Crossing Wall Street – August 10, 2018

“People calculate too much and think too little.” ― Charlie Munger

Earnings season has finally passed for us. It felt like the last few issues were just me reading off numbers to you: “So-and-so reported X cents, beat by Y and raised Z cents.” Despite all the math, earnings season is crucial for us, and it gives our strategy a moment to shine.

I’m happy to say that our Buy List has been doing very well lately. This week, we hit a new all-time high. We’re up 6.2% for the year, and we’ve already taken out our January peak, while the S&P 500 hasn’t quite done the same (though it’s getting very close). Going back to May 3, our Buy List is up 9.64% compared with 8.51% for the S&P 500.

Several of our stocks, like Ross Stores (ROST), Fiserv (FISV), Becton, Dickinson (BDX) and AFLAC (AFL), are at or near new 52-week highs. In this week’s issue, I want to change course and talk more about the economy and the general investing climate. The good news is that it looks very good for us. Let’s dig in and start with last week’s jobs report.

The Economy Is Good, Not Great

Last Friday, the government reported that the U.S. economy created 157,000 net new jobs for the month of June. That’s a decent figure, although it was below expectations. It means the jobs machine continues to plow on, past when many people thought it would peter out. The unemployment rate ticked down to 3.9%. The unemployment rate is lower now than it was for every single month from 1970 through 1999.

It’s true: the economy is doing well. Please understand that I mean that in a strict macroeconomic sense. Of course, lots of people are having a hard time. I don’t mean to imply that we’re on easy street. By a “strong economy,” I mean that in the aggregate, economic activity is expanding. I don’t have the final number on the Q2 earnings season, but the earnings beat rate was running over 80%, and the revenue beat rate was running at over 70%. That’s very good. Earnings were up over 20% compared with last year’s Q2.

We can see evidence in the government reports as well. The initial report on Q2 GDP showed an increase of 4.1%. That’s pretty good. Jobless claims continue to be near 50-year lows. The stock market is moving up, and the U.S. dollar is strong. What’s also interesting is that the breadth of the stock market is improving. It’s not just the FAANG stocks, but more and more smaller guys are joining the party.

It’s important that we keep an eye on interest rates. Last week, the Fed decided to leave rates alone. That was the right call, but they’ll almost certainly raise rates again in September. It won’t end there. The futures traders are betting that we’ll get another hike in December. Personally, I’m not so sure of that, but I’m open to being convinced. The recent remarks from Fed officials have stressed the need to move on rates before inflation starts to spark higher. The Fed always overshoots on rates. That’s not my opinion. It’s a well-established historical fact.

The Problem Is Wages

We should also remember that the Fed isn’t raising rates from normal to high. Instead, we’re going from very, very, very low to somewhat moderate. It’s just that we haven’t been in this range in a long time, so the change may feel larger than it is. Still, short-term interest rates are running below inflation. It’s been that way for 10 consecutive years.

The problem for the Fed is the troubling detail that appeared in last week’s jobs report, and that’s wages. Americans are seeing their pay growing, but after inflation, it hasn’t amounted to much. That’s frustrating to see. Of course, higher wages mean more shopping, and that means more profits. The improved earnings have actually lowered stock valuations over the last few months. (I wonder how many people realize that.)

This economy has been quite good for companies like Ross Stores (ROST) which focuses on bargain-sensitive consumers. The deep-discounter just made another 52-week high.

We’re also seeing renewed strength in some cyclical stocks. These are the sectors whose fortunes are mostly closely tied to the economic cycle: construction, railroads, steel, chemicals—stuff like that. On our Buy List, we’ve been getting big gains lately from our cyclicals. Later on, I’ll talk about the big rally in our wallboard company, Continental Building Products. Wabtec (WAB), our freight-services stock, is doing very well this year. Sherwin-Williams (SHW) started out poorly for us but has made an impressive turnaround.

As long as consumer spending and the housing market remain healthy, the economy will continue to chug along. A lot of people have asked me if the growing trade war will sink the economy. My answer is that it’s bad for the economy but probably not severe enough to trip things up. Among major economies, the U.S. is one of the least trade-intensive.

I would caution investors against being too heavily weighted towards technology stocks. We have some good ones on our Buy List. Check Point Software (CHKP), for example, has done well for us. It’s OK to have some tech stocks, but I don’t like the prices I’m seeing out there. Be careful not to be over-exposed.

I’d also urge investors not to forget dividends. We have lots of solid dividend-payers on our Buy List. Smucker (SJM), for example, now yields over 3%. Last month, the jelly folks raised their dividend by 9%. It was their 17th annual increase in a row.

AFLAC (AFL) has increased its dividend for 35 years in a row. Look for #36 in October. Going by Thursday’s close, the duck stock yields 2.22%. That’s equivalent to 567 points on the Dow, and you basically get that for just showing up.

It’s important not to chase stocks. Wait for good stocks to come to you. Make sure you’re well diversified, and pay attention to our Buy Below prices. Now here are some updates on our Buy List stocks.

Buy List Updates

In last week’s issue, I mentioned the excellent earnings reports from Continental Building Products (CBPX). However, the stock reported after the close on Thursday, and I wasn’t sure how the market would respond.

Well, now we know. The stock soared. CBPX gained more than 8% on Friday and then another 4.5% on Monday. It gained ground on Tuesday, Wednesday and Thursday as well. In the last week, the CBPX is up 18%. It’s now our second-biggest winner on the year (+32.5%), trailing only Wabtec (+36.9%). This week, I’m lifting my Buy Below on Continental Building Products to $40 per share.

In our last issue, I also discussed the good earnings report and higher guidance from Becton, Dickinson (BDX). The stock, however, dipped down 4% on the morning of the earnings report. I decided it was best to keep our Buy Below at $250 per share. That seemed like a nice, round number.

Well, the market kept to its trend. Not only did Becton make up the 4% loss, but it continued to rally past $250 and hit a new high. This is a really good company, and I don’t want investors to be left behind. That’s why this week, I’m bumping up our Buy Below to $260 per share.

While the big wave of earnings reports has passed us, we have three Buy List stocks with quarters that ended in July. They will be reporting earnings soon. JM Smucker (SJM) will report earnings on Tuesday, August 21. Ross Stores (ROST) and Hormel Foods (HRL) will report on Thursday, August 23. I should add that Ross has been acting very well lately. It’s up almost 15% this year. After those reports, we enter the quiet period for earnings reports. For nearly two months, only FactSet (FDS) and RPM International (RPM) will report. After that, the third-quarter earnings season will get underway in mid-October.

One other note on FactSet. Merrill Lynch said this week that it’s ditching Thomson Reuters as its primary data source and will now be using FactSet. That’s very good news. Merrill has 15,000 advisers. FDS jumped nearly 5% on Monday. I’m lifting our Buy Below on FactSet to $219 per share.

We also had good news from Fiserv (FISV). The board has authorized the company to buy back 30 million shares of stock. That’s about 7.5% of their outstanding shares. The stock broke out to another new high, and it’s a 20% winner for us this year.

That’s all for now. No Buy List earnings reports next week, but there are some key events to look out for. On Wednesday, we’ll get reports on retail sales and industrial production. The IP numbers have been looking better lately. On Thursday, we’ll get reports on housing starts and jobless claims. The jobless-claims numbers are still very close to the best figures since the 1960s. 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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