CWS Market Review – July 13, 2018

“Intelligent investment is more a matter of mental approach than it is of technique.”
– Ben Graham

On Thursday, the S&P 500 closed at its highest level since February 1. The Nasdaq Composite did even better, closing at an all-time high. Our Buy List is no slouch either. Since May 31, the Buy List is up 5.8%, which is well ahead of the broader market. Buy List stocks like Moody’s, Fiserv and Church & Dwight are at new highs.

What’s the reason for Wall Street’s happy mood? This really isn’t a case of good things happening. Instead, it’s the ebbing of the fear that bad things were coming. More specifically, the U.S. engaging in a protracted trade war with the world, especially China.

In this week’s issue, we’ll take a closer look at the trade news impacting Wall Street. I’ll also preview our Buy List earnings reports coming next week. Second-quarter earnings season is starting now. Get ready because we’re soon going to have a lot of earnings news.

The Jobs Machine Churns On

Here’s an interesting stat on our Buy List: In 15 of the last 16 trading sessions, the daily swing in our Buy List has been less pronounced than that of the overall market. In other words, on up days, we’re less up. On down days, we’re less down. In fact, we’ve been much less down.

In technical terms, this means our portfolio has a low “beta.” Typically, our beta is low, but it’s been unusually low recently. The reason is that Wall Street is swinging back and forth between two possible outlooks for trade. On some days, it looks good for trade. Then on other days, it doesn’t look so good.

The key is that our portfolio isn’t so wedded to these competing outlooks. We aim for high-quality stocks that prosper no matter what the environment. As a result, we’ve been sidestepping the trade-related swings of late. Think of the market as a boat that’s rocking in the waves. Our Buy List is nestled near the center of the boat, but lots of investors are perched at other side, getting soundly tossed about each day.

The S&P 500 has rallied eight times in the last ten days. Last Friday, China and the U.S. imposed tariffs on each other. I think some investors thought that the world would implode. Well, it didn’t happen. It’s as if there’s a sudden realization that life will go on.

The trade news is bad, but it’s not that bad. The economy will motor on. Later today, some of the big banks will report Q2 earnings. I think we’ll see good results. In fact, the banking sector was especially strong on Thursday. For Q2, corporate profits probably rose more than 20%.

Last Friday, the government released the jobs report for June, and the numbers were pretty good. The U.S. economy created 213,000 net new jobs last month. The unemployment rate ticked up from 3.8% to 4.0%. I dug into the decimals and the increase was closer to 0.3%. That’s the largest monthly increase in the unemployment rate since November 2010.

A big uptick in unemployment is a pretty good indicator of a recession, but I doubt it in this case. The reason is more workers joining the labor pool. That creates the oxymoron of more jobs leading to a higher unemployment rate. After nine years of economic expansion, the jobs-to-population ratio isn’t that high. In fact, the ratio is currently lower than it was at any point from 1987 to 2008.

But with good jobs news, we got some concerns about inflation. On Thursday, the government released the latest inflation figures for June. Consumer prices rose by just 0.1%. What’s notable is that, in the past year, inflation is up by 2.87%. That’s the fastest rate since January 2012.

I also like to look at the “core rate,” which excludes food and energy prices. In June, core inflation rose by 0.2%. The year-over-year increase is 2.26%, but that’s up by 0.54% since November. In other words, inflation has effectively erased two of the Fed’s rate hikes in the last few months.

To sum up, this is a very good time to be an investor. The trouble spots are still a ways off. Continue to focus on high-quality stocks like you’ll see on our Buy List. Don’t let a bad reaction to an earning report faze you. Traders are fickle. So often, our best stocks drop the day after earnings, but rally back later on. We also want to pay attention to stock that reaffirm or increase their guidance. Now let’s look at our first batch of Q2 earnings reports.

Second-Quarter Earnings Calendar

Over the next few weeks, 21 of our 25 Buy List stocks will report their earnings. I don’t have all the earnings dates just yet, but here’s a preliminary list of each stock, the earnings date and Wall Street’s estimate.

Company Ticker Date Estimate
Alliance Data Systems ADS 19-Jul $4.67
Danaher DHR 19-Jul $1.09
RPM International RPM 19-Jul $1.18
Snap-On SNA 19-Jul $2.95
Sherwin-Williams SHW 24-Jul $5.66
Stryker SYK 24-Jul $1.73
Wabtec WAB 24-Jul $0.93
Check Point Software CHKP 25-Jul $1.30
AFLAC AFL 26-Jul $0.99
Moody’s MCO 27-Jul $1.89
Fiserv FISV 31-Jul $0.74
Becton, Dickinson BDX 2-Aug $2.86
Ingredion INGR 2-Aug $1.92
Intercontinental Exchange ICE 2-Aug $0.89
Carriage Services CSV TBA $0.37
Cerner CERN TBA $0.60
Church & Dwight CHD TBA $0.47
Cognizant Technology Solutions CTSH TBA $1.10
Continental Building Products CBPX TBA $0.45
Signature Bank SBNY TBA $2.81
Torchmark TMK TBA $1.49

On Thursday, four of our Buy List stocks are due to report; Alliance Data Systems, Danaher, RPM International and Snap-on.

I’m most curious about Alliance Data Systems (ADS). The loyalty-rewards company has staged a furious turnaround for us. Three months ago, Alliance reported Q1 core earnings of $4.44 per share. That easily topped Wall Street’s estimate of $4.23 per share, however, that the estimate had been severely pared back going into the earnings report. Not long before, Wall Street had been expecting over $5.10 per share for Q1.

Regarding Q1, Alliance’s CEO said, “This quarter’s pro-forma revenue growth of 4 percent and core EPS growth of 13 percent should reflect our softest quarter of the year. Specifically, higher reserve levels required to cover the transitory impacts of the internal recovery investment was an approximate $0.60 hit to core EPS for the first quarter. Moving forward, recovery rates should move in our favor.”

ADS reiterated its full-year guidance of $22.50 to $23 per share with revenue of $8.35 billion. If those numbers are right, then ADS is going for a decent valuation. For Q2, Wall Street expects earnings of $4.67 per share.

Danaher (DHR) had a very good report for Q1. The company made 99 cents per share. Initially, the company provided Q1 guidance of 90 to 93 cents per share. They followed that up by saying that thanks to strong results from their Life Sciences and Diagnostics platforms, “specifically at Cepheid,” they’ll beat their guidance. They were right.

For Q2, Danaher sees earnings of $1.07 to $1.10 per share. In April, the company raised its full-year guidance. The old range was $4.25 to $4.35 per share. The current range is $4.38 to $4.45. In 2017, DHR made $4.03 per share.

RPM International (RPM) is usually one of our quietist stocks, but it’s been making a lot of noise lately. Since April 2, shares of RPM are up nearly 30%. The recent spark came when the company said they reached an agreement with Elliott Management.

According to the agreement, RPM will add two new board members. The board will also form an Operating Improvement Committee. The OIC will “focus on operational and financial initiatives to create and enhance shareholder value. Certain of these initiatives will center around setting and achieving new company margin targets based on top-performing industry standards and optimization of RPM’s balance sheet, including streamlining working capital and implementing new capital allocation guidelines and capital return plans.”

The idea is that RPM will be more transparent regarding its financial goals. They’ll provide an update for shareholders by November 30. Trades approved the deal. The stock jumped 9% on the Elliott news.

I should mention that RPM if an off-cycle stock. Their fiscal Q4 ended in May.
For Q4, they expect consolidated revenue growth in the “mid-to-upper” single digits. In April, RPM narrowed its full-year guidance from $3 to $3.10 per share to $3.05 to $3.10 per share. This is a good company going for a good valuation. Let’s also remember that RPM has raised its dividend for the last 44 years in a row. That’s a nice streak.

Snap-on (SNA) was our surprise winner last earnings season. The company reported Q1 earnings of $2.79 per share, seven cents more than estimates. The shares jumped more than 6% that day.

Lately, I’ve been concerned by weakness in Snap-on’s tool group. Fortunately, their other business units are picking up the slack. Wall Street currently expects Q2 earnings of $2.95 per share.

I’m also going to include Signature Bank (SBNY). Officially, the bank hasn’t said yet when they’ll report earnings, but they usually report early. I’m guessing it will report on Thursday. The stock just dipped down to an eight-month low. The New York-based bank took a massive charge during Q1 for its medallion loans. The other headwind SBNY is facing is the narrowing yield curve. Wall Street expects Q2 earnings of $2.81 per share.

Ingredion (INGR) won’t report until August 2, but after the bell on Thursday, the company warned that its Q2 results will be between $1.63 and $1.68 per share. Wall Street had been expecting $1.92 per share. They also lowered their full-year guidance from $7.90 to $8.20 per share, down to $7.50 to $7.80 per share. That’s the second time they’ve lowered guidance this year. Ingredion also announced an aggressive cost-cutting program. That usually makes me suspicious. A good company should always be looking to cut costs. I’m not pleased with Ingredion. I’m dropping my Buy Below price to $100.

That’s all for now. Earnings season will start to heat up next week. We’ll also get some key economic reports. The retail sales report comes out on Monday. Then on Tuesday, we’ll get a look at industrial production. The data series has improved over the last two years. Then on Wednesday, the housing starts report comes out. Also, Fed Chairman Jerome Powell will deliver his semiannual Congressional testimony on Tuesday and Wednesday. 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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