Yesterday, May 25, U.S. stocks looked set to bust right on through the top of the recent trading range at 2100 after moving to 2090.54 at the close.
Today, May 26, not so much. The index stalled at 2090–and closed at 2089.25.
Yesterday, it looked like the markets–both in the U.S. and overseas–had decided that a rate increase from the Federal Reserve was no big deal and wouldn’t put a dent in the global economy. And, markets, seemed to believe, the U.S. economy looked like it was ready to rebound from a weak first quarter.
Today not so much. U.S. economic data was mixed with good news on initial claims for unemployment–down for a second week–and pending homes sales–ahead the most since 2010–but with unexpected negative news on orders for durable goods. Orders for non-defense capital goods–excluding aircraft–fell 0.8% while economists had forecast a 0.3% gain.
Maybe this is just a pause as the market gets ready for an assault on 2100. Maybe it’s just a bit of uncertainty ahead of a speech Friday by Janet Yellen, the head of the Fed, and the release of revised estimates of first quarter GDP.
…I can’t help thinking that the fundamentals don’t justify a breakout above 2100 right now.
I know, I know: Fundamentals how quaint. Just indulge me for a minute and look at where we stand in terms of the stuff that’s supposed to, eventually, justify what we pay for stocks.
The first quarter of 2016 showed a 6.8% drop in earnings for the stocks in the S&P 500. That marked the fourth consecutive quarter of lower earnings–the first such streak since the fourth quarter of 2009. The estimate for the quarter as of March 31 had been for an 8.8% drop in earnings so I suppose the actual decline was better than expected.
Estimates for the second quarter, the one that ends on June 30, are better, but still forecast negative growth. FactSet calculates the consensus forecast at a decline of 4.7% in earnings and 1.2% in revenue. Yardeni Research is looking for a 4.1% drop in second quarter earnings.
Hardly the stuff to drive stocks already near an all time high to new heights.
Current estimates for the third quarter aren’t exactly the stuff to set the heart a flutter. FactSec is calling for 1.3% growth in earnings for the S&P 500. Yardeni sees 2.8%.
Positive instead of negative, but still….
Part of the problem is that if the Fed raises interest rates it’s not a plus for company earnings–outside of the financial sector. And if oil prices hold at the recent $50 a barrel or head higher, that too will take a bite out of earnings for everybody but oil companies.
(A big recovery in energy sector earnings is behind the current estimates for 7.5% earnings growth in the fourth quarter (FactSet) or 8.4% (Yardeni Research.)
Right now, according to Yardeni Research, profit margins for the S&P 500 companies, at 10.6%, looked to have peaked in 2015 for this cycle. (A peak in profit margins would also explain at least some of the drop in orders for capital goods. You don’t invest in as much new machinery if you think profit margins are coming down.)
If these estimates of fundamentals are correct, it’s hard to see much headroom above 2100 no matter what markets believe today or yesterday about the effects of Fed interest rate increases on global economies.
On the fundamentals, that is.
On my paid site JubakAM.com I aim for a mix of posts on macro trends and on individual stock picks. It’s a strategy I call tactical stock picking.
On the macro end, I’ve been posting on the wild swings in the market consensus on a June or July interest rate increase from the Federal Reserve. Odds of a June increase have climbed to 33% today, May 25, from just 4% before the release of the minutes from the Fed’s April meeting. What’s been especially interesting to track–and hard to explain–is the market’s swing from fear that a Fed interest rate move would tank the U.S. and global economies to a seeming belief today that the U.S. and global economies would be just fine with higher U.S. interest rates. The Standard & Poor’s 500 was up again–quite a turnaround from the weakness of early last week–but at a close of 2090 we’re still in the trading range of 2000 to 2100. We get data next week that could bust us above that range–ISM Manufacturing, ISM Services, and the May jobs report–but it could also send us back toward the bottom of the range. We’re getting a lot of movement here without much net change–or conviction. So far.
On the individual stock end, I posted today on a strategy for buying Apple on the iPhone 7 disappointment in the fall and why the recent really great numbers on orders for OLED equipment from Applied Materials supports that timing. It sounds like everybody and their Aunt Nellie is buying equipment to make brighter, thinner, and more energy efficient displays for their 2017 smart phones. Which leaves a big question for 2016 sales of why anyone would upgrade now rather than waiting a year. I think rumors for the new features on the iPhone 7 say that this September isn’t going to see big numbers for Apple. Which might create a buying opportunity ahead of the 2017 phones. Today’s piece on Apple is a delayed entry in my Sector Monday series. I’m planning a second post in that series tomorrow on robotics stocks. I’ll give you a little more on that subject here tomorrow,
That’s what I’m working on at my subscription JubakAM.com site. I think there’s some value to you in passing on the direction of my thinking about the market on that site. Hope so anyway.
Of course, there’s an ulterior motive to sharing this with you: If you decide that you’d like more of my thoughts on the market in my JubakAM.com posts, I’m hoping that you’ll subscribe to my site at JubakAM.com for $199 a year. (By the way, you can get a full refund during the first seven days if you change your mind for any reason.)
Update May 24. On May 4 natural and organic foods producer Hain Celestial Group (HAIN) announced fiscal third quarter 2016 earnings of 49 cents a share, in line with Wall Street projections. Revenue of $749.86 million, up 13.1% year over year, beat projections by $16.69 million. The company told Wall Street to expect slightly (and I mean slightly) better than expected revenue and earnings for the full fiscal year: $2.95 billion to $2.97 billion, up from the consensus of $2.94 billion and earnings of $2.00 to $2.04 a share, above the current $2.02 consensus.
That seemingly mildly positive report has sent the shares up 18.2% from the May 3 close of $41.09 to the close today, May 24, at $48.56. That continues a great run in the shares from the January 25, 2016 low of $33.46 and Hain is now up 20.2% for 2016 to date. (Unfortunately I added Hain to my Jubak’s Picks portfolio back on March 26,2015 and that position is still underwater to the tune of 23.2%.)
So why the strong positive reaction to a mild revenue beat and a slight uptick in guidance?
Two reasons, I think.
First, Wall Street analysts have decided that the slump in the company’s growth is over. Revenue climbed 13% year over year and earnings per share climbed 9% year over year.
Second, the company said it is looking at cutting costs so that more of that revenue growth turns into earnings growth.
To take the two points one at a time.
First, the growth slump had raised fears that the company was falling victim to increased competition in the very hot healthy, natural and organic foods market. As revenue has increased for that segment conventional grocers and big box retailers such as Target (TGT) and Wal-Mart Stores (WMT) have all moved to grab a slice of the pie. That has posed problems for healthy, natural and organics grocer Whole Foods Market (WFM)–more competition has meant pressure on margins–and there was certainly reason to think that the same phenomenon would hurt Hain Celestial Group. However, it increasingly looks like analysts and investors who pointed out that Hain Celestial operated a different business model than Whole Foods had a good point. Hain Celestial is a company that sells its branded healthy, natural and organic products through distribution channels that include conventional grocers (55% of sales) and big box retailers–as well as through Whole Foods and similar retailers. Hain Celestial has focused on building distribution in those channels so that it can capture growth no matter what channel it comes from. Margins are indeed lower in the conventional and big box channels but by capturing the growth in those new channels Hain Celestial keeps the ability improve margins by cutting costs in its own hands as revenue grows.
And thats why, second, the plan to cut costs is so important. If Hain Celestial can increase efficiency as it grows revenue, then the increased competition (and higher sales) in the segment from conventional and big box retailers actually can work to the company’s benefit. Talk about cost cutting is always just talk until the results show up (or not) on a company’s bottom line, but Hain Celestial has a good record of managing costs and increasing efficiency at the smaller companies it has acquired over the years. For example, SG&A expenses have fallen as a percentage of sales each year since 2010. I think this commitment to cut costs has a good chance of being more than just talk.
In the aftermath of the quarterly earnings announcement (and indeed in the weeks leading up to it) Wall Street analysts raised their target prices on the stock–something I always like to see after a stock has climbed 20% or so. Jefferies raised its target price to $55 from $50, for example. Oppenheimer had earlier raised its target price to $44 from $38. Morningstar, which has set its own target price at $47, forecasts 11% compounded average annual growth in revenue through 2020 and sees operating margins climbing 250 basis points to 13.5% from 2016 to 2020.
The big punishment dished out to Hain Celestrial in 2015, when the stock fell 31%, means shares are still reasonably priced at 24 times projected earnings for fiscal 2016. (Over the last five years Hain Celestial has traded at an average price to earnings ratio of 32.6) As of May 24, I’m reducing my target price from an overly aggressive (for a modestly growing U.S. economy, which accounts for 51% of company sales) $72 a share to $60. That’s still roughly 20% above the current share price.
Welcome back to December! Remember when the financial markets thought the Federal Reserve was going to raise interest rates three times or maybe even four times in 2016 and suddenly bank stocks were the thing to own? (At least until January when the Fed pulled back from its three or four times language and the market decided that one or none was more like it for interest rate increases in 2016 and sent the sector into a dumpster.)
Well, the positioning was back today–even if just for a day. After last week’s minutes from the April meeting of the Federal Reserve and after jawboning by half the Fed board of governors (it seems), financial markets have decided that a June interest rate increase could be back on the table–odds are now up to 36% from 4% before the release of the Fed minutes–and if not June then quite likely July–odds for a July increase climbed to 54% today.
That was more than enough to help the Standard & Poor’s 500 stock index to a gain of 1.4% as the index tacked on 28.02 points to hit 2076.06, comfortably, again, above the 2050 level that triggers worry that the S&P 500 is going to break through the bottom of its recent trading range.
The way upward was led by, you guessed it, banks as the SPDR S&P Bank ETF (KBE) climbed 1.86% led by stocks such as Morgan Stanley (MS) up 2.16%, JPMorgan Chase (JPM) up 1.7%, Bank of America (BAC), up 1.45%, and Capital One Financial (COF), up 1.37%. (Capital One is a member of my Jubak Picks Portfolio.)
The logic here is that bank earnings will climb if the Federal Reserve raises interest rates since that would increase the interest rate that banks can charge on their loans.
Of course, the growing conviction that the Fed will raise interest rates sooner rather than later (just two weeks ago you had to go out to February 2017 (and not July 2016) to find a Fed meeting that got better than 50% odds for an interest rate increase) took its toll on other sectors today. Gold fell another 1.8% to $1232 an ounce to set its longest losing streak since November. The dollar held near its recent two-month high against the euro.
There’s been precious little staying power to any market trend recently and today’s love affair with banks may prove to be short-lived as well. At an investor day event today Wells Fargo (WFC) lowered its projections for its 2016 return on assets to 1.1% to 1.4% from the 1.3% to 1.6% it projected at its 2014 investor day. For the full 2016 year the bank is now looking for a return on equity of 11% to 14%, down from 12% to 15%.
The big culprit is the bank’s large portfolio of energy loans and the company told investors it was taking steps to reduce the size of its portfolio of those loans. Wells Fargo said it had cut credit lines on 68% of the energy companies it had reviewed.
But it’s what the bank said about its net interest margin that might have the most impact on a continued bank stock rally. Because Wells Fargo, like many banks, has moved to reduce risk in its portfolio, it now expects that a 100 basis point upward shift in the yield curve after a Federal Reserve interest rate increase would add 5 to 15 basis points to its net interest margin. Previously the bank had estimated that a 100 basis point shift in the yield curve would add 10 to 30 basis points to its net interest margin. (100 basis points equal one percentage point.)
The speeches, interviews, and presentations from members of the Federal Reserve keep on coming. And they all say, “We’re prepared to raise rates soon.”
Over the weekend Eric Rosengren, head of the Federal Reserve Bank of Boston, told the Financial Times that he’s ready to back a rate increase.
The heads of the St.Louis, San Francisco, and Philadelphia Federal Reserve banks are due to speak today. (Update: In his remarks today Patrick Harker, head of the Philadelphia Fed, said he could see as many as two or three interest rate increases in 2016.)
Fed chair Janet Yellen is on tap for a speech on Friday.
All this speechifying has driven the odds for an interest rate increase at the Fed’s June 15 meeting to 32%, according to Bloomberg’s calculation, from as low as 4% before the release last week of the Fed’s minutes from its April meeting.
And all this talk makes Friday’s announcement of revisions to first quarter GDP growth even more important. Right now economists are looking for the revision to increase the growth rate to 0.9% from 0.5%. That would be a “fact” to back the Fed’s argument that the economy is strong enough to take an interest rate increase in stride. And that the first read on first quarter growth would be succeeded by stronger growth in the second half of the year.
The Standard & Poor’s 500 finished down a slight 0.21% for the day, against dropping below the 2050 level that has been support for this market recently.