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Weekly Issue: The Changing Mood of the Market

Weekly Issue: The Changing Mood of the Market

Over the last several days, volatility in the stock market has been rampant with wide swings taking place. Part and parcel of this has been a mood change in the stock market as high-flying stocks, including a number of technology ones, have come under pressure as investors re-think their growth prospects. That continued yesterday as shares of iPhone maker Apple (AAPL) became the latest one to dip into bear market territory with last night’s close following renewed concerns over the company’s device shipments in the near-term. This, in turn, has led to a few downgrades by Wall Street analysts, that at least in my view, are being somewhat short-sighted as the company continues to morph its business into one that is more reliant on high margin services rather than just the iPhone.

The same can be said with Amazon (AMZN), which has seen its shares tumble despite there being no slowdown in the shift to digital commerce as evidenced by the October Retail Sales Report. That report showed Nonstore retail sales for the month climbing just shy of 3x as fast as overall retail sales year over year. That was certainly confirmed in the latest earnings reports this week from Macy’s (M) and Walmart (WMT).  All indications, as well as expectations, have this aspect of our Digital Lifestyle investing theme accelerating into the all-important holiday shopping season. And yes, this keeps me bullish on our shares of United Parcel Service (UPS)

Now here’s the tough part to swallow – while we and our thematic way of investing are likely to be right in the medium to long-term, the mood in the stock market tends to prevail in the short-term. And with several of the concerns I’ve talked about here as well as in Tematica Investing and on our podcast, Cocktail Investing, rearing their heads odds are the stock market will continue to be a volatile one in the very near-term. This will likely see the current expectation resetting continue, especially for the sector-based investor view of “technology” stocks. Talk about a multi-headed sector that is simply a mish-mash of things – I’ll stick to our thematic lens approach, thank you very much. That said, with “tech” being in the doghouse, I’m using the time to evaluate a number of companies for the currently open Disruptive Innovators slot in our Thematic Leaders. Some of the current contenders include cloud-focused companies Dropbox (DBX), Instructure (INST) and Okata (OKT) among others.

This week

What’s been driving the latest round of roller coaster like thrills in the stock market can be found in the intersection of the latest earnings reports, economic data, and political developments. From sector investing perspective, we continue to get mixed results as evidenced by this week’s earnings reports as JC Penney (JCP) lagged expectations while Walmart (WMT) and Macy’s (M) beat them. From a thematic one, however, we see the dichotomy in those results as strong confirmation in our Digital Lifestyle investing theme as both Macy’s and Walmart delivered strong digital shopping performance in those quarterly reports, while JC Penney continues to struggle with its brick & mortar business.

Our Living the Life investing theme was also the recipient of positive confirmation this week as high-end outerwear company Canada Goose (GOOS) simply smashed top and bottom line expectations. Similarly, profits at luxury car company Aston Martin (AML.L) soared as its sales volume doubled year over year in the September quarter.

 

Sticking with Del Frisco’s

And while the Living the Lifestyle Thematic Leader that is Del Frisco’s (DFRG) reported a sloppy quarter following the disposal of its Sullivan’s business, the company shared a vibrant outlook, including the plan to grow its revenue and EBITDA to at least $700 million and $100 million by, respectively, by 2020 from the September quarter run rates of $420 million and $74 million, respectively. The intent on average will be to roll out two to three Double Eagles, two to three Barcelona Wine Bars and six bartacos restaurants each year, which is a measured move over the coming years and one that could be scaled back quickly should the domestic economy begin to falter several quarters out.

Near-term, Del Frisco’s should benefit from a pick-up in activity quarter to date following the arrival in the third quarter of its new chief marketing officer. On the earnings conference call, management shared Double Eagle’s private dining is up almost 20% in the first few weeks of the quarter and bookings for the rest of the quarter are up more than 20% compared to last year at this time.

The company also confirmed one of the key aspects of our investment thesis, which centers on margin improvement due in part to beef deflation. As discussed on the earnings call, the company’s total cost of sales as a percentage of revenue for the quarter decreased by 60 basis points to 27.3% from 27.9% in the year-ago period due to margin improvements at Double Eagle, Barcelona, and bartaco. This improvement and the year-over-year jump in bookings certainly point to the expected holiday inflection point panning out, which is also the most seasonally profitable time of year for Double Eagle and Grille. Cost-reduction efforts put in place earlier this year at these two brands should lead to visible margin improvement versus year-ago levels as the holiday volumes take effect.

  • For now, we’ll keep our long-term price target of $14 for Del Frisco’s (DFRG) shares intact, revisiting as needed should the company’s rollouts begin to slip.

 

Several headwinds remain in place

Despite these positive signals and happenings, we have to remember there are several headwinds blowing on the overall stock market. These include Italy standing firm with its latest budget, which puts it at odds with the European Union; Brexit limping forward; inflationary readings in both the October Producer Price Index and Consumer Price Index that will more than likely keep the Fed’s rate hike path intact, a looming concern for consumer debt and high levels of corporate debt; and the pending trade talks between the US and China at a time when more data shows a cooling in the global economy.

On a positive note, the NFIB Small Business Index’s October reading continued the near-two year string of record highs with more small businesses than not citing a bullish attitude toward the economy and expanding their businesses. A note of caution here as most businesses tend to exude such sentiment at or near the economic peak – few see the looming the downside. The NFIB’s report once again called out the lack of skilled workers with 53% of those surveyed reporting few or no qualified applicants.

This signals potential wage pressures ahead, however, the sharp fall in oil prices, which follows the notion of the slowing global economy and rising inventory levels, is poised to give some relief to both businesses and consumers as we head into the holiday shopping season. Yes, average gas prices have fallen to $2.68 per gallon from $2.89 a month ago, but they are still up vs. $2.56 per gallon this time last year. When it comes to gas prices, most consumers think sequentially, which means they are recognizing the drop in recent weeks, which in their minds offers some relief.

Noticed, I said some relief – consumers still face high debt levels with larger servicing costs vs. the year-ago levels. And let’s be honest, a consumer with a 12-gallon gas tank in his or her car that fills up twice a week is saving all of $4.80 per week compared to this time last month. In today’s world, that’s about enough to buy one pizza with some toppings a month. In other words, it will take more pronounced declines in gas prices to make a meaningful difference for those investors that resonate with our Middle-Class Squeeze investing theme.

 

What to watch next week

In looking at the calendar for next week, we have the Thanksgiving holiday, which long-time subscribers know is one of my favorites. While the stock market is only closed for that holiday, we do have shortened trading hours next Friday – better known as Black Friday – and that will kick off the race for holiday shopping. That means we can expect the litany of headlines over initial holiday shopping sales over the post-holiday weekend as we ease into Cyber Monday. And yes, I will be paying close attention to those results given our positions in Amazon and UPS.

Before we get to share our thankfulness with family and friends, we will have a few economic reports to chew through including October Housing Starts, Durable Orders and Existing Home Sales. This week even Fed Chair Powell recognized the softening housing market as a headwind to the economy, and in my view that sets the stage for yet another lackluster housing report next week. Inside the Durable Orders report, we’ll be watching the all-important core capital goods line, a proxy for business investment. The stronger that number, the better the prospects for the current quarter, which tends to benefit from “use it or lose it” capital spending budgets.

On the earnings front next week, we will continue to hear from retailers, such as Best Buy (BBY), Kohl’s (KSS), Ross Stores (ROST) and TJX Companies (TJX). With regard to our own Costco Wholesale (COST) shares, we’ll be paying close attention to results from competitor BJ Wholesale (BJ). Outside of those retailers, I’ll be listening to what Nuance Communications (NUAN) has to say about the adoption of voice interfaces and digital assistants next week.

More year-end trimming — big gains and managing 2017 capital gains

More year-end trimming — big gains and managing 2017 capital gains

KEY POINTS FROM THIS ALERT:

  • Following the continued surge higher in the shares of Cashless Consumption company USA Technologies (USAT), we are trimming back our position by selling one-third of the position, which will produce a gain of more than 85% over the last seven months, and leave ample exposure on the Tematica Investing Select List. As we make this trade, we will also set a stop loss for USAT at $7.50, which will lock in a gain of roughly 65% on the remaining shares.
  • We are also trimming back our position in Disruptive Technology company Universal Display (OLED), which closed last Friday up more than 240% from our October 2016 entry. Similar to the USAT trade, we are selling one-third of the position, which lets us book some fantastic gains, but also ensures meaningful exposure to ramping demand for organic light emitting diode displays. We are also boosting our stop loss on OLED shares to $125 from $100.
  • As we book these gains, we will also offset these gains for tax purposes by matching them with losses. As such, we are exiting our positions in Nuance Communications (NUAN) and the ProShares Short S&P 500 ETF (SH) shares, which are down roughly 7% and 27%, respectively since being added to the Select List in 2017 and 2016.

 

A week ago I shared that we would be doing some year-end house cleaning on the Tematica Investing Select List as well as looking to minimize 2017 capital gains. We are back at that today as we look to match both short and long-term gains with short and long-term losses. Here we go:

 

Trimming back USAT shares

Last week I boosted our price target on Cashless Consumption company USA Technologies (USAT) to $8.00 from $6.50, and the shares proceeded to go on a tear following an upbeat presentation at the Craig-Hallum Alpha Select Conference. I’ve been a long-time fan of the company’s business model that focuses on mobile payments, particularly for vending applications, for some time. As much as I am a fan, with the shares up roughly 85% in the last seven months and having blown past our new price target into overbought territory, it means now is the time to be a prudent investor.

In keeping with the Wall Street saying — bulls make money, bears make money, but pigs get slaughtered — we are going to sell one-third of the USAT position on the Tematica Investing Select List, which will harvest a significant win. Given that we are in the early stages of mobile payments around the globe, the remaining USAT shares will offer us ample exposure to our Cashless Consumption investing theme. Again, we want to be prudent, which means setting a stop loss at $7.50, which locks in a gain of roughly 66% on our remaining USAT shares.

  • Following the continued surge higher in the shares of Cashless Consumption company USA Technologies (USAT), we are trimming back our position by selling one-third of the position, which will produce a gain of more than 85% over the last seven months, and leave ample exposure on the Tematica Investing Select List.
  • As we make this trade, we will also set a stop loss at $7.50, which will lock in a gain of roughly 65% on the remaining shares.

 

Following the same strategy with Universal Display (OLED) shares

Much like USAT shares, the position in Disruptive Technologies company Universal Display (USAT) has also been on a tear this past year, soaring roughly 280% over the last 12 months compared to more than 27% for the Nasdaq Composite Index and 19% for the S&P 500. Again, while we know the ramp in organic light emitting diode display demand will continue in coming quarters, as investors we need to remain prudent.

Therefore, we are employing a similar strategy with OLED shares that we did with USAT shares – we will sell one-third of the position and book a hefty win, while keeping the balance in play to capture additional upside in the coming quarters. We will also boost the positions stop loss to $125 from $100, which will lock in a profit of 135% on the remaining shares.

  • Similar to the USAT trade, we are selling one-third of the Universal Display (OLED) position, which books a gain of roughly 240% from our October 2016 buy-in.
  • We are boosting our stop loss on the remaining OLED shares to $125 from $100.

 

 

Cleaning up the Select List and optimizing year-end capital gains

It’s not lost on us those two trades will deliver some meaningful short and long-term gains. While we’re fans, big fans in fact, of such gains, we’re also fans of minimizing capital gains. As such we’re going to further clean up the Tematica Investing Select List by offsetting those gains with losses as we make the following trades:

  • We are exiting our position in Nuance Communications (NUAN), which is down 8% since it was added to the Tematica Investing Select List in January of this year.
  • We’re also exiting ProShares Short S&P 500 ETF (SH) shares, which are down 27% over the last 20 plus months.

 

Booking losses are never fun, but in this case, it does serve to soften the 2017 tax bill. Not a bad thing at all, especially since it adds back, even more, capital back to the war chest. Given our positions in Amazon (AMZN), Apple (AAPL) and Alphabet (GOOGL), we have ample exposure to voice technology and interfaces that are part of our Disruptive Technology investing theme. And while we are shedding the inverse ETF position, given our concerns with the other overall market that appears to be stalling amid tax reform, we’ll examine other hedging strategies to utilize when the time is right.

 

 

 

WEEKLY ISSUE: Adding to the Select List as we continue to ride the smartphone wave

WEEKLY ISSUE: Adding to the Select List as we continue to ride the smartphone wave

In this Week’s Issue:

  • As Trump Bump Gives Way to Trump Slump, What Will the Fed Do?
  • Putting UNFI and AT&T Under the Microscope
  • Nuance Communications – Big Deals for this Disruptive Technology Player
  • AXT Inc. – More Than Riding the Smartphone Wave

 

Welcome to this week’s issue of Tematica Investing. Following last week’s addition of Guilty Pleasure company MGM Resorts International (MGM) to the Tematica Select List, we’re adding another new name in compound semiconductor substrate company AXT Inc. (AXTI) – more on it and exactly what compound semiconductors are will be had shortly. But first, let’s have a quick look at what’s coming across our desk this week . . .

 

As Trump Bump Gives Way to Trump Slump, What Will the Fed Do?

We’re just several hours away from the Federal Reserve announcing what is likely to be a modest bump higher in interest rates, a move that is widely expected by investors. We here at Tematica continue to see it as the Fed looking to re-arm itself ahead of the next eventual recession. Note we said eventual, for even though we continue to see step downs in 2Q 2017 GDP expectations, the domestic economy continues to chug along at a sluggish pace. That’s a speed we expect to be with us as we head into the summer doldrums. After today’s market close there will be 12 trading days left in the quarter, which means companies are on the cusp of entering their quiet periods, and before too long we’ll get any and all negative earnings preannouncements.

As we get more June economic data and those preannouncements, we could see the stock market revisit last week’ move lower for reasons that we recapped in this week’s Monday Morning Kickoff. With the Eurozone elections being a non-event, a sense of calm returned to the market this week, but once we’re past the Fed’s expected action, the next item to preoccupy investors will be expectations for the second half of 2017. We continue to suspect expectations for both GDP and earnings will have to be adjusted given the Trump Slump, but that’s for the market, not the positions we’ve identified as benefitting from thematic tailwinds that reside on the Tematica Select List:

  • We will continue to keep shares of Amazon (AMZN), Alphabet (GOOGL), Dycom (DY), Facebook (FB), Applied Materials (AMAT), Universal Display (OLED) and others on the Select List.
  • We will be revisiting stop loss levels over the following weeks in order to have them in position for 2Q 2017 earnings, which will commence soon after the July 4th holiday weekend.

 

 

Putting UNFI and AT&T Under the Microscope

We are putting shares of United Natural Foods (UNFI) on notice, as they’ve slumped after reporting above-consensus quarterly earnings of $0.77 per share on an 11.1 percent year-over-year jump in revenue to $2.37 billion, which was shy of expectations. Looking ahead, UNFI reaffirmed its bottom-line guidance for the full year, expecting earnings between $2.53-$2.58 per share. However, revenue guidance was lowered and the company now expects below-consensus sales between $9.29 billion and $9.34 billion after previous guidance called for sales between $9.38 billion and $9.46 billion.

  • As we review our position in UNFI, we’ll be recalculating our price target, which currently sits at $65. Expect more on this in the coming days and weeks.

We’re also keeping close tabs on AT&T (T) shares. We’ve been patient with this position, but year to date it’s fallen 9 percent before factoring in dividends paid. Our thesis over the changing business model following the merger with Time Warner (TWX) remains, and we expect more concrete details to emerge in the coming months given the timetable to close the deal by year-end.

  • Our inclination is to scale into T shares below $38, which would modestly improve our cost basis.
  • Stay tuned for more on this as well.

 

 

Nuance Communications – Big Deals for this Disruptive Technology Player

It’s been a bit since we updated subscribers on speech recognition and virtual assistant provider Nuance Communications (NUAN), but that’s primarily because until recently the business has been chugging along. For its March quarter, the company hit consensus expectations and guided the current quarter in line with Wall Street forecasts, which laid the groundwork for the shares to climb more than 8 percent over the last three months. More recently, however, things are once again shaking at Nuance as the company inked deals with Amazon (AMZN), Apple and Alphabet (GOOGL) to bring its Nina platform to power customer service chatbots on iMessage, Alexa and Google Home devices.

Already, Nuance’s Nina platform powers customer service bots for about 6,500 companies and organizations, including many telecoms, banks, and airlines. The reality is, you may have already used this Nuance solution and not recognized it. Per Nuance, Nina-powered bots can resolve 80 percent of customer requests, such as transferring money, or changing airline seats.
We’d point out this is in addition to Nina powering other messaging services, including Facebook Messenger, WeChat, and text messaging applications.

As it relates in particular to Apple, the chatbot capability is scheduled to appear within iOS 11, and the plan is to integrate Nuance’s solutions with Apple Business Chat to enable a new breed of artificial intelligence (AI)-based intelligent assistants within Messages. What this means is users will see a messages icon pop up on brand websites, in search results, and elsewhere that will allow people to contact those brands with one tap.

From our perspective, this could prove to be an interesting behind the scenes development that if it were to spread to Siri and Apple’s new HomePod, could make for more robust offering that currently expected. It also reaffirms our view that at some point Nuance is likely to be a takeout candidate.

  • With 13 percent upside to our $21 price target, we continue to have a Buy on NUAN shares.
  • As we get a better understanding, and some hands-on experience with these new capabilities across Apple, Amazon and other recent wins, we’ll look to revisit our price target.

 

AXT Inc.  – More Than Riding the Smartphone Wave

Over the last decade, RF semiconductor companies like Skyworks Solutions (SWKS) and Qorvo (QRVO) have seen strong moves in their businesses as well as stock prices. RF semiconductors are what allows that cellphone in your pocket to communicate wirelessly with networks (RF stands for radio frequency) and it enables that communications at a far more battery efficiency than its silicon semiconductor counterpart.

As the Connected Society investment theme plays out in the marketplace, it’s easy to see the two factors driving demand for these semiconductors.  First, the move from 2G to 3G and 4G technologies has resulted in greater RF semiconductor content per device, beginning in mobile phones and now in smartphones. The second factor is the
adoption of wireless technologies across multiple devices ranging from gaming controllers to tablets, GPS devices, and wearables to name a few.
We are now on the cusp of seeing these two forces step up once again as mobile carriers get ready to beta 5G technologies, which will add another layer of RF content to connected devices, and newer connected markets, like the Connected Home, Connected Car and the Internet of Things approach their tipping points. Speaking of Connected Car, later this week, we’ll have more on the Connected Car market when Ted Cardenas from Pioneer joins us on this week’s Cocktail Investing Podcast. Be sure to catch it on TematicaResearch.com or head on over to iTunes and subscribe.

Back to the matter at hand, each of these connected devices requires a bevy of RF semiconductors ranging from switches and filters to power amplifiers. In the silicon semiconductor world, chips are fabricated on wafers. With RF semiconductors, they are grown on substrates based on elements found on the periodic table. We’ll keep it simple here when it comes to compound semiconductors, and will post more background information on the website. For now, what you do need to know is RF semiconductors’ performance characteristics across their varied applications lend themselves to our Disruptive Technology investment theme.

Again, the basic building block of these disruptive semiconductors is the substrate and brings us to AXT Inc. (AXT) a worldwide manufacturer of compound and single element substrates that include Gallium Arsenide (GaAs), Indium Phosphide (InP), and Germanium (Ge) flavors. The company has manufacturing facilities and investments in 10 subsidiaries and joint ventures in China that produce raw materials as part of its vertically integrated supply chain. Applications for the company’s InP substrates include fiber optic networks, passive optical networks and data center connectivity among others. Moving to Ge substrates, key markets for the material include satellite solar cells and optical sensors and detectors including infra-red detectors.

The substrate category that has the greatest volume opportunity remains GaAs, which as mentioned above is used in smartphones and other burgeoning connected device markets such as augmented and virtual reality devices, gaming applications as well as facial recognition security applications like the one in beta by Jet Blue (JBLU) as well as SmartTV, auto, medical, gaming and industrial applications. Pretty much any device is poised to include RF semiconductors, but let’s remember the single largest market by volume remains the smartphone market. With greater RF semiconductor content per device as more of the globe migrates to 4G and LTE technologies, we see rising demand for AXT’s GaAs substrates. With RF semiconductor content taking another step up with 5G, the outlook for AXTI’s GaAs substrates looking favorable over the next several years.

Given the wide array of end markets served, no particular customer accounted for more than 10 percent of revenue in 2016, but we suspect key customers include Skyworks Solutions and Qorvo, given their position in the RF semiconductor space. Consensus estimates call for Skyworks to grow its revenue 10 percent this year and again next year, while forecasts for Qorvo call for its revenue to grow 4-9 percent over the next several quarters. As we’ve noted with Applied Materials (AMAT), we are seeing China invest heavily in developing its in-country semiconductor capabilities, and based on order books for both Applied and Veeco Instruments (VECO), this includes compound semiconductors. As such, we could see the mix of customers and geographies at AXT shift over the coming quarters. In our view, that plays to AXT’s strength given its existing operations in China.

Much the way we are watching Applied Materials and Veeco for cues on organic light emitting diode demand, we will also be watching them for compound semiconductor capacity additions. Applied in particular has reported strong order growth, which led the company to recently boost its outlook. As part of its first-quarter results, Veeco reported a third consecutive quarter with bookings above $100 million vs. $94 million in revenue for the quarter, bringing its backlog at the end of the quarter to more than $200 million.

Let’s Have a Look at AXT Fiscal and Stock Performance

Current expectations call for AXT to deliver revenue of $91 million this year, up from $81.3 million last year, but there could be upside based on the deployment of 5G networks as well as reception for Apple’s (AAPL)next iPhone. As several compound semiconductor technology applications mature over the coming quarters, revenue at AXT is expected to rise to $103-$107 million, with EPS forecasted to climb to $0.31 per share, up from $0.19 this year. We’d note that over the last year, AXT has managed to beat analyst expectations in all four quarters, even as EPS expectations have ticked higher. One other item to point out, the company has no debt and $77 million in cash (roughly $2 per share) and is generating positive cash flow.

Historically, smartphone demand has ramped in the second half of the calendar year. Apple (AAPL) is set to take the wraps off its latest iPhone model this fall. Given the likely competitive response from Samsung, HTC, LG and others, we expect the seasonal pattern to hold, which means we should see a pick-up in demand for AXT’s substrates in late July. Other connected devices, ranging from connected speakers, gaming consoles and so on, should also see a seasonal bump in the back half of the year as part of the year-end holiday shopping season. With the seasonal pattern expected to hold, this likely means AXT shares will move higher as revenue and earnings are poised to climb meaningfully in the second half of the year compared to the first half. While the positive is that tends to result in favorable multiple expansion, it also means that we need to be mindful about the typical revenue fall off from the fourth quarter to the first quarter, given the seasonal drop off in smartphones and other volumes as we move into late January and February.

With all of that said, we see AXT shares reaching $9 over the coming months. We derive that price target through a confluence of historical P/E and enterprise value (EV) to revenue metrics. Our plan will be to either use market weakness during the summer months to scale into the shares, or to build our position on signs the seasonal smartphone ramp is trending stronger than expected.

The Bottom Line in AXT Inc (AXTI):

  • We are adding AXTI Shares to the Tematica Select List, which at market close yesterday traded at $6.45 per share.
  • We are setting a price target on the shares of $9, and anticipate it reaching that level over the coming months. We derive that price target through a confluence of historical P/E and enterprise value (EV) to revenue metrics.
  • Our plan will be to either use market weakness during the summer months to scale into the shares, or to build our position on signs the seasonal smartphone ramp is trending stronger than expected.

 

Putting Some Defensive Measures in Place Ahead of Tuesday’s Trump Speech

Putting Some Defensive Measures in Place Ahead of Tuesday’s Trump Speech

If you’ve missed our weekly Monday missive that is the Monday Morning Kickoff, we’d encourage you to pursue it later today as it offers both context and perspective on last week, including much talk about the Fed, and sets the stage for this week.

This week, we’ve got a lot of data coming at us, more corporate earnings that prominently feature our Cash-strapped Consumer and Fattening of the Population investing themes. There are a number of events and conferences as well, and before too long we’ll have some thoughts on this week’s Mobile World Congress, an event that meshes very well with our Connected Society, Disruptive Technology and Cashless Consumption investing themes.

We expect to see a number of announcements ranging from new smartphone models, connected as well as autonomous vehicle developments, voice digital assistant initiatives, drones, and payment systems to name a few. We’ll be watching these with regard to a number of positions on the Tematica Select List, including Universal Display (OLED), Nuance Communications (NUAN), AT&T (T), Dycom Industries (DY), CalAmp (CAMP) and Alphabet (GOOGL) as well as Amazon (AMZN). Already Amazon has announced it will bring its Alexa VDA to Motorola’s smartphones, and we see that as the tip of the proverbial iceberg his week.

As the Mobile World Congress gets underway, however, we have another event that should capture investor attention. After presenting today what’s called a “skinny budget”, (which we view as the “opening bid budget”) tomorrow night President Trump will be speaking to a joint session of Congress. Typically this is referred to as the State of the Union Address, but it’s not called that for a newly elected president. Trump has already shared that he will be talking about health care reform — “We’re going to be speaking very specifically about a very complicated subject…I think we have something that is really going to be excellent.”

As we’ve said before, we’re optimistic and hopeful, but thus far it seems Republicans have yet to find common ground on how to move forward on this. In addition to healthcare reform, investors, including us, will be listening for more details on Trump’s fiscal policies. The issue is speeches such as this tend to be lacking in specifics, and we would be rather surprised to see Trump deviate from that tradition. Moreover, we’ve already seen the Treasury Secretary push out the timetable for a tax report to late summer, and Trump himself suggested that we are not likely to see his tax reform proposal until after the healthcare reform has been addressed.

As we shared in this morning’s Monday Morning Kickoff, with the S&P 500 trading at 18x expected earnings, it looks like the stock market is out over its ski tips. Two drivers of the market rally over the coming months have been:

  • The improving, but not stellar economic data
  • The hope that President Trump’s policies will jumpstart the economy.

We’ve been saying for some time that the soonest we’d likely get any meaningful impact from Trump’s policies would be the back half of 2017. That’s been our perspective, but as we know from time to time, the stock market can get ahead of itself, and we see this as one of those times. The stock market’s move reflects expectations for an accelerating economy – it’s the only way to get the “E” that is earnings growing enough to make the market’s current valuation more palatable.

 

Need to Keep Our Eyes on Both Sides of the Equation

One of the common mistakes we see with investors is they almost always only focus on the upside to be had, without keeping an eye on the downside risks. If Trump is successful when it comes to the domestic economy, and we’d love nothing more than to see acceleration here, earnings will likely grow materially.

One of the potential risks we see this week is the market being disappointed by the lack of details that Trump will share tomorrow night, which might be read as a push out in timing relative to what the stock market expects. As we said on last week’s Cocktail Investing podcast, resetting expectations is a lot like children that open presents on Christmas morning to find something other than what they expected — it’s far from a harmonious event and more like one that is met with mental daggers, confusion, and second guessing. In short, not a fun time at all.

For that reason, we’re going to make some defensive adjustments to the Tematica Select List, which has enjoyed the market rally over the last few months and led to strong moves in our Universal Display (OLED), AMN Healthcare (AMN), Costco Wholesale (COST) shares as well as several others.

 

With an eye toward preserving profits, we are going to introduce the following stop losses:
  • Alphabet (GOOGL) at $800
  • Universal Display at $70
  • AMN Healthcare at $37
  • PowerShares NASDAQ Internet Portfolio ETF (PNQI) at $90

 

Alongside these new stop losses, we’re also going to raise several existing ones:
  • Boost our stop loss on AT&T (T) to $36 from $31
  • Raise our stop loss on International Flavors & Fragrances (IFF) to $115 from $105
  • Boost our stop loss on Costco Wholesale to $170 from $165
  • Increase our stop loss on Disney (DIS) shares to $100 from $87

 

Again, our thought is better to be safe than sorry given where the market currently sits. We’ll continue to review other positions on the Tematica Select List with similar actions where and when it makes sense.