Earnings Season – This Is What We’re Watching

As the stock markets reach new all-time highs, publicly traded companies are just beginning to report sales and earnings for the second quarter of 2017. Over the next couple of weeks we will be watching for a number of data points within the earnings reports, along with management commentary around their businesses.

We have been seeing year-over-year earnings growth accelerate over the past several quarters for the broad market index, the S&P 500. In fact, S&P earnings were in decline for four quarters (mid 2015 to mid-2016), with the drop attributed to just one sector, energy. For the first quarter of 2017, we saw earnings growth of 14%; we expect 10% growth in the second quarter. We currently expect earnings growth to accelerate in the second half of this year, providing a strong foundation for the stock market. Looking further out, consensus earnings growth of nearly 12% is expected for 2018, according to FactSet, as seen in the chart below:

A company’s earnings growth is not the only driver of a stock’s price, however. In fact, a study by McKinsey & Co. showed that a 1% beat had virtually no impact of the price of a company stock five days after the earnings announcement.* Often, companies will guide analysts’ expectations down prior to the quarterly report in an effort to create a beat…managing expectations, some might say. More important, we believe, is the quality of earnings and management’s outlook versus current expectations.

We look for sales and earnings growth from core operations, not boosted by one-time events or shifts from one quarter to the next. We want to see expanding operating margins, not an earnings benefit from a one-time item such as a lower tax rate. Investors should be encouraged by management’s discussion of rising orders or new technology that will grow the business over the longer term. Is the sector showing greater growth characteristics than most have expected? Management sentiment around improved operating efficiencies or a more suitable capital structure are other positive factors that can drive stock prices higher.

Yes, a series of disappointments will impact the price of a stock over time. The disappointments would create distrust in management’s ability to accomplish their goals. Similarly a pattern of significantly exceeding expectations will lead to stock price outperformance.

However, a single disappointment, if accompanied by an improved short and/or long term outlook can result in positive stock price performance. We believe we are in a period of rising earnings, which tends to be positive for stock prices. Stay tuned.

* McKinsey & Co. Strategy & Corporate Finance – 2013

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Posted on July 20, 2017 Read More

Bear Calls

The current bull market in US stocks has been in place since early 2009, which puts us at roughly eight years. That’s not the longest bull market in history, but it’s close. The fundamentals have supported this long bull market, they are:

  • A stable and growing economy
  • Corporate earnings growth
  • A low interest rate environment (which makes stock returns more attractive)

It’s been an ideal environment for stock markets to achieve new highs, but the recent updraft in the first half of 2017 has some folks talking about corrections and crashes again. Most of their basis for a correction is based upon some sort of valuation metric or contrarian indicator. The chart below is a great example of this; it shows the biggest stock markets in the world (G7 countries) combined market capitalization as a percentage of their collective GDP’s:

We can see that it’s approaching the highs of 2001 and 2007 peaks. It’s not up to the 1.5X level but it’s getting closer.

Another chart that’s surfaced recently illustrates the amount of cash institutional investors are holding right now. Yes, it’s currently at eight-year lows. Bears might argue that there’s no more money left on the sidelines to buy stocks and push markets higher. See below:

And finally, Banc of America has a sell-side contrarian indicator that is getting some press lately. The chart below are the results from a survey of Wall Street strategists’ recommendations. The indicator measures the collective bullishness/bearishness of the strategists. An indicator below the green line is bullish for stocks, and above the red line is bearish. Right now, the reading is at 6 year highs, but still in neutral territory. See below:

We’re not going to argue that the market isn’t expensive these days, it is. S&P 500 PE Ratios are above their 5 and 10 year averages, but in our opinion, they deserve to be higher than normal due to the constructive fundamental environment we’re in. In addition, valuation rarely kills a bull market, deteriorating fundamentals do, and right now fundamentals are OK. Our investment team watches the market every day and we constantly survey the fundamental landscape, both here and abroad. Right now, we consider the following critical to moving the market forward:

  • Corporate earnings growth. Earnings season begins this week and should solidify forecasts of 10% growth this year
  • Economic growth. Global GDPs, labor market metrics and manufacturing statistics are always on our radar screen. Right now, all are still in expansion mode
  • Finally, interest rate movements. We understand that rates will most likely move higher over time, but we expect rate normalization to be slow and measured

We understand the anxiety a mature bull market can present, but if valuation and contrarian indicators are the only evidence bears are bringing to the table, that’s not enough to call it a wrap. Disappointing earnings growth, recession and high interest rates can kill a market. Yes, fundamentals can change, we’re watching, but not seeing signs of these metrics deteriorating yet. Remember, markets have been hitting new highs since 1817 when the NYSE was established. It’s never a straight line, we do have corrections, but over the last 200 years markets continue to be resilient.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Posted on July 12, 2017 Read More

What is happening with retail stocks?

On June 16, Amazon (AMZN) agreed to purchase Whole Foods (WFM) for $13.7B. The announced purchase has led to many questions regarding Amazon’s place in the grocery market and what it means for competitors. This transaction is simply the most recent example of a major disruption in the overall retail market, which has had a large effect on several stocks in the consumer sector. In today’s market reflection, we will examine what has occurred in the consumer landscape and the ramifications for investors.

In measuring total retail sales, the general trend has been relatively healthy. As seen in the chart below, retail sales have been steadily growing over the last 5 years, ranging between 1.5% to over 6% year over year growth. The data reflects that US consumers are still active and spending money.

The change that has occurred, and has had a massive effect on consumer stocks, is the transition of retail sales from physical stores to online. The below chart reflects online retail growth (red bar) compared to total retail growth (pink bar). Online retail is growing over 7x faster than total retail, and that number has accelerated over the last 3 years.

This trend has been most prevalent within nonstore (or online) retailers versus large scale department stores. Per the chart below, sales at US department stores have fallen for 23 straight months while nonstore retailers have continued to grow and gain share.

The effect of this share shift has been reflected in stock prices of retail providers. The below data reflects stock performance of several large retailers from 2014 to present. Not surprisingly, the ecommerce leader (Amazon) and home improvement retailers (Home Depot, Lowe’s) have been the best performers over the last 3 years. On the other side, physical based retailers in apparel and home goods (Kohl’s, JC Penney, Macy’s, Sears) have been the worst performers.

This share shift has not only had an impact on large scale retailers, but have included smaller mall-based retail as well. Companies like Gymboree, Payless ShoeSource, and Gander Mountain have all filed for bankruptcy this year, and have announced initiatives to close several hundred stores as part of their restructuring plans. These store closures have not only manifested itself in the share price of retail companies, but has had a negative effect on the real estate investment trusts (REITs) that lease mall space to these retailers. The data below reflects the underperformance of two largest mall based REIT providers (SPG and GGP) versus the broad REIT universe (VNQ).

For our portfolios, our asset selection in the retail space is centered on finding opportunity in the retail markets and avoiding, or selling, stocks that we believe will continue to suffer as a result of changes in the retail landscape. In that regard, we continue to hold companies like Simon Property Group (SPG) and Kohl’s (KSS), as we believe solid operating fundamentals and cash flow generation are not accurately reflected in current stock valuations. Conversely, we recently removed Target (TGT) from our portfolio due to our lack of conviction in their ability to turn around the weakening fundamentals of the company against stiffening competition.
As with any significant changes to market or industry dynamics, it is important to assess the risks of companies within the space to determine opportunity versus avoidance. At Nevada Retirement Planners, we believe that proper due diligence and active management allows us to take advantage of opportunities the market provides in the various portfolios we have available.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Posted on June 21, 2017 Read More
 
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