Chair Janet Yellen indicated a wait and see attitude and suggested that we will see only one or two increases later this year instead of four as she had indicated earlier in the year. Since then a crack in the wall of solidarity has opened. St. Louis Fed President and FOMC voting member James Bullard did his best to put a damper on sentiment. Bullard said that an April rate hike remains on the table, even though the Fed Funds futures currently sees only a 14% chance of a rate hike at the upcoming policy meeting. The market sees a 40% chance of a hike in June while expectations for a hike in July are running at 51%. The next FOMC meeting is scheduled for April 26th and 27th.
Lest we end this week with you thinking we have lost that lovin’ feeling for stocks, don’t be dismayed. There is going to be several key buying opportunities this year and being ready to pounce is what we want to get ready for. This simple strategy guided Warren Buffett to many years of great results.
Gold Tarnished
The recent disconnect between gold prices maintaining relative strength alongside U.S. equities didn’t hold up this week despite the terrorist attack. In fact, Gold, which would normally get some market love during times of political uncertainty and turmoil, plunged $35 for the week, cratering beneath what is considered by many gold bugs as key support at $1220. Currently sitting at the $1217 level. A break of $1200 could be a technical catalyst for more selling.
Oil Stalls Out Around $40
The Oil patch produced mixed signals for the week. Baker Hughes reported a drop of 15 rigs in the United States. That’s welcome news. However, U.S. government data on Wednesday showed crude stockpiles jumped over 9 million barrels last week, three times more than forecast. That put Crude futures prices into a two-day slide. By week’s end, however, Crude recovered to the $40 level.
Under these conditions, there is little surprise that stocks of Energy companies topped the list of underperforming groups for the week. Don’t draw any big conclusions about the direction of Crude from this one week. As we have said on several occasions: nobody knows and everybody guesses. It is just another week in the Oil patch. But we will say that having it hold steady at the $40 level gave the stock market a degree of security. It’s amazing how close stocks move with crude. So if crude heads back to the $30 level in the coming weeks, we are hard-pressed to see how stocks can rally from here.
Economic Reports This Coming Week:
The Washington data devils will be on the rampage this week starting right off on Monday morning before the opening. Most importantly, there is lots of consumer data for Fed watchers to mull over. Personal Income and Consumer Spending for February appear to have weakened noticeably compared with January. This is very much consistent with our observations dating back to that huge credit card financed spending binge at Christmas time. If both of these data points are accurate, it will be hard to see how Consumer Confidence will show a rise when reported on Tuesday.
The most important number for the week is Monday’s Core Inflation report that is expected to be within the FOMC target of 2.0-2.5%.
The next most important data will come out on Friday with Nonfarm payrolls, Average Hourly Earnings and the Unemployment Rate. For the sake of hard working America, we hope the 0.3% increase proves accurate.
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RELEASE TIME (EST)
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REPORT | PERIOD | FORECAST | PREVIOUS | ||||||||
| MONDAY, MARCH 28 | ||||||||||||
| 8:30 am | Advance Trade In Goods and Services | Feb. | -$62.3 billion | -$62.2 billion | ||||||||
| 8:30 am | Personal Income | Feb. | 0.1% | 0.5% | ||||||||
| 8:30 am | Consumer Spending | Feb. | 0.0% | 0.5% | ||||||||
| 8:30 am | Core Inflation | Feb. | 0.2% | 0.3% | ||||||||
| 10 am | Pending Home Sales | Feb. | 1.8% | -2.5% | ||||||||
| TUESDAY, MARCH 29 | ||||||||||||
| 9 am | Case-Shiller Home Prices | Jan. | -- | 5.7% | ||||||||
| 10 am | Consumer Confidence Index | Mar. | 94.1 | 92.2 | ||||||||
| WEDNESDAY, MARCH 30 | ||||||||||||
| 8:15 am | ADP Employment | Mar. | 205,000 | 214,000 | ||||||||
| THURSDAY, MARCH 31 | ||||||||||||
| 8:30 am | Weekly Jobless Claims | 3/26 | 270,000 | 265,000 | ||||||||
| 9:45 am | Chicago PMI | March | -- | 47.6 | ||||||||
| FRIDAY, APRIL 1 | ||||||||||||
| 8:30 am | Nonfarm Payrolls | March | 210,000 | 242,000 | ||||||||
| 8:30 am | Unemployment rate | March | 4.9% | 4.9% | ||||||||
| 8:30 am | Average Hourly Earnings | March | 0.3% | -0.1% | ||||||||
| 10 am | ISM Manufacturing | March | 50.5% | 49.5% | ||||||||
| 10 am | Construction Spending | Feb. | -0.2% | 1.5% | ||||||||
| 10 am | Consumer Sentiment | March | 90.5 | 90.0 | ||||||||
| TBA | Motor Vehicle Sales | March | 17.4 million | 17.4 million
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High Yield Corner
After weeks of strength, the high yield market took a pause, but the positive momentum of the last month remains unbroken.
In junk bonds, yields on issues rose slightly as measured by the Bank of America Merrill Lynch US High Yield Master index. Yields rose from 8.12% at the beginning of the week to 8.39%. Since prices go down when yields go up, this means junk bonds saw their values fall a bit and junk bond funds NAVs fell at the same time. Both the SPDR Barclays Capital High Yield Bond ETF (JNK, $34, down 40 cents for the week) and the iShares High Yield Corporate Bond ETF (HYG, $81, down $1.05 for the week) fell 1%, but remains up YTD. More significantly, junk bonds are up over 7% from their lowest point in February, when The Bull Market Report recommended these assets.
Property REITs also fell 1.7% this week, a steeper fall than the 0.7% decline in the S&P 500. No major news was driving the trend, which seems to be driven by fear of weaker income from rentals. Since the decline was broad based, impacting commercial, industrial, and residential-focused REITs, it seems the market is indiscriminately selling on the expectation of weaker economic conditions.
Yet indicators of weakness are getting fewer and further between. This week, the Bureau of Economic Analysis revised 4Q GDP estimates upwards by 40%, a massive increase that economists were not expecting. The upgrade was driven by an increase in personal consumption expenditure, a key indicator of middle class American confidence and spending activity. This more than offsets some disappointing data points, such as low durable goods purchasing, weak home buying activity, and sluggish manufacturing data. Combined, the data is mixed, but does not indicate a dramatic slowdown or the kind of recessionary conditions many prognosticators were whispering a month ago.
In that context, the strength in property REITs and high yield bonds makes sense, and the recent pause is nothing more than short-term volatility. Looking at BDCs, one comes to a similar conclusion. The BDC ETF (BDCS, $20) actually ended the week up slightly, with many Business Development Corporations (BDCs) ending the week mostly flat, like Prospect Capital (PSEC, $7.12), Main Street Capital (MAIN, $31), and Fifth Street Capital (FSC, $5.00). Since BDCs rely on American middle market companies remaining solvent - which is only possible if medium sized businesses see continued demand from American consumers - the market continues to have faith that the economy is going to remain stable, if not spectacular.
Energy-related Master Limited Partnerships ended the week on a sour note, thanks largely to oil’s reversal. The Alerian MLP ETF (AMLP, $10.47) fell 6% in the last week and is down 13% year-to-date, much worse than oil’s YTD performance. This volatility again confirms our view that MLPs are best avoided for now. Since these companies cannot be a source of income with minimal capital losses, they are best seen as a proxy bet on oil with an income stream attached. Yet they have massively underperformed large cap oil stocks like Exxon Mobil (XOM, $84), which is up year-to-date.
Apple Corner
There were some important upgrades in Apple (AAPL, $106, unch.) during the week. Apple released the 4-inch iPhone, calling it the “SE”, which has most of the power of the popular and expensive iPhone 6. Credit Suisse sees these new key features and the new low price point of $399 as a good move for the iPhone business. The phone compares favorably with competitive products in the $300-to-$500 smartphone arena. The firm sees thinks 25 million units can be sold, which if met would produce a strong impact to the bottom line. Credit Suisse has an Outperform rating with a $140 price target, the highest of the three upgrades this week.
Apple’s March 21st launch event was greeted by investors with a muted response, as shares remained range bound throughout the course of the week, channel-surfing between $105 - $107. Forbes offered the following analysis: “With the launch of the new 4-inch iPhone SE, Apple has done quite a bit to upend its ‘new, older, oldest’ lineup strategy. For some time now, the newest iPhone has been on sale for $649 with last year’s model $100 less expensive and the one from the year before slotting in at $449. The new SE breaks from tradition in two critical ways for Apple. First, it uses nearly the same hardware inside as the iPhone 6s. This isn’t just a phone for people looking to save money. Second, the starting price is $399 - where no iPhone has gone before. There’s a lot to unpack here about why this is so important for Apple and consumers.”
Merrill Lynch reiterated a Buy rating and $130 price target. For Merrill it is all about health care. During its much-hyped March 21st event, Apple unveiled "CareKit," a new software-based healthcare platform. CareKit is an open source framework, where developers can create applications that can be used by individuals to monitor health levels, and subsequently share relevant data with their doctors. Apple, with the launch of CareKit, has already released two apps, with one intended for treatments of Parkinson’s Disease, while the other is for post-surgery care.
Merrill Lynch believes that CareKit takes a BIG STEP in Apple’s mission to emerge as a leader in the evolution of Healthcare. HealthKit was rolled out in 2014, and ResearchKit last year. HealthKit is a central data collection area for a comprehensive health profile. ResearchKit allows medical research to be collected easily. Here is what Apple says about this product: http://www.apple.com/il/researchkit. One immediate example of this was that medical research in a Parkinson’s study witnessed a massive boost immediately after the ResearchKit was launched. Additionally, the Asthma Health study spotted triggers for asthma symptoms across all 50 states. Merrill Lynch believes that Apple’s strong move into Healthcare could propel the company into becoming a significant player in this huge field.
The 3rd upgrade came from Argus, who reiterated a Buy rating with a $135 price target. They believe that Apple remains attractive on value, and discounted free cash flow valuations.
BMR Take: These upgrades tell us that Wall Street likes this company and we feel that EVENTUALLY, the stock will head higher towards a new all-time high ($134). Be patient oh Bull Market Report readers. Investors will be talking about Apple later this year and saying: “Remember when Apple was trading at that ridiculously low price of $106?” You heard it here first!
Notes at the Margin
By Philip K. Verleger, Jr.
http://www.pkverlegerllc.com/publications/notes-at-the-margin
We hereby give you a bit of Philip Verleger’s weekly commentary on the future of the oil business. Mr. Verleger has been studying and advising clients in the Energy business for over 30 years. It is his opinion alone that we bring you today.
Oil’s New Future
Industry Reemergence
The oil industry’s reemergence requires its recognition that, for it to survive, oil prices must be very low for a significant period of time, say, until 2020. For such a strategy to succeed, producers must abandon the idea of a production freeze now or for a number of years. Low prices will achieve several goals.
First, they will stimulate consumption by current consumers and consumers who might otherwise substitute alternatives such as electric cars. Low prices will also guarantee petroleum a future in the market by forcing those who sell alternative-powered technologies to achieve greater cost reductions.
Second, low prices will accelerate the demise of coal. Low oil and natural gas prices are doing this in the United States. The effect will spread to the rest of the world. A rapid decrease in coal use would reduce global greenhouse gas emissions, giving proponents of the remaining fossil fuels (oil and natural gas) more time to find compromise with those advocating the limitation of total emissions.
Third, low prices will suppress development of liquefied natural gas. Last week the Australian firm Woodside Petroleum announced its cancellation of the $30 billion Browse floating-platform LNG project. Developers of such endeavors had counted on their ability to sell the output at high prices to Asian buyers. The collapse in oil prices makes this impossible. The Browse project died and with it one competitor for oil. More such successes are needed.
Fourth, low oil prices will slow the advancement of new production technologies. Exploration and development costs dropped dramatically during the early years after World War II as new technologies were applied. The declining costs supported expansion of US output even as regulators in Texas struggled to sustain higher prices by limiting output. The situation today is identical. Higher prices (probably above $50 per barrel) will stimulate unexpected increases in supply of between one and two million barrels per day per year. The only way to suppress this effect is to keep prices low.
Fifth, low oil prices will slow penetration of alternative fuels such as electricity in transportation. Many believe the success of firms such as Tesla has been fueled by government subsidies. They are partially correct. However, high oil prices were a factor, too, probably the most important one with regard to gaining consumer acceptance.
Last, low oil and gas prices will slowly but surely put many of the very large oil and gas firms such as Shell out of business. This last step is essential. The large publicly held multinational companies are the greatest threat to price stability confronting the low-cost producers. These firms - particularly Chevron, ENI, Exxon, Rosneft, Shell, Statoil, and Total - spend large amounts on developing very high-cost projects that often require very high prices to be profitable. The oil sands in Canada and Australia’s Gorgon natural gas projects are examples. Once completed these facilities produce regardless of price levels, threatening the existence of the efficient, low-cost producers in the Middle East. Low prices will reduce the contribution of these high-cost projects to global supply, eventually restoring an economic order where the producers with the lowest-cost supply can produce at capacity while other producers having higher costs contribute as needed.
The new oil world that emerges must embrace a model we describe with three phrases: efficiency, production maximization, and cost minimization. With the new model, the world will be flooded with low-cost crude for a long time. High-cost producers will be forced to shut, and few if any large high-cost projects will be funded. Instead, a rational economic order will develop where production from low-cost areas is maximized, and higher-cost supplies enter the market until supply and demand balance.
This does not imply that supply and demand will fall to the competitive level as agricultural products do. The price of corn, for example, trades around the level set by supply and demand because no one farmer or group of farmers has the market power to raise its revenues by cutting production. Oil need not be the new corn. We will see a new order in which one country (presumably Saudi Arabia) or a group of countries (Middle East producers) may have sufficient market power to raise prices and their income by cutting output. Price stability could be achieved not at the competitive level but at a higher cartel-determined level, one that increases producer incomes without encouraging speculative investment.
This new order will provide an orderly way for new technologies such as fracking to penetrate, boosting supply in a market-stabilizing rather than market-destabilizing fashion. The global contribution of new technologies to supply will increase at a steady rate rather than at the destabilizing speed (“race for output”) encouraged by the artificially high prices between 2007 and 2014.
The new order will also encourage financial institutions to fund rational, well-thought-out projects rather than throwing money at promoters and large multinational companies as they have for the last 10 years.
The Options Corner
We like United Parcel Service (UPS: $105) a lot. We will give you a hint: We’re going to add it to our Stocks for Success Portfolio this week! It is one of those high-priced stocks that works well with an options strategy. The volatility level of UPS is low so the premium of its options are low as well. In taking a long-term bullish view of the company it is possible to control shares by buying a LEAP. (A LEAP is simply an option that expires in January.) So you have the January 2017 LEAP and the 2018 LEAP. We like the 2018 option because it gives you plenty of time to watch the stock grow and allows you to sell calls against the stock (in this case against the option) to get cash back, lowering the cost of the option.)
Let’s look at some real prices here. You will be amazed at how the market prices UPS options. The stock closed Friday at $105. When we buy LEAPS we like to buy a strike-price that is IN the money. For example, the January 2018 $90 call or LEAP (the words are interchangeable) is priced by the market at about $17. Let’s analyze this. The option gives you the right to buy 100 shares of the stock at $90, giving the option an intrinsic value of $15. ($105-$90). It is WORTH $15. Since you are paying $17 for it, there is just $2 of TIME VALUE built into the price. Note that If you were to buy the stock, 100 shares at $105 is $10,500. But with the option priced at $17 ($1,700 for one option), for only $1,700 you control 100 shares of UPS at $105. Kind of extraordinary when you think about it.
Oh – Did we mention that buying and selling options is risky? Right. IT IS VERY RISKY and not for everyone. Always check with your broker who will undoubtedly try to talk you out of it.
Back to the $90 call. Let’s say UPS goes to $125 by the end of this year. What would the option sell for? Well, it HAS to at least sell for the difference between the strike price and the price of the stock which is $35. It will probably sell for a tad more to account for time value so let’s say it will sell for $37. You paid $17, so your return is 117% in less than a year. Not bad. PLUS you have ONE MORE YEAR before the option expires. The stock could go higher.
The downside is quite bleak of course because if the stock goes to $90 by the end of this year, the option will have no intrinsic value and will probably sell for around $5. So your $17 investment has turned into $5, a 70% drop. Can you afford to lose 70% of your investment? Only you can answer that question.
Next week we’ll cover how you can get some of the cost of the option back by selling calls against it.
BMR Companies and Commentary
Our Stocks for Success and Special Opportunities have been carefully selected to provide diversification and best-in-class in each sector. Here are some thoughts on the stocks we favor. On Wednesday we added Fitbit Inc. (FIT: $14.60) to our Special Opportunities Portfolio and invite you to read the report on the website.
Here are some thoughts on other stocks we favor:
Gilead Sciences (GILD: $91, up 1%) When is bad news actually good? The answer is when you are Gilead Sciences being sued by Merck (MRK, $53, $147 billion market cap) over patent infringement. On Tuesday a federal jury ruled in favor of Merck who claimed a whopping $20 billion in damages and sought a perpetual royalty of 10% on all sales of Gilead’s hepatitis drugs Harvoni and Solvadi. On Thursday, the jury set damages at $200 million with no royalty payments required. The reward fell significantly short of the 10% royalty on U.S. sales of the two drugs the company was seeking. The award covers sales between 2013 and 2015, which amounted to more than $20 billion. The jury calculated sales at $5 billion and assessed a 4% royalty to reach $200 million. Gilead announced that it will appeal which will tie up this award for years. Gilead’s super blockbuster drugs generated over $12.5 billion in US revenues last year, out of total global sales of $19 billion, so for Gilead, $200 million is petty cash. This is as good as bad news can get. Note that the hepatitis treatment market is forecast to reach $100 billion. Right now Gilead and Merck are the only two players with this new and highly effective treatment. The stock should trade much higher on this news alone. At a $125 billion market cap, we can see Gilead someday reaching $200 billion in value, making it one of the largest firms on the planet.
Devon Energy Corp (DVN: $27, unch.) Shares have been on a rampage since being added to our favored list little more than a month ago on February 23rd at $19. To be precise, the stock has appreciated 42% in that short time. The balance sheet was replenished with cash from the $1.5 billion equity offering in mid-February and the company is putting non-core assets on the selling block. The company has great real estate in Oklahoma. Wall Street is taking notice, with Edward Jones recommending the stock just recently.
Home Depot Inc. (HD: $131, down $1 for the week) There is some good news for stockholders coming from SunTrust Bank – they said that a big wave of home remodeling is about to take place. Total outlays are expected to rise 8% this year to $155 billion. This is almost 3 times as fast as the whole economy is likely to grow and right in Home Depot’s sweet spot.
Tesla (TSLA: $228, down 2.2%) It just keeps getting better for Tesla stockholders. The company received another upgrade Monday, this time from the Argus Research. Last week it was Oppenheimer that upgraded the company with a $300 price target. When Argus took a shot at Tesla, they came up with a $333 price tag. The heart of the recommendation was the progress Tesla is making in production shortfalls. Also, construction of the Nevada “Gigafactory” that will reduce battery pack costs is making progress toward completion.
Tesla will be unveiling the new S-car next week. There’s nothing quite like the launch of a new Tesla to whet the appetite of shareholders and send a shiver through the spines of the many members of Tesla’s bet-against crowd - with short interest currently weighing in at 31%. That’s exactly what shorts will have to contend with March 31st when the company rolls out its new Model S. Strap on those seat belts: It should be a fun ride. And remember, a large short position is very bullish. (Why? Because if the company does well, those shares have to be bought back, forcing the price higher.)
A NEW ADDITION TO OUR HIGH YIELD PORTFOLIO
Published this past week on Saturday the 26th.
KIMCO REALTY RESEARCH REPORT
KIMCO REALTY (KIM)
We are adding Kimco to our High Yield Portfolio
Key Measures
52-Week Price Range: $22-$29
Shares Outstanding: 415 million
Market Capitalization: $11 billion
Dividend: $1.02 per share
Yield: 3.7%
Target Price: $32
Sell Price: $25
Price at time of publication : $28.
See our website for the full report.
Good Investing,
Todd Shaver
Editor in Chief