CWS Market Review – May 18, 2018

“Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.” – Will Rogers

I wish I could say the stock market has been interesting lately, but it hasn’t. The market’s been pretty dull, which doesn’t bother me. For a while, the Dow looked like it was getting exciting, as it had an eight-day winning streak, but that came to an end on Tuesday. The market took a mild dip on Tuesday, and things haven’t moved much since then.

The bond market has been a little more interesting. The yield on the 10-year closed Thursday at 3.11%; that’s a seven-year high. This is all part of the larger trend that’s been going on for some time. Rates are going up all across the yield curve. In fact, the yield on the three-month Treasury bill recently crossed 1.9%, and may soon hit 2%, which it hasn’t seen in a decade. The yield on the three-month is now higher than the yield on the S&P 500. The financial crisis happened 10 years ago, and things are still getting back to normal.

In this week’s CWS Market Review, I’ll describe some of the market’s recent action. Even though it appears boring on the outside, there are some interesting stirrings just beneath the surface. I’ll explain more in a bit. I’ll also preview two of our Buy List earnings reports coming next week. Ross Stores loves to play the game of telling us that earnings for the coming quarter will be blah. But then on earnings day, they give us good news. Before we get to that, let’s look at the market’s hidden bear.

The Hidden Bear Market

Around here, we’re not much for market-timing. If I could do it well, and consistently, then I’d be all for it. The problem I’ve found is that being a market timer forces your mind to be a bear-market predictor, which is a bit different. It’s pretty simple, really. If you’re looking for signs of trouble, you’ll soon start seeing them everywhere (Korea! Tariff! The Fed!), and that’s not good for your portfolio.

We just came through a good earnings season. Across the board, we’ve seen good earnings reports, plus optimistic forecasts for the coming year. At the same time, the stock market peaked in late January. After the initial tumble, the bears haven’t been able to move the dial much. Don’t be fooled: they’re not done trying.

But as stock prices are down from their highs, and earnings have improved, valuations are also lower. We assume that a bear market must be a sudden and ugly drop. But what if, instead of a big plunge, the market just rolled along for several months, maybe even more than a year, all the while earnings improved? The flat P and higher E would depress P/E Ratios, and that’s the same net effect as a bear market. Happening in this way, it almost goes unnoticed.

Related to a shift toward lower valuations, we’ve seen a pronounced rotation on Wall Street. As I mentioned in last week’s issue, energy stocks have been performing much better. They continued to get even stronger this week. This is most likely tied to an improving economy, and higher long-term yields.

The tech sector, which has been creaming the market almost nonstop for five straight years, is starting to look weak. I should note we’ve seen more than one head fake from tech in the past year. But the prospects for tech are important, because they tell us how much investors are willing to shoulder risk.

When the Dow was at 15,000, loading up on FAANG stocks wasn’t too scary. Nowadays, the market is more discerning, plus the indexes are heavily dependent on large-cap names. Here’s a good example: Before it got dinged on Thursday, Cisco accounted for 6% of the entire gain for the S&P 500 this year.

Meanwhile, the defensive sectors have gotten some relief. Consumer staples have been getting lapped by the market for more than two years. In fact, you can spot some pretty general yields among blue-chip consumer stocks. Both Smucker and Hormel yield over 2%, and Church & Dwight isn’t far behind.

Some healthcare names have been improving as well. For example, Stryker came very close to touching a new high this week. As a technical note, I think of healthcare as a defensive sector, but it’s not as purely defensive as utility stocks or consumer staples. Still, the improvement in these sectors, combined with the weakness in tech, leads me to think that the market is becoming more conservative and less tolerant of risk. Tesla, for example, is more than 26% off its high.

A few names on the But List that look particularly good at the moment include Check Point Software (CHKP), Danaher (DHR) and Cognizant Technology Solutions (CTSH). Now let’s look at two “April Cycle” Buy List stocks due to report earnings next week.

Earnings Reports Next Week from Ross Stores and Hormel Foods

We have two Buy List earnings reports next week. Both Ross Stores and Hormel Foods are due to report on May 24. Hormel reports before the market opens. Ross’s report will come after the close.

In March, Ross Stores (ROST) released a very good fiscal-Q3 earnings report, but the shares dipped due to poor guidance. Or what was perceived by others as poor guidance. Let’s run through the numbers. For Q4, the deep-discounter earned 99 cents per share. That beat its own guidance of 88 to 92 cents per share. Sales for Q4 rose 16% to $4.1 billion. The key metric to watch is same-store sales, which rose 5% versus a 4% gain last year. I was particularly impressed by Ross’s operating margins.

Ross also raised its dividend by 41%, from 16 to 21.5 cents per share. Ross has raised its dividend every year since 1994. The company also added $200 million to its buyback program. The authorization is now up to $1.075 billion. This is the sixth year in a row that Ross has been on our Buy List, and it’s been a big winner for us.

Now let’s turn to guidance. Barbara Rentler, the CEO, said they’re taking a “prudent approach to forecasting.” Well, they often do that. Ross projects earnings this year to range between $3.86 and $4.03 per share. Ross also said it expects same-store sales growth of 1% to 2%. Sorry, but they’re low-balling us again.

For Q1, Ross projects earnings between $1.03 and $1.07 per share. That’s up from 82 cents per share last year. Ross expects same-store sales growth of 1% to 2% for the first quarter. Again, that’s too low.

There are a few key facts to remember. For one, Ross plans to open another 100 stores this year. The company is also raising its minimum wage to $11 per hour. TJX, their main rival, has not made that pledge. Higher wages can save money in the long run, since you have lower turnover and a happier workforce.

Fortunately, the shares have made back a lot of what they lost after the Q4 earnings report in March. That’s one of the benefits of our long-term approach. We don’t dump a stock just because traders get nervous.

Hormel Foods (HRL) has been one of our disappointing stocks so far this year. I don’t think the blame lies with them. Most everything in the consumer-staples group has been treated unkindly this year. Actually, Hormel has been behaving better in recent weeks.

Three months ago, Hormel Foods reported fiscal Q1 earnings of 56 cents per share. Of that, 12 cents was due to tax reform, so on a practical level, they made 44 cents per share in terms of continuing operations. That matched Wall Street’s consensus.

Hormel raised its FY 2018 guidance to a range of $1.81 to $1.95 per share. The previous range was $1.62 to $1.72 per share. The company also raised its starting wage from $13 to $14 per hour. In November, Hormel increased its dividend from 17 cents to 18.75 cents per share. That marked its 52nd annual dividend increase.

For Q2, Wall Street’s consensus is for 45 cents per share. That may be a bit too high, but I don’t see Hormel adjusting its full-year guidance.

Buy List Updates

Cerner (CERN) has been in the news lately due to a lot of headaches involving its new digital health program from the VA. Actually, this isn’t a new story, but the new development is a report that blasted the program. The story is also getting extra attention because the project has been supported by Jared Kushner.

The project’s price tag and political sensitivity — it was designed to address nagging problems with military and veteran health care at a cost of about $20 billion over the next decade — means it is “just another ‘too big to fail’ program,” the tester said. “The end result everyone is familiar with — years and years of delays and many billions spent trying to fix the mess.”

The unclassified findings could further delay a related VA contract with Cerner Corp., the digital health-records company that began installing the military’s system in February 2017. The VA last year chose Cerner as its vendor, with the belief that sharing the same system would facilitate the exchange of health records when troops left the service. The military program, called MHS Genesis, was approved in 2015 under President Barack Obama.

In a briefing with reporters late Friday, Pentagon officials said they had made many improvements to the pilot at four bases in the Pacific Northwest since the study team ended its review in November.

To be fair, the problems don’t appear to originate with Cerner, but rather with an antiquated government system. Fixing this turns out to be a bigger issue than people expected. I want to make it clear that there’s no allegation of wrongdoing on Cerner’s part. Cerner is a buy up to $61 per share.

I also want to make to adjustments to our Buy Below prices. Before I do that, let me remind you that our Buy Below prices are not price targets. I change them pretty frequently. The Buy Below prices are merely guidance for current entry into a stock.

I often get emails asking me if stock A, which is 15% below its Buy Below, is better than stock B, which is only 5% below its Buy Below. The answer is no. As long as a stock is below its Buy Below price, I like it. We try to keep things as simple as we can around here.

This week, I’m lifting our Buy Below on Stryker (SYK) to $176 per share. I’m also raising Wabtec (WAB) to $97 per share.

That’s all for now. There will be no newsletter next week. The stock market will be closed on Monday, May 28 for Memorial Day. Next week’s market will probably be fairly tame as we head into the three-day weekend. On Wednesday, the Fed will release the minutes from its last meeting. Then on Thursday, we’ll get a look at existing-home sales. On Friday, the durable-goods report comes out. 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

Buy Prices

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Dividend Investors are Happier People and How You Can Be One of Them

This week I have been giving presentations to investors attending the Las Vegas MoneyShow. One of the great parts of what I do at the show is meeting subscribers to my newsletter. My first presentation was a joint discussion of dividend investment strategies with Kelley Wright. Further below I’ll share some of rights top stock picks based in his investment strategy.

Wright is the managing editor of Investment Quality Trends. The IQT service provides buy/hold/sell recommendations on a group of about 350 blue chip stocks. To be included in the database, a company must have paid dividends for at least 25 consecutive years with histories of dividend growth. The service rates stocks based on the current yield in relation to the historic yield range. For example, if a stock’s yield is near the low end of the range it is a sell candidate. When a stock gets to the high end of the range, it would be time to buy. Total returns are generated when the share price cycle upward from a low yield to a high yield.

The IQT method is not so much about high yield stocks as a method to buy stocks when they are undervalued. The stocks in Wright’s watch list will have their highest yields when they are out of favor with the investing public. This is very much of a value strategy, and the analysis will recommend buying out of favor share of long-term high-quality companies.

Here are four stocks from Wright’s presentation that his method separates out currently as good value buys. He used the term “ridiculous values” several times.

How To Generate Safe Income From High Yield Bonds

High yield bonds, often known as junk bonds, have been very popular investments since the financial crisis of 2008. The high yield market took a nosedive around the time of the crisis, but bounced back pretty quickly, and has been stable ever since.
As interest rates have started going higher, so too have the yields on high yield bonds. For the general high yield market, yields have gone from about 5% to 6% over roughly the last year. For reference, true junk (CCC rated bonds) has a much higher yield at around 10%.

On one hand, 6% is a solid yield in this day and age. For the most part, credit risk is not something you have to worry about all that much, even with so-called junk bonds. On the other hand, a lot of highly rated stuff got crushed in 2009, when almost no one had any concerns over credit risk.

Of course, high yield investors don’t have to worry about credit risk if they use ETFs instead of the bonds themselves. It’s also much easier (and more affordable) to use a high yield bond ETF instead of buying individual high yield bonds.

The most popular high yield ETF is iShares iBoxx High Yield Corporate Bond ETF (NYSE: HYG). It’s currently got a dividend yield of 5.1% and trades over 15 million shares a day on average. The options market is also very active, with over 130,000 options trading on an average daily basis.

Speaking of options, they are a great way to generate even more income on high yield bonds or high yield ETFs. In fact, I just came across an interesting trade this week which involved writing puts on HYG.