CWS Market Review – April 13, 2018

“Beware geeks bearing formulas.” – Warren Buffett

The Monday before last, the S&P 500 closed below its 200-day moving average. This was a big deal, because it hadn’t happened in 21 months. Back then, the index had previously closed below its 200-DMA for a grand total of one day. This was during the freak-out following the Brexit vote.

Are we repeating ourselves? Since Monday, April 2, we’ve had a nice little rebound, but I’m skeptical it can last much longer. Over the last three weeks, the S&P 500 has been locked in a trading range that’s about 3% wide. While daily volatility has increased, the market seems unable to get any real momentum, either up or down.

Some of this seems to be driven by our on-again off-again trade war. Here’s something to think on. Earlier this week, our stock market rallied thanks to encouraging free trade talk from Chinese President Xi Jinping. It’s not every day that a Communist pseudo-dictator helps the U.S. stock market with his free-trade rhetoric. But here we are.

More importantly for us, Q1 earnings season is here. The guessing game about corporate profits is over, and we’ll soon see results. Over the next three weeks, 20 of our 25 Buy List stocks will report earnings. On balance, this should be a very good earnings season for Wall Street (thank you, tax reform), and an especially good one for us. I’ll preview some of our reports that will arrive next week. Before we get to that, though, let’s take a look at the minutes from the Fed’s last meeting.

The Fed Is More Optimistic about the Economy

Yes, yes, I know—the Fed minutes are dull as dirt. And sure, the economists speak in dry econo-jargo-babble. Fortunately for us, I’m well versed in their dark and mysterious tongue, and I’m happy to translate.

On Wednesday, the Fed released the minutes from its March 20-21 meeting. This is when the Fed decided to raise interest rates. What’s interesting about these minutes is it shows how much more optimistic the Fed is about the economy, especially compared with a few months ago. Economists, it seems, can be as fickle as investors.

I should explain that the Fed minutes are a study in indefinite pronouns. The minutes aren’t complete transcripts. Instead, we read that “some members” said this while “a few members” said that. It usually takes a little decoding, but I was surprised when “all” was used a few times. For example, “all” members expect inflation to rise in the coming months. Also, “all” members agreed that the economy has gotten better in recent months.

That’s good to see, and looking at the recent data, I have to agree. Last Friday, the government said the economy created 103,000 net new jobs in March. That’s low, but the trend is still good. In fact, we haven’t had a negative month for NFP in nearly eight years.

The unemployment rate came in at 4.1% for the sixth month in a row. That ties us for a 17-year low. One weak spot is wages. The government said that average hourly earnings are up 2.7% in the last year. That’s not bad, but it should be better.

The good news is that inflation continues to be subdued. This week, we learned that headline consumer prices fell 0.06% last month. That was the first monthly drop in 10 months. Some of the drop was caused by lower energy prices. Gasoline prices were down nearly 5% in March.

The “core rate,” which excludes food and energy prices, rose by 0.18% last month. In the last year, core inflation is running at 2.1%. That’s higher than it’s been in a few months. Still, core inflation hasn’t strayed far from 2% for more than seven years.

Some of the Fed’s recent optimism is due to tax reform. However, the central bank is concerned about the prospects of a trade war. (Or so said “a strong majority,” which may be a new one.)

How does this affect us? In the near term, not much. Don’t expect a Fed rate hike at the next Fed meeting in early May. But we’ll surely get one at the June meeting. Even after that, real interest rates will still be negative. Despite the higher volatility, this is still a good time to be an investor.

The Fed is a long way from damaging the market or the economy, but investors must be careful. Don’t chase stocks. Don’t sell on every wobble. Stay focused on the long term, and stick with fundamentally-superior stocks. Now, let’s take a look at earnings season.

Q1 Buy List Earnings Calendar

Here’s a calendar of our Buy List earnings reports for this quarter. I’ve included each stock’s reporting date (there are a few we don’t know yet), ticker and Wall Street’s consensus estimate.

Company Ticker Date Estimate
Torchmark TMK 18-Apr $1.45
Alliance Data Systems ADS 19-Apr $4.51
Danaher DHR 19-Apr $0.94
Snap-On SNA 19-Apr $2.73
Sherwin-Williams SHW 24-Apr $3.15
AFLAC AFL 25-Apr $0.97
Check Point Software CHKP 25-Apr $1.28
Stryker SYK 26-Apr $1.60
Moody’s MCO 27-Apr $1.71
Fiserv FISV 1-May $0.73
Becton, Dickinson BDX 3-May $2.62
Church & Dwight CHD 3-May $0.61
Ingredion INGR 3-May $1.89
Intercontinental Exchange ICE 3-May $0.87
Signature Bank SBNY TBA $2.67
Cerner CERN TBA $0.58
Cognizant Technology Solutions CTSH TBA $1.06
Carriage Services CSV TBA $0.58
Wabtec WAB TBA $0.90
Continental Building Products CBPX TBA $0.36

There are four reports scheduled for next week. On Wednesday, April 18, Torchmark (TMK) will kick things off for us. This insurance firm doesn’t generate a lot of news, which is how I like it. For Q4, they beat the Street by a penny per share. For 2017, Torchmark made $4.82 per share. That was up from $4.49 per share in 2016. Their ROE was 28.2%, which is quite good.

Wall Street expects earnings of $1.45 for Q1. That sounds about right. For all of 2018, Wall Street is looking for $6.03 per share. That’s probably a tad too low. Still, even if it’s right, that means TMK is going for 14 times earnings. That’s a good price. This is a very solid company.

On Thursday, April 19, three of our Buy List stocks are scheduled to report. I’m most curious about Alliance Data Systems (ADS). The loyalty-rewards stock has gotten slapped around badly this year. ADS dropped from a high of $278 in January down to $203 last week. Some investors think the company is about to slash its earnings forecast.

Investors were also concerned that Facebook’s limiting of the information it shares with data brokers could hurt ADS. For its part, ADS said it doesn’t have a close relationship with any social-media platform. It also reiterated its full-year guidance of $22.50 to $23 per share. For Q1, the consensus on Wall Street is for earnings of $4.51 per share.

Also on Thursday, Danaher (DHR) is due to report. Three months ago, the company said that Q1 earnings would range between 90 and 93 cents per share. Then in March, the CEO said they’ll beat that.

“We have seen a strong start to 2018 from both a core-revenue and margin perspective, and based on our results through February, we now expect first-quarter-2018 adjusted EPS to be above the high end of our previously communicated guidance range. Better than expected results in our Life Sciences and Diagnostics platforms – specifically at Cepheid – are the main drivers for this performance as we continue to see positive momentum in these businesses.”

For all of 2018, Danaher sees earnings of $4.25 to $4.35 per share. I had been expecting a little more, but I’m not worried. DHR made $4.03 per share in 2017. DHR is a keeper.

While ADS is our biggest loser YTD, Snap-on (SNA) is a close second. For Q4, SNA had earnings of $2.69 per share, which was three cents above Wall Street’s consensus. For the year, the company made $10.12 per share.

Forbes recently had a good article explaining why Snap-on’s stock was a bargain. You can see the whole thing here. I’ll highlight two important facts. One is Snap-on’s improving margins. The article also notes that the concerns about Snap-on’s financing business are overblown. Wall Street expects Q1 earnings of $2.73 per share.

I also want to add Signature Bank (SBNY). Technically, the bank hasn’t said yet when they’ll report Q1 earnings, but I suspect it will be on April 19.

What I like about Signature is that their business has been improving, and I don’t believe that’s been fully reflected by the share price. For Q4, they beat the Street by 20 cents per share. The bank made $8.91 per share for 2017, and I think they have a good shot of breaking $11 per share this year. The stock is probably going for less than 12 times this year’s earnings. For Q1, Wall Street expects earnings of $2.67 per share.

When looking at banks, there’s a key metric to watch: the “efficiency ratio.” It’s a bank’s overhead as a percent of revenue. The lower this number, the better. Signature defines its efficiency ratio as net interest expense divided by total income. As a general rule, anything below 50% is considered good. For Signature, the efficiency ratio was 33.5% last quarter.

That’s all for now. Next week will be dominated by earnings news, but there will be a few key economic reports to look for. On Monday, we’ll get the retail-sales report for March. The last three reports have all showed declines. Then on Tuesday, we’ll get the industrial-production report for March. On Wednesday, the Fed will release its latest Beige Book report. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

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How to Profit from Solving the World’s Water Shortage

Water is seemingly everywhere, covering about 70% of our planet. Yet, fresh water is extremely scarce – accounting for a mere 3% of the world’s supply. Of that amount, the vast majority is either locked up in glaciers or reside in inaccessible subterranean pockets.

And the fresh water that is accessible is not evenly distributed around the planet. For example, there is plenty of water in Siberia. But few people live there.

Of the amount of fresh water that is available, roughly 70% of that goes to agriculture to feed the world’s population. The enormous amount of water needed to grow the crops and livestock needed to feed and clothe the world’s growing population is creating a dire global situation.

The U.S. media tends to ignore events in the rest of the world, but there is a scary situation developing in South Africa’s second-largest city, Cape Town, with its four million residents.

Cape Town is best known as a tourist haven and the center of South Africa’s wine industry. But now population growth and a record drought in the region have combined to push the city to the brink – to being very close to ‘Day Zero’ when its water reservoirs run dry.

3 REITs Raising Dividends in May

For income stock investors, the best defense against interest rate increases from the Fed is to own shares in companies that periodically increase their dividend rates. It is a widely held yet inaccurate belief that REIT values must fall if interest rates continue to increase. REITs are active businesses in which the good ones are managed to grow income and the dividends paid to investors through the full cycle of interest rate changes. Buying stocks just before they announce a dividend increase provides an attractive opportunity for quick share price gains along with larger forward dividend payments.

In the market sector of real estate investment trusts (REITs) we can monitor how well an individual REIT is performing from its history of dividend growth. In the long-term, REIT results are primarily driven by economic growth. In the U.S. the growth rate continues to expand. Another positive for REITs is that they are not exposed to the challenges of international trade.

Most REITs announce a dividend increases once a year, in the same month each year. Across the sector there are increase announcements in almost every month in the calendar. You can often get a nice share price gain by buying shares before a dividend increase announcement hits the news wires. I maintain a database that covers about 140 REITs. I use the database to track dividend rates, yields and increases. Of the 140, about 90 have histories of regular dividend increases. There are three REITs that are likely to announce a dividend increase in May.