CWS Market Review – July 12, 2019

“We don’t have any basis, or any evidence, for calling this a hot labor market.”
– Jerome Powell

Future historians will note that on Wednesday, July 10 at 9:50 a.m. ET, the S&P 500, for the first time ever, broke through 3,000.

Sure, it fell back again, but it really did happen. Then on Thursday, the Dow broke above 27,000.

What was the cause of this latest rally? That came in the form of Fed Chairman Jay Powell. The Fed head spoke before Congress this week and strongly hinted that the Fed was ready to lower interest rates. How many times is still not known, but Wall Street is pleased with the news. Since June 3, the S&P 500 is up over 9%.

In this week’s CWS Market Review, I’ll go over the latest from the Fed. Also, earnings season is upon us. We have our first Buy List earnings reports coming next week. I’ll preview what’s in store.

The Fed Signals It’s Ready to Cut Rates

Last Friday, shortly after I sent you last week’s issue, the government reported that the U.S. economy created 224,000 net new jobs in June. That was an impressive figure, and it was higher than Wall Street had been expecting. The unemployment rate rose a tick to 3.7%.

On Thursday, we got a CPI report that was a bit higher than expected. The government said that inflation rose 0.1% last month, while the “core rate,” which ignores food and energy, rose by 0.3%. That was the highest jump for core inflation since early 2018.

Also on Thursday, the jobless-claims report fell to 209,000. That’s the lowest in three months.

Taking these three news items together, it appears that the labor market is doing well, and there may be cost pressures building in the economy.

This seems to have had zero effect on the Federal Reserve and its plans for interest rates. This week was the Humphrey-Hawkins testimony. This is the law that requires that the Chairman of the Federal Reserve to go to Capitol Hill twice a year to testify before the House and Senate Committees.

(Years ago, I used to go to these. Once I got the coveted the seat directly behind Bernanke.)

The chairman was asked directly if he thought the labor market was running hot. He said, “We don’t have any basis, or any evidence, for calling this a hot labor market.” That’s unusually frank language for a Fed chair. They’re trained to speak in Obfuscation.

Also this week, we got the minutes from the Fed’s June meeting. They seemed to indicate a growing consensus at the Fed for an interest-rate cut.

Consequently, on Thursday, the Dow, Nasdaq and S&P 500 all closed at record highs. The unemployment rate is near a 50-year low, and the Fed is ready to rescue us. I have to admit that I don’t see the need for a rate cut right now. I thought the December hike was a mistake, so I suppose I can see one rate cut. Wall Street, however, sees a string of rate cuts coming our way. According to the futures markets, there’s a 100% chance of a cut at the end of this month. It’s hard to get more certain than that.

That’s not all. Traders think there’s a 70% chance of another cut in September, plus a third rate cut in December. That could be right. Chairman Powell said, “we hear lots of reports of companies having a hard time finding qualified labor; nonetheless, we don’t really see wages responding.”

Once concern is that if the Fed doesn’t cut, then it would be out of alignment with monetary policy in Europe. The European Central Bank may start a new round of bond buying. In fact, the ECB may soon cut interest rates again, which are already negative. Inflation expectations have plunged in Europe.

Here’s an interesting chart. The blue line is the real Fed funds rate based on core inflation. The red line is the year-over-year growth in nonfarm payrolls. These two lines had a fairly moderate correlation that was broken apart by the last recession.

Can the Fed cut rates when the market is near an all-time high? Ryan Detrick ran the numbers and found that since 1980, the Fed has cut rates 17 times when the S&P 500 was within 2% of a new high. One year later, the market was higher all 17 times.

One of the good aspects of our style of investing is that we don’t need to predict Fed policy. While I find the Fed’s plans to be stronger than necessary, they don’t alter our basic approach. The important takeaways are that lower short-term rates are mostly bullish for the stock market. Lower short rates usually allow for higher equity valuations. Indeed, that probably explains why the market jumped to new highs this week.

There are also important internal changes to the market. When short-term rates fall, high-dividend stocks are more appealing. We can certainly see that effect in our portfolio. Conversely, financial stocks tend to lag as rates fall. (Please note that I’m speaking in very general terms.)

This week has been a good one for our Buy List. We’re up more than 22% this year. But second-quarter earnings season is about to start. Let’s take a closer look.

Second-Quarter Earnings Preview

There’s hasn’t been a lot of news about our stocks recently. Mostly, it’s been a broad rally, and several of our stocks have made new 52-week highs. On Thursday, both Cerner (CERN) and Moody’s (MCO) made new highs. Both stocks are up over 40% for us this year and have a chance of dethroning FactSet (FDS) as our top performer this year.

Here’s a list of our stocks, the reporting date and Wall Street’s consensus. I have to include my typical warning that these dates and numbers sometimes change. Some companies are, shall we say, not overly forthcoming when it comes to shareholder communication.

Company Ticker Date Estimate
Eagle Bancorp EGBN 17-Jul $1.12
Danaher DHR 18-Jul $1.16
RPM International RPM 22-Jul $1.14
Sherwin-Williams SHW 23-Jul $6.40
Torchmark TMK 24-Jul $1.65
Check Point Software CHKP 24-Jul $1.37
Cerner CERN 24-Jul $0.64
Stryker SYK 25-Jul $1.94
AFLAC AFL 25-Jul $1.07
Hershey HSY 25-Jul $1.17
Raytheon RTN 25-Jul $2.64
Moody’s MCO 31-Jul $2.00
Church & Dwight CHD 31-Jul $0.52
Cognizant Technology Solutions CTSH 31-Jul $0.92
Intercontinental Exchange ICE 1-Aug $0.93
Disney DIS 6-Aug $1.76
Becton, Dickinson BDX 6-Aug $3.07
Signature Bank SBNY TBA $2.71
Fiserv FISV TBA $0.81
Continental Building Products CBPX TBA $0.52
Broadridge Financial BR TBA $1.71

I want to cover two earnings reports scheduled for next week.

Eagle Bancorp (EGBN) is due to report on Wednesday, July 17. Three months ago, the bank missed earnings by one penny per share. I’m not too concerned by that.

Eagle is currently going through a transition after the former CEO, Ron Paul, announced his retirement. Susan G. Riel had been the interim President and CEO, and now she’s taken those positions permanently.

About the Q1 results, Riel said, “The Company’s assets ended the quarter at $8.39 billion, representing 9% growth over the first quarter of 2018. First-quarter 2019 earnings resulted in a return on average assets of 1.62% (1.85% excluding nonrecurring costs as defined above) and a return-on-average tangible common equity of 13.38% (15.26% excluding nonrecurring costs as defined above).”

For Q2, Wall Street expects earnings of $1.12 per share. EGBN is currently going for just over 11 times next year’s earnings estimate.

Danaher (DHR) is scheduled to report its earnings the following day, on July 18. Three months ago, Danaher reported Q1 earnings of $1.07 per share. That was three cents more than estimates.

Danaher has been quite busy this year. The company is buying GE’s biopharma business for $21.4 billion. Danaher said it expects Q2 earnings to range between $1.13 and $1.16 per share. The company lowered its full-year guidance. The previous range was $4.75 to $4.85 per share. The new range is $4.72 to $4.80 per share. This reflects the share dilution to buy GE Biopharma. The deal should close sometime in Q4.

Sometime in the second half of this year, Danaher will IPO Envista Holdings, which is their dental business. The ticker symbol will be NVST. Shares of DHR hit a new 52-week high last week.

I’m also going to include Signature Bank (SBNY). The bank hasn’t said yet when it will report earnings, but going by previous years, July 18 is a good candidate.

Signature may be one of our most frustrating stocks to own. The stock seems to move in big streaks. SBNY was a 30% winner for us this year by February 11. After that, it started to lag. Fortunately, SBNY is on the rise again.

Three months ago, the shares got dinged after the bank missed estimates by 12 cents per share. For Q2, Wall Street expects earnings of $2.71 per share. The stock is currently going for about ten times next year’s earnings. With the earnings report, the bank may increase its dividend as well.

That’s all for now. In addition to earnings reports, there are some key economic reports next week. On Tuesday, we’ll get the latest report on retail sales and industrial production. Then on Wednesday, the report on housing starts is released. Thursday is jobless claims, and Friday is consumer confidence. We’ll also get an update on the budget for this year. 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

P.S. Next Friday, July 19, I’ll be on Bloomberg TV’s market wrap segment at 4 p.m. Tune in!