Crossing Wall Street – October 11, 2019

“The expectation of an event creates a much deeper impression on the exchange than the event itself.” – Jose de la Vega, 1688

Third-quarter earnings season is finally here! This is like Judgement Day for Wall Street. If you do well, your shares can be richly rewarded. However, if you disappoint the market gods, they show little mercy.

This could the first quarterly earnings decline for the S&P 500 in three years. If I had to guess, I’d say that we’ll narrowly avert a decline, but it will be close. Still, earnings expectations have come down a lot. Since January 1, the estimates for Q3 earnings have been pared back by 8%. The typical Wall Street game is to lower expectations just low enough that companies can beat them by a few percentage points. Then, of course, they declare victory.

In this week’s issue, we’ll look at some of our Buy List stocks that are due to report earnings next week. But first, last week we learned that the unemployment rate fell to a 50-year low, yet the Federal Reserve has been cutting rates, and will likely do so again soon. What gives? I’ll share my thoughts.

It’s a Weird, Weird World

The current state of the economic world is weird. At least, it is to me. All the standards that I learned and had become used to, it seems, have been thrown out the window.

I never thought that bonds with negative yields were possible, yet here we are. There’s several trillion dollars’ worth of them to tell me I’m wrong, so I’ll believe them.

I didn’t think the Federal Reserve could lower interest rates to 0%. Or keep them there for years. Or see other central banks go even lower. Yet it happened.

I didn’t think the U.S. economy could expand at a tepid yet steady pace for ten years. Again, it happened.

Nor did I think the economy could create so many jobs so consistently, yet not see much in the way of wage increases. But we saw it.

It seems to me that the natural interest rate has dropped to near 0%. That’s so bizarre to me, but I suspect it’s true.

All of these trends baffle me, and I can’t explain what’s happening. Sure, I have some ideas. But the point is that the current economic models for the world aren’t very useful right now. The financial crisis broke economics, and no one’s put it back together yet. At some point, I imagine we’ll see some brilliant young professor who will tie all the pieces together. But until then, I’m pretty stumped.

You’ll notice that the conflict I’m describing isn’t so much between me and someone else. It’s really between me and me—what I see going on and what I’ve been taught. I’m not alone.

Here’s the important point for us. You don’t need to have the world figured out to be a good investor. All you really need is discipline and time. I’d also add a suppleness of mind that allows you take in discordant evidence. Most people, when presented with evidence that conflicts with their belief, simply dismiss the evidence. Dogmas offer comfort.

Now let me apologize for that brief bit of navel-gazing, and we’ll turn to last week’s labor report. On Friday, the government said that the economy created 136,000 net new jobs last month. The previous month’s figures were revised a bit higher.

The unemployment rate ticked down to 3.5%. That’s the lowest in 50 years. It’s also the lowest peacetime rate in more than 70 years. (Some folks on Twitter took me to task for calling this peacetime. Sorry, but I stand by my claim. In terms of mobilization, the current deployments are nowhere close to the numbers we saw in Korea and Vietnam. Not to mention that there was a draft.)

Despite the unemployment rate’s being so low, there’s still not much in the way of inflation. This week’s inflation report showed no change for September. The core rate rose by 0.1%. That’s good to hear since the three months prior to that all saw increases of 0.3%. If there was any threat of higher prices, that fear seems to have passed.

This means the Federal Reserve will almost certainly cut interest rates again when they meet on October 30. Another cut will bring the Fed’s target for the Fed funds rate to 1.5% to 1.75%. There’s a chance that the yield curve could revert soon. The spread between the three-month and 10-year yields is down to one basis point. A few weeks ago, the spread was over 50 basis points.

What about after that? I think the Fed might take it easy after that. Lower rates will help the mortgage market, and that will filter down to the housing sector. Have you noticed that Continental Building Products (CBPX), our wayward wallboard stock, is up more than 25% since early August? Sherwin-Williams (SHW), the paint people, just touched a new 52-week high. About this time last year, SHW was getting crushed by the market. As Jesse Livermore said, “It never was my thinking that made the big money for me. It always was my sitting.”

Now let’s turn to earnings season.

Earnings Preview for Eagle Bank and Signature Bank

Earnings season kicks off for us next week when Eagle Bank and Signature Bank are due to report. Actually, I’m guessing that Signature will report on October 17. They haven’t said so yet, but I’m guessing that based on previous years. Eagle has said they’ll report on October 16.

Let’s start with Eagle Bancorp (EGBN) because their last earnings report caused so much trouble. In July, Eagle said they made $1.08 per share for their Q2. That was pretty good. It was four cents more than expectations.

The problem is that Eagle also said their legal bill has soared due to “investigations and related document requests and subpoenas from government agencies.”

A few key points. The bank made it clear that this will not “materially impact its results.” Also, the bank isn’t under any regulatory restrictions. The problem is that Eagle isn’t allowed to talk about what’s happening. I suspect this is connected to local Washington, D.C. political scandals. On July 18, the shares dropped almost 27%.

For Q3, Wall Street expects earnings of $1.07 per share. Eagle is trading for less than 10 times this year’s earnings estimate.

Three months ago, Signature Bank (SBNY) reported earnings of $2.72 per share. That beat expectations by one penny.

Net interest margin came in at 2.75%. That’s down 20 basis points from a year ago. That’s not great, but it’s certainly respectable for this environment.

I’m happy to say that Signature is almost done with its taxi-medallion mess. The bank went into this in a big way, but then thanks to ride-sharing apps, the medallions plunged in price. That left the bank holding a bunch of bum loans.

In Q2, Signature sold off $46.4 million in medallion loans. That leaves them with $18.8 million in non-performing medallion loans plus $43.8 million in repo-ed medallions. It was a costly mistake, but the issue is basically behind them.

For Q3, Wall Street expects Signature to earn $2.70 per share.

Hormel Foods Updates Guidance

This week, Hormel Foods (HRL) hosted an investor day. The Spam folks narrowed their full-year guidance by a tiny bit. Hormel now sees full-year earnings ranging between $1.76 and $1.80 per share. The previous guidance was $1.71 to $1.85 per share.

The shares pulled back some on the news. Q4 results will come out on November 26. Hormel remains a buy up to $46 per share.

That’s all for now. Earnings reports will probably dominate the headlines next week. The bond market will be closed on Monday for Columbus Day, but the stock market will be open. On Wednesday, the retail-sales report comes out. This should give us a good look at consumer spending which had been doing well. Then on Thursday, we’ll get the report on industrial production. There will also be reports on housing starts and building permits. 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