CWS Market Review – March 15, 2019

“Most investors want to do today what they should have done yesterday.”
– Larry Summers

Last Friday, Wall Street got spooked by a poor jobs report. For February, the economy created just 20,000 net new jobs. Wall Street had been expecting nine times that number. Some folks are dismissing this as a one-off and not indicative of a souring economy, while others think this is the beginning of more bad news.

As for me, I take a middling view. The economy is still doing well, but as investors, we need to be prudent. The fact is that earnings growth is slowing down. We’re currently in the “lull” period between earnings seasons when there’s not a lot of financial or economic news. As such, every news item probably draws undue influence.

Every day, it seems, the market gets jostled by whatever the current headline is on China or North Korea or Brexit. These issues simply aren’t that central to the market’s long-term bearing. For investors, everything comes down to earnings and interest rates. Outside that, the rest is noise.

In this week’s issue, I want to take a closer look at where we are with the economy. There are some cracks appearing in the façade. I also want to take an early look at Q1 earnings season, which is still a month away. This looks to be the slowest growth for earnings in quite some time. Later on, I’ll cover some news impacting our Buy List stocks. (Ross Stores has some ambitious plans for 2019.) But first, let’s take a deep dive into one of the worst jobs reports in years.

The Jobs Report Was a Bust, but Should You Be Worried?

Last Friday, the government released the jobs report for February, and the numbers weren’t good. The U.S. economy created just 20,000 net new jobs last month. That was far below expectations of 180,000. In fact, this was the third-lowest number of the past eight years. The unemployment rate ticked down to 3.8%.

A few points. One is that the jobs data is revised several times. Also, by the government’s admission, the jobs data is a rough estimate with a fairly large error margin. The problem is that this report aligns with some (note my word choice here) other economic data.

For example, I’ve previously discussed the rotten retail-sales report for December. I tend to think it’s a bad number because businesses like Walmart and Ross Stores said they’ve been doing well. This week, however, the retail-sales report for January was a bummer as well. In fact, the lousy report for December was revised downward. It’s even lousier. For Q1, the Atlanta Fed now expects GDP growth of just 0.4%. Yikes!

I’ve also noticed that some of the recent weekly jobless-claims reports have been on the soft side. That could be due to the government shutdown. That data series tends to bounce around a lot. Also, the labor markets tend to be a lagging indicator. In fact, I’ve dug through the numbers and found that high unemployment is often a very good buy signal for stocks.

As always, the housing market is crucial. This week, the new-home-sales report came in below expectations. The soggy housing market may pick up soon since mortgage rates have fallen to the lowest in over a year. Recently, economists at Goldman Sachs made the case that housing is due for a rebound. I think they’re right, and it’s another reason why a patient Fed is good news.

We’ll know more about housing when we find out the earnings report from Buy List stocks like Sherwin-Williams (SHW) and Continental Building Products (CBPX). In fact, shares of Continental have dropped lower recently. The stock had gapped up a favorable earnings report, but it’s given back all those gains. My Buy Below for Continental is currently $31 per share, but if you’re able to get in below $26, then you got a good deal. I’ll caution you it will take time to rally.

Not all the economic news has been bearish. This week, the Commerce Department said that orders for durable goods rose by 0.4% in January. That’s the highest in six months. Also, the jobs report showed that average hourly earnings are up 3.4% in the last year. That’s not great, but it’s the highest rate in the last ten years. That underscores an important aspect of the economic recovery: lots of jobs have been created, but wage growth has been listless. I think we’re a long way from full capacity.

On Wednesday, the S&P 500 did something I would not have predicted. It hit its highest level since early October. This is also another reason why I don’t try to predict where the market is headed. (Once a member of the financial media asked me what my “year-end target” was. I said “December 31st.” I haven’t heard back from him.) Here’s a cool fact: Since World War II, the stock market has been up in the 12 months following the midterm election every time. That’s a perfect 18-for-18.

Before this week, the S&P 500 fell eight times in nine sessions. Monday, Tuesday and Wednesday of this week were all strong up days. The index is currently above its 50- and 200-day moving averages. However, I want to stress caution. Within the stock market, the industrial sector has been badly lagging. Coupled with this, small-caps issues have lagged while the biggest stocks have enjoyed the best gains.

This is a good time to be conservative. Look for solid dividend stocks (SJM at 3.3%!), and stay away from any shaky high-fliers. As always, pay attention to our Buy Below prices. They’re here for your protection. Now let’s take a look at what we can expect when first-quarter earnings season begins in a few weeks.

This Could Be the Worst Earnings Season in Three Years

March is already halfway over, and soon Q1 earnings season will be upon us. This will be an interesting season for Wall Street because the earnings got a big boost in 2018 thanks to the corporate tax cut. That story has run its course. For Q4, the S&P 500 had the highest number of earnings misses since Q4 of 2013.

Currently, Wall Street expects Q1 earnings from the S&P 500 of $37.12 per share. That’s the index-adjusted number. Every one point in the index is worth roughly $8.4 billion. Over the last six months, the Q1 estimate has been revised lower by nearly 10%. If that estimate is correct, it would represent growth of just 1.6% over last year. That would be the weakest growth in some time. In fact, there’s a good shot that Q1 growth won’t be growth at all, but instead will show an earnings decrease.

The big weak spot is Energy. Oil prices still haven’t done much. We don’t own any energy stocks on the Buy List. That’s not a bold prediction on energy prices. I just haven’t seen anything that caught my eye. Consider that ExxonMobil (XOM) is expected to earn $4.32 per share this year. That’s down from $4.88 per share last year. In 2011, the company made $8.37 per share.

The other earnings weak spots are in Materials (-11%) and Consumer Discretionary (-11%). This certainly reflects the housing slowdown. On the plus side, earnings for Financials are expected to be up 14%, and Healthcare is expected to be up 30%. Quiz: What are the best-performing sectors over the past year? Answer: REITs and Utilities. Yep, the boring stuff has been working.

Interestingly, the Financial sector has the lowest aggregate Price/Earnings Ratio. We can see that on our Buy List. All three of our major financial stocks, AFLAC (AFL), Eagle Bancorp (EGBN) and Signature Bank (SBNY), are going for less than 12 times this year’s earnings.

Buy List Updates

I usually don’t pay much attention to ratings changes from Wall Street firms on our Buy List stocks, but I wanted to pass along two items this week. RBC Capital Markets lifted its price target on Stryker (SYK) from $184 to $204. They have an “outperform” rating on the stock. Stryker continues to be a very good stock. Also, Raymond James upgraded Broadridge Financial Solutions (BR) to “outperform” and set a price target at $118 per share.

Let me reiterate that I’m not a fan of price targets. It’s a silly concept. If a stock is good, then it’s good. There’s no set line that it needs to cross. Our Buy Below prices aren’t targets, and you’ll notice how often we change them.

Ross Stores (ROST) says it plans to open 100 new stores this year. In February and March, Ross opened 22 stores, plus six dd’s Discount stores. For 2019, the company plans to open 75 Ross Stores and 22 dd’s.

“These recent openings reflect our ongoing plans to continue building our presence in both existing and newer markets, including the Midwest for Ross, and expansion of dd’s DISCOUNTS into Oklahoma and Illinois,” said Jim Fassio, President and Chief Development Officer. “We now operate a total of 1,745 Ross Dress for Less and dd’s DISCOUNTS locations across 38 states, the District of Columbia, and Guam. As we look out over the long-term, we remain confident that Ross can grow to 2,400 locations and dd’s DISCOUNTS can become a chain of 600 stores given consumers’ ongoing focus on value.”

Ross now runs 1,500 Ross Stores. The stock recently beat earnings, raised its dividend and announced a big share buyback.

We have two Buy List earnings reports between now and Q1 earnings season. FactSet (FDS) is due to report on March 26. The stock is currently above my Buy Below price. Hold off on buying it for now. I may change our Buy Below, but I want to see the earnings report first. I’ll have more details next week. RPM International (RPM) is due to report its fiscal Q3 earnings on Thursday, April 4. Wall Street expects earnings of 12 cents per share.

That’s all for now. The Federal Reserve meets again on Tuesday and Wednesday. The policy statement will come out on Wednesday afternoon. Don’t expect any change to interest rates. The Fed will also update its economic projections for the next few years. The factory-orders report is on Tuesday. Then on Friday, the existing-home-sales report is due 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