Trade and Impeachment Uncertainty Returns

Trade and Impeachment Uncertainty Returns

Today’s Big Picture

US equity futures point to a drop at the open and are being driven by two-weekend news items. First, on the impeachment front, a second whistleblower has come forward claiming first-hand knowledge of the allegations against President Trump. Second, reports are indicating Chinese officials are reluctant to agree to a broad trade deal as aimed for by President Trump and would likely exclude the reformation of Chinese industrial policy and government subsidies, two topics of longstanding U.S. complaints. 

This combination along with weak economic data out of Europe this morning is adding a fresh dose of uncertainty back into the market following Friday’s supposed Goldilocks September Employment Report, and raises questions…

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All Eyes On The September Jobs Report

All Eyes On The September Jobs Report

Today’s Big Picture

US market futures point to a modestly lower open Friday morning. After the disappointing manufacturing and services data this week, all eyes will be on today’s Nonfarm Payrolls report, which is expected to see 145,000 jobs added in September, up from 130,000 in August with the unemployment rate holding at 3.7% and wages gaining +0.2%. Keep in mind that the General Motors (GM) strike will add some confusion to the data as striking workers aren’t counted in payrolls.

We’ll also be looking for any updates on the previous downward revisions to payrolls. In August the BLS cut job gain estimates for 2018 and early 2019 by about 500,000, the largest such downward revision in the past decade. Overall we’ve seen downward revisions for around 17 months – a sure sign that labor market dynamics ...

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Weekly Issue: Adding to BABA and DRFG

Weekly Issue: Adding to BABA and DRFG

 

Key points in this issue:

  • The market hits new records, but the corporate warnings are growing
  • We are using the recent fall-off in both Rise of the New Middle-Class investment theme company Alibaba (BABA) and Guilty Pleasure theme company Del Frisco’s (DRFG) to scale into both positions. Our price targets remain $230 and $14, respectively.
  • We’re putting some perspective around the National Retail Federation’s 2018 Holiday Shopping forecast that was published yesterday.
  • As more holiday shopping forecasts emerge, and we progress through the upcoming earnings season I plan on revisiting our current $2,250 price target for Amazon (AMZN) shares. More details on the pending acquisition of PillPack are also a catalyst for us, as well as Wall Street, to boost that target.
  • Heading into the holiday shopping season, our price target on UPS shares remains $130.
  • We continue to see Costco Wholesale (COST) a prime beneficiary of the Middle-class Squeeze. Our price target on the shares remains $250.
  • What to watch in tomorrow’s September Employment Report? Wage growth.

 

The market hits new records, but the corporate warnings are growing

While we’ve seen new records for the stock market indices this week, we’ve also seen the S&P 500 little changed amid fresh September data that in aggregate points to a solid US economy. This week we received some favorable September economic news in the form of the ADP Employment Report as well as the ISM Services Index with both crushing expectations. Despite these reports, the S&P 500 has barely budged this week, which suggests to me investors are expecting a sloppy September quarter earnings season. No doubt there will be some bright spots, but in aggregate we are seeing a number of headwinds compared to this time last year that could weigh on corporate outlooks.

Already we’ve had a number of companies issuing softer than expected outlooks due to rising input and transportation costs, trade and tariffs, political wrangling ahead of the upcoming mid-term elections, renewed concerns over Italy and the eurozone, and the slower speed of the economy compared to the June quarter. A great example of that was had yesterday when shares of lighting and building management company Acuity Brands (AYI) fell more than 13% after it reported fiscal fourth-quarter profit that beat expectations, but margins fell amid a sharp rise in input costs. The company said costs were “well higher” for items such as electronic components, freight, wages, and certain commodity-related items, such as steel, due to “several economic factors, including previously announced and enacted tariffs and wage inflation due to the tight labor market…”

Acuity is not the first company to report this and odds are it will not be the last one as September quarter earnings begin to heat up next week. As the velocity of reports picks up, we could be in for a bumpy ride as investors reset their growth and profit expectations for the December quarter and 2019.  The good news is we are our eyes are wide open and we will be prepared to use any meaningful moves lower to scale into our Thematic Leader positions or other positions on the Select List provided our investment thesis remains intact. Pretty much what we’re doing this morning with Alibaba (BABA) and Del Frisco’s Restaurant (DFRG) shares. As I watch the earnings maelstrom unfold, I’ll also be keeping an eye on inflation-related comments to determine if the Fed might be falling behind the interest rate hike curve.

 

Adding to our Alibaba and Del Frisco Restaurant Thematic Leader Positions

This morning we are putting some capital to work, scaling into and improving the respective cost basis for Alibaba (BABA) and Del Frisco’s Restaurant Group (DFRG), the Rise of the New Middle-Class and Guilty Pleasure Thematic Leader holdings.

Earlier this week, the administration inked a trade deal between the US-Mexico-Canada that has some incremental benefits, not yuuuuuuuge ones. But in the administration’s view, a win is a win and with that odds are the Trump administration will focus on making some progress with China trade talks. Per the recent Business Roundtable survey findings

As that happens we should see some of that overhang on BABA shares begin to fade, allowing the factors behind our original thesis to shine through. Before too long, we’ll be on the cusp of the upcoming Chinese New Year, the largest gift-giving holiday in the country, and as know from our own holiday shopping here in the US, consumer spending picks up ahead of the actual holiday.

We’re also seeing Wall Street turn more bullish on BABA shares – yesterday, they received a price target upgrade to $247 from $241 at Goldman Sachs that in its view reflects Alibaba’s expanding total addressable market with continued growth in its cloud business. We view this as more people coming around to our way of thinking on Alibaba’s business model, which closely resembles that of Amazon (AMZN) from several years ago. In short, the accelerating adoption of Alibaba’s digital platform along with the same for its cloud, streaming and mobile payment services should expand margins at the core shopping business and propel its other businesses into the black. Again, just like we’ve seen at Amazon and that has propelled the shares meaningfully higher.

Could we be early with BABA? Yes, but better to be early and patient than late is my thinking.

  • We will use the pullback in Alibaba (BABA) shares to improve our cost basis in this Rise of the New Middle-class position. Our price target on Alibaba shares remains $230.

 

Turning to Del Frisco’s, we have fresh signs that beef prices will trend lower over the next few years as beef production begins to climb. In the recently released Baseline Update for U.S. Agricultural Markets, projections through 2023, the Food and Agricultural Policy Institute (FAPRI) at the University of Missouri estimated the average price of a 600-to 650-pound feeder steer (basis Oklahoma City) at $158.51 per hundredweight (cwt) this year, and then declining to as low as $141.06 in 2020.

As a reminder, beef prices are the biggest impact on the company’s margin profile, and falling beef prices bode extremely well for better profits ahead. Even if we see a fickle consumer emerge, which is possible, but in my view has a low probability of happening given the increase in Consumer Confidence levels, especially for the expectation component, those falling beef prices should cushion the blow.

  • We are adding to our position in Guilty Pleasure company Del Frisco’s (DFRG), which at current levels will improve our cost basis. Our price target remains $14.

 

The NRF introduces its 2018 Holiday Shopping Forecast

Yesterday, the National Retail Federation published its 2018 holiday retail sales forecast, which covers the November and December time frame and excludes automobiles, gasoline, and restaurants sales. On that basis, the NRF expects an increase between 4.3%-$4.8% over 2017 for a total of $717.45- $720.89 billion. I’d note that while the NRF tried to put a sunny outlook on that forecast by saying it compares to “an average annual increase of 3.9% over the past five years” what it did not say is its 2018 forecast calls for slower growth compared to last year’s holiday shopping increase of 5.3%.

That could be some conservatism on their part or it could reflect their concerns over gas prices and other aspects of inflation as well as higher interest costs vs. a year ago that could sap consumer buying power this holiday season. Last October the NRF expected 2017 holiday sales to grow 3.6%-4.0% year over year, well short of the 5.3% gain that was recorded so it is possible they are once again underestimating the extent to which consumers will open their wallets this holiday season. And if you’re thinking about the chart on Consumer Confidence above and what I said in regard to our adding more DFRG shares, so am I.

While I am bullish, we can’t rule out there are consumer-facing headwinds on the rise, and that is likely to accelerate the shift to digital shopping this holiday season, especially as more retailers prime the digital sales pump. As Tematica’s Chief Macro Strategist, Lenore Hawkins, is fond of saying – Amazon is the deflationary Death Star, which to me supports the notion that consumers, especially those caught in our Middle-class Squeeze investing theme, will use digital shopping to offset any pinch they are feeling at the gas pump. It also means saving some dollars by not going to the mall – a double benefit if you ask me, and that’s before we even get to the time spent at the mall.

On its own Amazon would be a natural beneficiary of the seasonal pick up in shopping, but as I’ve shared before it has been not so quietly growing its private label businesses and staking out its place in the fashion and apparel industry. These moves as well as Amazon’s ability to competitively price product, plus the myriad way it makes money off its listed products and the companies behind them, mean we are entering into what should be a very profitable time of year for Amazon and its shareholders.

  • As more holiday shopping forecasts emerge, and we progress through the upcoming earnings season I plan on revisiting our current $2,250 price target for Amazon (AMZN) shares. More details on the pending acquisition of PillPack are also a catalyst for us, as well as Wall Street, to boost that target.

I’ve long said that United Parcel Service (UPS) shares are a natural beneficiary of the shift to digital shopping. With a seasonal pickup once again expected that has more companies offering digital shopping and more consumers shopping that way, odds are package volumes will once again outpace overall holiday shopping growth year over year. From a financial perspective, that means a disproportionate share of revenue and earnings are to be had at UPS, and from an investor’s perspective, that means multiple expansion is likely to be had.

  • As we head into the holiday shopping season, our price target on UPS shares remains $130.

 

Coming up – Costco earnings and the September Employment Report

After tonight’s market close, Middle-class Squeeze company Costco Wholesale (COST) will issue its latest quarterly results. Given the monthly reports that it issues, which has seen clear consumer wallet share gains in recent months and confirmed the brisk pace of new warehouse openings, we should see results tonight. As you are probably thinking, and correctly so, we are entering one of the strongest periods of the year for Costco, and that means watching not only its outlook, relative to the holiday shopping forecast we discussed above, but its membership comments and new warehouse location plans ahead of Black Friday. Two other factors to watch will be its comments on beef prices – the company is one of the largest sellers of beef in the world – and where it is seeing inflation forces at work.

In terms of consensus expectations for the quarter to be reported, Wall Street sees Costco serving up EPS of $2.36, up more than 13% year over year, on revenue of $44.27 billion, up 4.7% from the year ago quarter.

  • We continue to see Costco Wholesale (COST) a prime beneficiary of the Middle-class Squeeze. Our price target on the shares remains $250.

 

Tomorrow’s September Employment Report will cap the data filled week off. Following the blowout September ADP Employment Report, expectations for tomorrow’s report have inched up. While the number of jobs created is something to watch, the two key factors that I’ll be watching will be the payroll to population figure and wage data. The former will clue us into if we are seeing a greater portion of the US population working, while any meaningful movement in the latter will be fuel for inflation hawks. If the report’s figures for job creation and wage gains come in hotter than expected, we very well could see good news be viewed as concerning as investors connect the dots that call for potentially greater rate hike action by the Fed.

Let’s see what the report brings, and Lenore will no doubt touch on it as part of her next missive.

 

Uncertainty and volatility to remain in place as we enter 2Q 2018

Uncertainty and volatility to remain in place as we enter 2Q 2018

1Q 2018 – A Return of Volatility and Uncertainty

Last week was not only a shortened week owing to the Good Friday market holiday, but it also brought a close to what was a tumultuous first quarter of 2018. The stock market surged higher in January, hit some rocky roads in February than got even more volatile in March. All told, the S&P 500 ends the first three months of 2018 in a very different place than many expected it would in mid-January. While the four major domestic stock market indices finished March in the black, the only one to finish 1Q 2018 in the black was the Nasdaq Composite Index. Even that, however, was well off its January high. What we saw was a very different market environment than the one we’ve seen between November 2017 and the end of January 2018.

As we begin April, we have China responding to the Trump Administration’s steel and aluminum tariffs with their own on a variety of U.S. goods and President Trump suggested he was ruling out a deal with Democrats on DACA. This likely means the uncertainty and volatility in the stock market over the last several weeks will be with us as we get ready for 1Q 2018 earnings season.

In my view, this should serve as a reminder that “crock pot cooking” does not work when applied to investing — rather than just fix and forget it, there’s a need to be active investors. Not traders, but rather investors that are assessing and re-assessing data much the way we do week in, week out.

Of course, our view is thematic data points, as well as economic ones, offer a better perspective for investors. In last week’s Cocktail Investing Podcast, Lenore Hawkins, Tematica’s Chief Macro Strategist, and I explain how the combination of thematic investing and global macro analysis are the chocolate and peanut butter of investing. Coming out of the holiday weekend, I am seeing several confirming data points for our Safety & Security investing theme in the form of the data breach that hit Saks Fifth Avenue and Lord & Taylor. According to reports, Russian hackers obtained “a cache of five million stolen card numbers.” This comes just a few days after Under Armour (UAA)  disclosed that an unauthorized party acquired data associated with 150 million MyFitnessPal user accounts.

During the quarter, we selectively added shares of Rockwell Collins (ROK) and Paccar (PCAR) to the Tematica Investing Select List and recently pruned Universal Display (OLED) and Facebook (FB) shares. The former two were selected given prospects for capital spending and productivity improvement in the country’s aging plants, while Paccar is poised to benefit from the current truck shortage as well as the increasing shift toward digital commerce that is part of our Connected Society investing theme.

With Universal Display, it’s a question of expectations catching up with the current bout of digestion for organic light emitting diode display capacity. We’ll look to revisit these shares as we exit 2Q 2018 looking to buy them if not at better prices, at a better risk-to-reward tradeoff. With Facebook, while we see it benefitting from the shift to digital advertising the current privacy and user data issues are a headwind for the shares that could lead advertisers to head elsewhere. Much like OLED shares, we’ll look to revisit FB shares when the current dust-up settles and we understand how Facebook’s solution(s) change its business model. In the near-term, the verbal CEO sparring between Facebook’s Mark Zuckerberg and Apple’s (AAPL) Tim Cook over privacy, trust and business models should prove to be insightful as well as entertaining.

 

The Changing Stock Market Narrative

The narrative that has been powering the market saw a profound shift a third of the way through the quarter to one of mixed economic data, uncertainty over monetary and trade policies emanating from Washington that could disrupt the economy, and now short-lived concerns over inflation. Recently added to that list are user data and privacy concerns that have taken some wind out of the sales of FAANG stocks. This is very different than the prior narrative that hinged on the benefits to be had with tax reform.

 

 

Perhaps the best visual is found in the changes to the Atlanta Fed GDP Now forecast (see above). The forecast sat at more than 5% in January before a number of downward revisions as a growing portion of the quarter’s economic data failed to live up to expectations. And as we can see in the chart, as the economic data rolled in during late February and March, the Atlanta Fed steadily ticked its forecast lower, where it landed at 2.4% as of March 29. To be fair, we will receive March economic data that could prop up that forecast or weigh on it further. We’ll be scrutinizing that data this week, which includes the March readings for the ISM Manufacturing and Services indices, auto & truck sales and the closely watched monthly Employment Report. We’ll also get the last of the February numbers, namely the Construction and Factory Order reports.

As we digest the ISM reports, we’ll be watching the new orders line items as well as prices paid to keep tabs on the speed of the economy entering the second quarter in addition to potential inflation worries. In terms of potential inflation, we, along with the investing herd, will be closely scrutinizing the wage data in the March Employment Report. We will be sure to dig one layer deeper, denoting the difference between supervisory and non-supervisory wages. As you’ll recall, those that didn’t do that failed to realize the would-be worry found in the January Employment Report was rather misleading.

In addition to those items, we’ll also be looking at key data items for several Tematica Investing Select List positions. For example,  the March heavy-duty truck order figures that should validate our thesis on Paccar (PCAR) shares, while Costco Wholesale’s (COST) March same-store sales figures should show continued wallet share gains for Cash-strapped Consumer, and the monthly gaming data from Nevada and Macau will clue us in to how that aspect of our Guilty Pleasure investing theme did in February and March.

 

Gearing Up for 1Q 2018 Earnings Season

Last Friday we officially closed the books on 1Q 2018, and that means before too long we’ll soon be staring down the gauntlet of first-quarter earnings season. With that in mind, let’s get a status check as to where the market is trading. Current expectations for the S&P 500 call for 2018 EPS to grow 18.5% year over year to $157.70. Helping fuel this forecast is the expected benefit of tax reform, which is leading to EPS forecasts for a rise of more than 18% year over year in the first half of 2018 and nearly 21% in the back half of the year. To put some perspective around that, annual EPS growth has averaged 7.6% over the 2002-2017 period. As we parse the data, we’d point out that on a per-share basis, estimated earnings for the first quarter have risen by 5.3% since Dec. 31; historically, analysts have reduced those expectations during the first few months of the year.

 

 

What do we think?

While we remain bullish on the potential investments and incremental cash in consumer pockets because of tax reform, we have to point out the risk that tax reform-infused GDP expectations — and therefore EPS expectations — could be a tad lofty. We’ve already seen a growing number of companies use the incremental cash flow to scale up buyback programs and in some cases dividends. Also, as we’ve seen in the past, consumers, especially those wallowing in debt, may opt to lighten the debt load. Lenore made this point last week when she appeared on Fox News’s Tucker Carlson Tonight.

 

 

Again, this is a possibility and one that we’ll be monitoring as we get more data in the coming weeks and months as we look to position the Tematica Investing Select List for what’s to come in 2018 and beyond. Combined with the rising concern of tariffs and trade that could disrupt supply and goose inflation in the short to medium term, it’s going to be even more of a challenge to parse company guidance to be had in the coming weeks that could be less than clear. I’ll be sure to break out my extra decoder ring as I get my seatbelt secured for what is looking to be a bumpy set of weeks.

As I noted above, we were prudently choosey with the Tematica Investing Select List in 1Q 2018, and while we will continue to be so as share prices come in, I’ll look to take advantage of the improving risk-to-reward profiles to be had.