Category Archives: Tematica Investing

Weekly Issue: Trump Brings Volatility Back to the Market

Weekly Issue: Trump Brings Volatility Back to the Market

Key points inside this issue:

  • Getting the check on shares of Del Frisco’s Restaurant Group

Volatility has returned to the market, not due to the March quarter earnings season, which in aggregate is shaping up so far to be better than expected but rather to the latest development on the US-China trade front. Over the weekend President Trump said he planned to increase tariffs on $200 billion of Chinese goods to 25% from 10% this Friday even as negotiations for a U.S.-China trade deal are set to resume on Wednesday. In addition, Trump threatened to impose 25% tariffs on an additional $325 billion of Chinese goods “shortly.”

Recall that at the start of this year Trump was poised to boost tariffs to the 25% level but opted to postpone such a move as the U.S. and China began to hold trade talks. The thing that makes this latest threat rather interesting is the reports that China and U.S. were close to a trade deal, with an agreement potentially as soon as this Friday.

As I noted several months ago, odds are Trump is using some of the tactics he laid out in his book, “The Art of the Deal.” One of those tactics is “use your leverage,” and this is the one Trump is likely employing with this weekend’s talk of tariffs following last week’s IHS Markit PMI data.

That data showed the China manufacturing economy slowing in April as its PMI reading fell to 50.2 for the month, down from 50.8 in March, and its new order component also slowed month over month. Per IHS Markit, “Data indicated that subdued sales largely stemmed from weaker foreign demand, as new export business fell for the second time in the past three months.” While the IHS Markit April PMI data for the U.S. also cooled compared to March, other indicators point to the domestic economy continuing to grow at or near 2%.

In my view, the likely scenario is Trump is “using his leverage” given the state of the Chinese economy to garner incremental concessions from China as the next round of trade talks begins later this week. We will see how this develops in the coming weeks, especially as the administration appears to be hell bent on enacting this new round of tariffs on Friday. 

My strong suspicion is this is all playing out like an episode of “The Apprentice” — as we near the last key segment of the show, the drama ramps up considerably ahead of the big reveal, which is pretty much what we suspected all along. In other words, I see this latest salvo by President Trump and ramping up the drama, and odds are we will see some forward progress on the US-China trade front. 

Again, that is my suspicion and we don’t invest on suspicions, but rather on the addressing the evolving landscape. As such, I’ll look to position the Thematic Leaders and the Tematica Select List as needed come a trade resolution or another round of tariffs, that could spark a retaliatory move by China. Either way, more to come!

The Eurozone gets another growth haircut

As if the latest act in the US-China trade war and recent economic data isn’t enough for you, yesterday the European Commission cut its growth forecast the EU in general and for Germany in particular and warned on the ballooning debt level for Italy.  The EU now sees the 19-nation single currency bloc growing 1.2% this year, which is down from the already tepid level of 1.3% it called for in February. 

The EU also warned that Italy’s public debt would balloon to a record of almost 134% of GDP in 2019 and grow even further in 2020 to 135% of GDP, well over commitments made to Brussels and more than double the EU’s 60% limit. Clearly,  we haven’t heard the last of this, and let’s not forget  with negotiations for the EU’s divorce with the UK stalled and no agreement in sight we run the risk of a no-go Brexit deal. 

The moral of the investing story this week is that risks to the market’s vapid increase year to date in 2019 remain even though the March quarter earnings season is, so far, coming in ahead of expectations. 

While former Intel CEO Andy Grove made “only the paranoid survives” famous, I still prefer this quote from Warren Buffett at times likes this – “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”

Tematica Investing

The renewed concern over trade has weighed on the market in general and on shares of not only the Thematic Leaders but also those that reside on the Tematica Select List. As I discussed above, it’s too soon to tell if this is a real threat or something designed to prod the Chinese at the negotiating table. As usual, the herd is shooting first and asking questions later, which has rarely served long-term investors well. As we look at the majority of the Thematic Leaders and companies that have earned their place on the Select List, the thematic tailwinds continue to favor them. 

Should the trade landscape change in a meaningful way – read that as Trump goes forward with the threatened tariff increase and/or China retaliates – then we will likely see expectations for economic growth and earnings be meaningfully reset. The likely knee jerk reaction will be for investors to flee multinational companies in favor of those whose businesses have greater exposure to domestic economy. Should this scenario come to pass, I’ll be focusing our thematic lens on domestic opportunities, but let’s wait a few days and see what happens. As always, the devil is in the details. 

Getting the check on Del Frisco’s shares

Above I said the vast majority of Thematic Leaders are performing well thus far in 2019. One that has been under pressure of last has been Guilty Pleasure thematic leader Del Frisco’s Restaurant Group (DFRG). We’ve been patient with the company, which since December has been conducting a strategic review. However, following the company’s March quarter results that beat on the top line, but missed on EPS, we are exiting the name. 

While the company saw comparable restaurant sales increase 1.3% during the quarter compared to year-ago levels, margins felt the impact of new location openings, which is slated to continue as DFRG expands its restaurant footprint in the coming quarters. Then there is the issue of the company’s strategic review. Per the earnings press release,

“… we are limited in what we can disclose or comment, but the Board is continuing to work with Piper Jaffray and Kirkland & Ellis in a diligent manner. No assurances can be made with regard to the timeline for completion of the strategic review, or whether the review will result in any particular outcome.”

Remember, this review began in December, and it’s been hinted that part of what’s been dragging the process out is multiple buyers for different pieces of Del Frisco’s. Our growing concern is that even if a partial or full M&A transaction arrives, given the margin prospects for the coming quarters any takeout premium could be modest at best.

Turning to Del Frisco’s balance sheet, the company had $4.6 million in cash at the end of the March quarter, down from $8.5 million at the end of 2018. Even after accounting for non-recurring items during the quarter, Del Frisco’s still delivered a net loss of $3.4 million for the quarter. And with new location openings expected to weigh on margins near-term, odds are the company will continue to bleed cash.

And that brings us back full circle to something that may be delaying a potential M&A transaction. A smart buyer will look to squeeze the company it wishes to buy in order to get the best possible acquisition price, which benefits not only the buying company’s shareholders but also the integration and cost savings process.

Clearly this holding is not working out exactly as planned, and it has been rather frustrating. As new details inside of Del Frisco’s have become available, my growing concern is that either no M&A deal will emerge, and if it does, we run the risk of takeout offers being near current share price levels.

In my view, either of the above scenarios would be read as a disappointment given that inside the current DFRG share price there is likely some implied takeout valuation factor. Currently DFRG shares are trading at more than 12x enterprise value to 2019 EBITDA expectations vs. 11.2x for competitor Ruth’s Hospitality (RUTH).

To sum it up, I see the risks associated with holding DFRG shares mounting, with any resolution not likely to recoup the losses to date that we’ve endured. Better to get out now and minimize additional losses is my thinking.

  • We are issuing a Sell on shares of Del Frisco’s Restaurant Group (DFRG) and removing them from the Thematic Leaders. 

Weekly Issue: Despite a better than expected March quarter GDP print, April signs point to a slowing global economy ahead

Weekly Issue: Despite a better than expected March quarter GDP print, April signs point to a slowing global economy ahead

Key points inside this issue:

  • Earnings season notables from Amazon, Disney, Alphabet/Google and Nokia
  • We are sitting out this week with a new option recommendation, waiting for the market to find its footing rather than get stopped out due to either an earnings season swing one way or the other. 

Last Friday we received the better than expected initial March GDP quarter print of 3.2%, which was well ahead of the expected range of 2.3%-2.5% depending on the source. Digging into that report, we found that inventory build was a key factor in the upside surprise. In our weekly Roundup comments, we shared that such builds tend to be temporary factor for the economy, and we’ll be watching to see the speed at which that inventory build is utilized in what the data shows to be a slowing global economy. To gauge that speed of inventory digestion, it means examining some of the key economic data, and this being the start of the month, there is no shortage of that to be had. 

Yesterday morning we received the IHS Markit Caixin China General Manufacturing PMI reading for April and at 50.2, it was down meaningfully from 50.8 in March. Technically still in expansion territory, but barely so. Inside the report, new export orders returned to contractionary territory, suggesting cooling overseas demand, and while “stocks of purchased items returned to contractionary territory, the measure for stocks of finished goods fell more markedly. 

Granted this is somewhat better than the data from a few months ago that showed China’s manufacturing economy contracting full on, but the April data does not suggest a meaningful upturn is imminent. 

Over the next few days, we’ll get the April IHS Markit PMI data for Japan, eurozone and the US, but yesterday’s National Association of Business Economics’ (NABE’s) April survey of economists showed 53% of respondents now see the economy growing by more than 2% this year. That’s down from 67% in January. When we factor in the initial GDP print of 3.2% for the March quarter, it suggests a more pronounced slowdown in the coming quarters than was thought at the start of 2019. That likely means business’s ability to chew through that March quarter inventory build will not be brisk and will serve as an economic headwind in the current quarter. 

Like always, I’ll be watching the economic tea leaves in the coming days and weeks as we look to zero in on the true speed of the domestic and larger global economy. This includes keeping tabs on what appears to be the never-ending US-China trade conversation. Yesterday morning, it was reported that Treasury Secretary Steven Mnuchin suggested the U.S. and China are closing in on a trade deal. Our position remains the same as it has been for some time – hopeful, but we acknowledge the details of any agreement will be what matters most, not headlines touting victory.

Tematica Investing

As we all know, we are smack dab in the middle of the March quarter earnings season, and there have been some high-profile beats, but also some high-profile misses complete with revised outlooks to the downside. Stepping back, the market is coming to grips with the data we’ve received over the last few months and its impact on company business models. In some cases, as we saw with results from Clean Living Thematic Leader Chipotle Mexican Grill, or those from Procter & Gamble Co. (PG) and The Hershey Co. (HSY), specific corporate strategies are paying off. Meanwhile, results from 3M (MMM), Tesla (TSLA), The Sherwin-Williams Co. (SHW), GATX (GATX), The Gorman-Rupp Co. (GRC), and others, remind us that pockets of the global economy have slowed considerably. 

I expect this dichotomy to continue into next week as the March-quarter earnings season continues. As we and the market digest these reports, the coming of additional economic data, and any progress on trade talks, we’ll be able to triangulate on the next likely move for the market as we move further into the second trading month of the quarter.

Now let’s review some of the recent results for stocks on the Thematic Leaderboard and the Select List:

Amazon (AMZN)     Thematic King

Shares of Amazon climbed following the company’s March-quarter results last week that simply crushed expectations. The likely follow through on those results was offset by Amazon once again providing in-line guidance which is likely to prove to be conservative. From an operations perspective, sales and profit growth were posted by the company’s two largest business segments — North America and AWS — while continued revenue growth at International and cost containment dramatically shrank that segment’s operating profit drag during the quarter. And while Amazon’s advertising business shrank quarter over quarter as the holiday shopping season subsided, year over year the company grew that business by 34%, putting to rest chatter concerning its level of growth. 

Perhaps the most noteworthy item exiting the company’s earnings call was the announcement that free Prime two-day shipping would become free one-day shipping. In my view, this changes the table stakes for retail, and will no doubt lead to share gains for Amazon ahead of the upcoming Prime Day, but also as we move through the remainder of the year. Our price target on Amazon shares remains $2,250.

Walt Disney (DIS)    Digital Lifestyle

Disney shares continued their march higher this week, adding to impressive gains in recent weeks that were sparked by the formal unveiling of its Disney+ streaming service. Fueling the move higher were several items, including the growing euphoria surrounding “Avengers: Endgame,” its latest tent pole franchise film that as expected pierced the $1 billion level at the box office in record time. Also last week, Comcast (CMCSA) shared it will sell its ownership stake in Hulu to Disney, which I expect will shore up its forthcoming Disney+ offering. 

As I have shared previously, as Disney+ gains traction, I expect Wall Street will re-think how it values DIS shares. Disney will report its quarterly results on May 8 and no doubt remind investors of its vibrant film slate for the balance of 2019. With both of those factors in mind, I am boosting our price target on DIS shares to $140 from $125.

Alphabet/Google (GOOGL)       Disruptive Innovators

Earlier this week, Alphabet/Google reported mixed March quarter results with a beat on the bottom line, but quarterly revenue that fell shy of Wall Street consensus forecasts. Heading into the report, our GOOGL shares were up more than 22% year to date, even as recent reports from Facebook, Inc. (FB), Amazon and Twitter  (TWTR) showed them gaining in digital advertising. Google bears have been pointing to growing traction from, Inc. (AMZN) in the digital advertising space, which continues to attract advertising spend from radio, TV and print. All of this set a very high bar for Google in terms of expectations, as it has been putting up 20% revenue growth in a string of recent quarters.

By the numbers, Google delivered EPS $11.90 per share vs. the expected consensus of $10.61 expected on revenue of $36.34 billion, vs. $37.33 billion expected. Digging into that 17% revenue increase year over year, Google’s core advertising revenue rose 15.3% year over year, down sharply from the 20%-24.4% range during 2018. 

To some extent, this is the law of large numbers at play, and if we take a longer view, we see Google’s advertising revenue rose some 43% in the March 2019 quarter compared to the March 2017 quarter. Digging deeper into the figures, we find that YouTube, in particular, had difficult year-over-year comparisons following advertising changes implemented in early 2018.

So, what’s the issue?

According to forecasts from the likes of eMarketer, digital advertising spend is expected to grow 19%-20% this year compared to 2018.

It would appear that Google is off to a slow start in 2019, especially compared to the 26% year-over-year gain in advertising revenue put up by Facebook during its March quarter. Again, some perspective — Facebook’s March quarter advertising revenue was $14.9 billion, which is impressive, but is far behind the $30.7 billion captured by Google during the same quarter.

Despite its size, there are opportunities for Google to grab incremental digital advertising spend share in the coming quarters. Two such examples include new shoppable ad units in Google Images, which would allow brands companies to highlight multiple products available for sale in sponsored image results. The other ties to the company’s comping streaming gaming service introduced at its Game Developers Conference, allowing developers to reengage players with relevant ads across Google’s properties. And then there is Google’s position in mobile search and advertising as mobile utility continues to increase across the globe.

In short, Google’s core advertising business has several drivers of growth remaining. That said, I will monitor these and other efforts to grow the advertising business to ensure these plans are capturing revenue as expected. As one might expect, some across Wall Street trimmed their price targets, while the bears take the expected victory lap. I’ll continue to focus on the next 12-18 months, not the next few weeks. Our price target on GOOGL shares remains $1,300.

Nokia Corp. (NOK) Disruptive Innovators

Last Thursday morning, we received the March Durable Orders and Shipments report, which showed a 2.7% sequential increase in total orders and a 0.3% increase for shipments on the same basis. That’s a favorable order figure and suggests better-than-expected strength in the economy. However, with this report in particular, we need to ferret out the drivers between core capital goods, defense and aircraft. In doing so, we find core capital goods, the data series that ties best with the industrial and manufacturing economy, saw orders rise 6.6% month over month, while core capital goods shipments advanced 0.2%.

Digging a bit deeper into the March Durable Orders and Shipments report, we find considerable order strength in Communications Equipment (+9.0% month over month), Transportation (+7.0%) and Nondefense Aircraft & Parts (+31.2%), with more modest gains for Machinery, Motor Vehicles & Parts, and Electrical Equipment, Appliances and Components. Order declines were seen from Primary Metals, Fabricated Metal Products and Computers & Related Products.

Donning my investing hat, we see the surge in Communications Equipment adding confidence to the expected increase in 5G activity that should bolster its business in the coming quarters. Last week, Nokia delivered the telegraphed weak March quarter it signaled in January. If we were in the later stages of 5G network deployments, we would be far more concerned with these misses relative to Wall Street expectations. However, as both Verizon Communications Inc. (VZ) and AT&T Inc. (T) both shared this week, we are still in the very early earnings for 5G both here in the U.S. and abroad. Verizon even shared that it plans to announce more 5G-capable devices in the coming months. And this speaks to one of the key differentiators for Nokia — namely, Nokia Technologies, its IP licensing arm that delivers operating margins near 82%. That’s more than head and shoulders above historical margins for the Networks business during peak periods of demand. For the March quarter, nearly all of Nokia’s operating profit was generated by Nokia Technologies, which is on a run rate to deliver €1.4 billion (roughly $900 million).

The growing momentum in the 5G market is what allowed Nokia to keep its 2019 earnings forecast intact as the combination of revenue growth and improving margin profile falls to the bottom line. As Nokia noted in its earnings release, “5G revenues are expected to grow sharply, particularly in the second half of the year, driven by our 36 commercial wins to date.” As more device companies look to tap the 5G market opportunity, Nokia Technologies is positioned for further upside in the coming quarters. Should that come to pass, which in our view is more likely than not, it translates into either greater comfort with Nokia’s 2019 earnings-per-share targets or potential upside in the second half of 2019 and beyond.

Our position has been that 5G is a market opportunity that will gain momentum in the coming quarters and likely hit the U.S. commercial tipping point in 2020 with China/Japan to follow and then Europe. With hindsight being 20/20, we were likely early on adding Nokia to the Thematic Leaderboard, however, as the 5G inflection point approaches the shares will remain on the board. Subscribers who are underweight NOK shares should consider using post-March quarter earnings weakness in the shares to add to their holdings. Our long-term price target for NOK shares remains $8.50.

This Week’s Issue: Hear those engines? It’s earnings season!

This Week’s Issue: Hear those engines? It’s earnings season!

Coming into this week 15% of the S&P 500 companies have reported and exiting it that percentage will jump to 45%. What the market and investors will be focusing on this week is what led to upside or downside surprises for the reported quarter and how is the current quarter shaping up relative to expectations. Remember, that during the March quarter we saw downward revisions in S&P 500 EPS expectations for the quarter such that the consensus called for EPS declines year over year. Currently, expectations for the current June quarter are up 10% sequentially but are flat year over year. 

If we get the data to show these March reports and prospects for the current quarter are better than expected or feared, we could see the 2019 view for S&P 500 earnings move higher vs. the meager 3.7% growth forecast to $167.95. If that happens, it will mark a change in view for 2019 expectations, which have been eroding over the last several months, and could drive the market higher. However, if we see a pickup in downward EPS cuts, we could see those 2019 S&P 500 consensus expectations come under pressure, which would make the stock market even more expensive following its year to date run of 16%. 

Now to sift through the onslaught of more than 680 companies reporting this week, which based on what we’re seeing this morning from Coca-Cola (KO), Lockheed Martin (LMT), Twitter (TWTR) and Pulte Group (PHM) suggest potential upside to be had. Tucked inside those results were positive data points for several of our investing themes:

Coca-Cola is feeling the tailwind of our Cleaner Living investing theme as sales of its flavored waters and sports drinks rose 6% year over year, significantly faster than the 1% growth posted by its carbonated drinks business. During the earnings conference call, CEO James Quincy shared that the management team is looking to make Coca-Cola a “total beverage company” by adding coffees, teas, smoothies and flavored waters to a portfolio that has traditionally offered aerated drinks.

Lockheed Martin Corp reported better-than-expected quarterly profit yesterday, benefitting from the Safety & Securitytailwind associated with President Donald Trump’s looser policies on foreign arms sales boosted demand for missiles and fighter jets.

Efforts to improve its advertising business model helped Twitter capture some of our Digital Lifestyletailwind as year over year monetizable daily user growth returned to double digits for the first time in several quarters. 

Verizon (VZ) beat quarterly expectations and on its earnings conference call 5G and its deployment in the coming quarters was a key topic during the question and answer session. Verizon will continue to build out its network and bring more 5G capable smartphones to market, which in my view continues to bode well for our Digital Infrastructureand Disruptive Innovators Thematic Leaders, Dycom (DY) and Nokia (NOK). Nokia will report its quarterly results later this week, and following Ericsson’s better than expected results that tied to strength in North America and 5G, Nokia could surprise on the upside as well.

Splitting the Housing and Retail Sales hairs

Late last week we received some conflicting economic data in the form of the March Retail Sales report and the March Housing Starts data. While retail sales for the month came in stronger than expected — a welcome sign following the last few months in which that data disappointed relative to expectations — March housing starts fell to their weakest point since 2017 despite a tick down in mortgage rates. Now let’s take a deeper dive into those two reports:

In looking at the March Retail Sales report, total retail rose 1.7% month over month (3.5% year over year) with broad-based sales strength and nice gains seen across discretionary spending categories. While we are quite pleased with the month’s data, subscribers know we tend to favor a longer-term perspective when it comes to identifying data trends. Consequently, as we are bracing for the March quarter earnings onslaught it makes sense to examine how retail sales in this year’s March quarter compared to the year-ago quarter. Here we go:

Leaders for the March 2019 quarter vs. March 2018 quarter:

  • Nonstore retailers up more than 11%, which bodes very well for Thematic King Amazon  (AMZN) and to a lesser extent our Alphabet (GOOGL). Let’s remember that those packages need to get to their intended destinations, which likely means positive things for United Parcel Service (UPS), and I’ll be checking that report, which is out later this week. 
  • Food services & drinking places rose 4.4%, which points to favorable data for Guilty Pleasure Thematic Leader Del Frisco’s Restaurant Group (DFRG). And yes, I continue to wait on more about its strategic review process. 
  • Health & personal care stores were up 4.6%.
  • Building material & garden suppliers and dealers increased by 4.7%.

Laggards for the March 2019 quarter vs. March 2018 quarter:

  • Sporting goods, hobby, musical instrument, & book stores were down 7.9 
  • Department Stores fell 3.8%, which comes as no surprise to me given the accelerating shift to digital shopping that is part of our Digital Lifestyle investing theme. 
  • Miscellaneous store retailers were down 3.8%

Turning to the March Housing Starts report, the aggregate starts data fell to the weakest level since 2017, but that decline includes both single-family and multifamily housing starts. Breaking down those two components, single-family starts were down 0.4% to 781,000, the slowest pace since September 2016, while permits decreased 1.1% to 808,000, the lowest since August 2017. Multifamily starts, which include apartments and condominiums, were unchanged month over month at 354,000, while those permits fell 2.7%. 

The March results may have been influenced to some degree by harsh weather in the Northeast, which contended with heavy snowfalls, and in the South as it dealt with record flooding along the Mississippi and Missouri rivers. Even so, the housing data were off despite a decline in the 30-year mortgage rate to roughly 4.15% this month from 4.86% last October, according to data from Marcrotrends. This decline likely signals that consumers are being priced out of the market as developers and home builders continue to struggle with building affordable properties amid rising labor and materials costs. We also must consider the state of the consumer, who is dealing with the impact of higher debt levels across credit cards, auto loans and student loans — a combination that is sapping disposable income and the ability to service mortgages on homes they may not be able to afford.

Generally speaking, most existing homeowners in the U.S. use the capital from selling their current homes to help fund the purchase of their next dwellings. This means we as investors should watch Existing Home Sales data as a precursor to new home sales and housing starts. Despite February’s better-than-expected sequential print, Existing Home Sales have been falling on a year-over-year basis since February 2018.

Per March Existing Home Sales report, which showed a 5.4% sequential drop vs. February and a similar decline vs. a year ago. For the March quarter, existing home sales fell 5.3%, which in our opinion does not augur well for a near-term pick up in the overall housing market, especially as the recent decline in mortgage rates has not jump started new mortgage applications.

Generally speaking, the housing market has two seasonally strong periods during the year, the spring and fall selling seasons, of which spring tends to be the stronger one. This year, it could be argued that harsh weather in various parts of the U.S. has resulted in the spring selling season getting off to a slow start. Leading up to it, we have seen a climb in the inventory of new homes listed for sale, according to That’s the supply side of the equation, but the side we remain concerned about is demand.

As we get more data in the coming weeks, we’ll be better able to suss out if we are dealing with a weather related situation, a consumer affordability one or some combination of the two. If the data points to a consumer affordability one, we may consider Home Depot (HD), which is a company that cuts across our Middle Class Squeeze and Affordable Luxury investing themes. Through last night, however, HD shares are up some 28% year to date, and are sitting in over bought territory. Should we see a sizable pullback over the coming weeks as more earnings reports are had and digested, this could be one to revisit. 

Weekly Issue: Apple and Disney Showing Transformational Signals

Weekly Issue: Apple and Disney Showing Transformational Signals

Key points inside this issue

  • What the March NFIB Small Business Optimism Index had to say
  • Making sense of the IMF’s latest economic forecast cut
  • Ahead of Disney’s (DIS) Investor Day today, we continue to have a Buy on Disney (DIS) shares, and our $125 price target is under review
  • Based on its recent string of monthly same-store-sales reports and year over year progress in warehouse openings, with more to come, I am bumping our price target on Middle-Class Squeeze Leader Costco Wholesale (COST) to $260 from $250.  
  • Our price target on Thematic King Amazon (AMZN) shares remains $2,250.
  • Our price target on Alphabet/Google (GOOGL) shares remains $1,300.

What the March NFIB Small Business Optimism Index had to say

This past Tuesday, we received the March Small Business Optimism Index reading from the National Federation of Independent Business (NFIB). The index edged higher, month over month, to 101.8. For the March quarter, the Optimism Index reading averaged 101.56, with March’s reading the highest, which was well below the March 2018 quarter’s 106.4 reading and the 105.5 level for the December 2018 quarter. Clearly, the year-ago level benefited from tax-reform euphoria and while the index has fallen in recent months, the uptrend during first quarter is another sign the domestic economy continues to grow, rather than contract like we are seeing in the Big 3 economies of Europe: Germany, France and Italy.

Digging into the report, one of the bigger soft spots was inventories, as levels were viewed as too large and plans to invest pointed to more firms reducing rather than adding to their inventories. That’s another sign to us of potentially softer guidance relative to expectations in the upcoming earnings season.

Adding to that we also found the Outlook for General Business Conditions component, which looks at the coming six months, has softened considerably, hitting 11 in March, continuing the downtrend in the data since peaking at 35 last July. To us, this reflects that the ongoing trade war, domestic economic data and growing worries over the consumer have taken their toll.

What’s most worrisome to us, however, is the accelerating decline in small business earnings over the last two months. Survey respondents chalk this up to falling sales volume and rising costs that include labor, materials, finance, taxes and regulatory costs.

With lower tax rates and the cut in federal regulation by the Trump administration, the other three factors are the likely culprits behind the month-over-month declines in earnings the last few months. On top of that, the sales expectation for the coming three months has also softened compared to the second half of 2018.

With small business being one of the key job creation engines, these softening sales and earnings expectations could pressure hiring plans and corporate spending, adding to the headwind(s) for the domestic economy.

What’s also interesting ahead of bank earnings that kick off later this week, is the survey revelation that loan availability became harder to obtain during February and March. There was also a drop in expectations for credit in March.

Rather than relying on just one set of numbers, we here at Tematica prefer to leverage several pieces of data to get a fuller, more robust picture. In this case, however, it does mean that we’ll be on guard with bank earnings, especially from those that are outside of the bulge bracket banks — JPMorgan Chase (JPM), Citigroup (C), Bank of America (BAC) and the like. Those names tend to be far more diversified in their revenue streams and can weather the potential storm far better than smaller, regional banks, such as First Community Bankshares (FCBC), that make their profits primarily on deposit and loan volumes.

Making sense of the IMF’s latest economic forecast cut

Also, on Tuesday, the IMF lowered its 2019 World Growth Outlook to 3.3% from 3.5% in January to reflect cuts in both US and European forecasts and a modest upward revision in China. The downward revisions come as the IMF appears to be factoring the recent global economic data that we’ve been getting in recent weeks and in its view “this weakness” is expected to continue in the first half of 2019. Following on that, yesterday morning the European Central Bank (ECB), held interest rates steady and warned that recent data pointed to a “slower growth momentum” in the eurozone.  

In many respects these comments were not surprising given the domestic economic and global IHS Markit data we’ve been reviewing here over the last few months. If anything, we see the IMF’s downgrade as overdue. But similar to how the Fed is a cheerleader for the domestic economy, the IMF is forecasting a global economic rebound in 2020, but then proceeds to list a series of downside risks and uncertainties, including “a rebound in Argentina and Turkey and some improvement in a set of other stressed emerging market and developing economies” and a “realization of these downside risks could dramatically worsen the outlook.” 

Rather than get wrapped up in the economic forecasts of the IMF, the Fed or other entity, we’ll continue to parse the data and triangulate the data points to get as real-time a view on the domestic and global economy as possible. This includes not only the government issued economic indicators, but also those from trade associations and other third parties. Yesterday we talked on the March Small Business Optimism Index from the NFIB and what it had to say. Other indicators we’ll be watching include monthly truck tonnage data, which fell year over year in February per the American Trucking Association, and weekly rail carloads fell 8.9% year over year in March per data from the Association of American Railroads. 

Late yesterday, we received the Fed’s minutes from its March FOMC monetary policy meeting. Recall that exiting the March meeting, the Fed’s post-meeting statement said it would be patient when it comes to future monetary policy actions as it downgraded its GDP forecast in 2019 and 2020. Moreover, it’s updated Economic Projections forecasted only one rate hike between March 2019 and the end of 2020. The meeting minutes confirmed this patient view was widespread across the committee. No surprise there in my view. With inflation data, as well as the vector and velocity of other recent domestic data, tipping lower, I expect the Fed is likely to remain optimistic but dovish in its forthcoming commentary and speeches, especially as the US-China trade negotiations drag on. 

And here we go…. March quarter earnings season 

The March quarter earnings season “fun” will start off with a trickle of earnings this week, 28 in all including several high-profile bank earnings later this week. The pace will pick up next week when roughly 170 companies will be issuing their results. The following week, which begins on April 22nd, it jumps considerably with more than 700 companies issuing their quarterly results and guidance. It is going to be fast; it is going to be furious. 

As you know, over the last few weeks I’ve been increasingly vocal about the potential for a rocky stock market during this earnings season as expectations are likely to get reset for a variety of reasons including the slowing speed of the global economy, dollar headwinds, rising costs, and trade uncertainties to name a few. And let’s remember the March 2018 earnings season saw companies wrap their heads around the impact of tax reform on their collective bottom lines. That bottom-line life preserver, from a guidance perspective, has come and gone.  Be sure to hold some downside protection over the next few weeks, like the ProShares Short S&P 500 ETF (SH) shares.

Tematica Investing

First Apple and today Disney

A few weeks ago, Apple (AAPL) held its special event that focused on its Services businesses, specifically the forthcoming streaming video, gaming and news services, all of which look to drive recurring subscription revenue. Today, The Walt Disney Company (DIS) will hold its annual investor meeting at which it will debut Disney+, its own streaming service. The new service from Disney will not only utilize the entire Disney and Fox entertainment library but also build on the company’s direct to consumer efforts with original programming across its Marvel, Star Wars, Pixar and other tentpole franchises. 

While DIS shares have not graduated to the Thematic Leaders, they have been on the Select List since mid-2016 as part of our former Content is King investment theme, which has since been folded into the Digital Lifestyle theme. When we first learned of the Disney+ service, my view was that if success is measured by consumer adoption, it had the possibility of transforming how investors should value the company. As more details have emerged on the service, it seems that more across Wall Street have adopted that same view. Earlier this week DIS shares received an upgrade from Cowen & Company to Buy, while BMO Capital Markets raised its rating to Outperform. These moves follow a boost from Goldman Sachs and Rosenblatt Securities last week. 

As we move from leaks and rumors on Disney+ to firm details with today’s event — and event that should also touch on other developments as well such as the roll out of Star Wars across Disney’s theme parks — I will revisit my longstanding $125 price target on the shares. 

  • Ahead of Disney’s (DIS) Investor Day today, we continue to have a Buy on Disney (DIS) shares, and our $125 price target is under review

Costco Wholesale does it again in March

Last night Middle Class Squeeze Thematic Leader Costco Wholesale (COST) reported March same-store comps of +5.7% (5.9% excluding gas and foreign exchange.) Compared to the data in recent Retail Sales reports, Costco continues to take consumer wallet share, but to me what was far more striking was the step up in its same-store comps month over month from +3.5% (+4.6% excluding gas and foreign exchange). It would seem it’s not just me looking to fight the tide of rising food prices by buying in bulk at Costco. 

The other item that I track rather closely when Costco issues these monthly reports is the number of open warehouses. Exiting March, it had 770 open warehouses, which compares to 749 exiting March 2018. That year over year increase bodes extremely well for Costco as more warehouses delivers increased high-margin membership fee revenue, which generates roughly 70% of the company’s operating income. 

  • Based on its recent string of monthly same-store-sales reports and year over year progress in warehouse openings, with more to come, I am bumping our price target on Middle-Class Squeeze Leader Costco Wholesale (COST) to $260 from $250.  

eMarketer sees continued Digital Advertising growth ahead

Ad spending will continue to rise across the globe, with digital driving most of the growth. According to data published by eMarketer, this year worldwide digital ad spending will rise by 17.6% to $333.25 billion, which means that, for the first time, digital will account for roughly half of the global ad market. In my view, this reflects the changing nature of where, how and when we consume content be it video, music, news or some other format that is a key part of our Digital Lifestyleinvesting theme. Advertisers want to go where the eyeballs are, and while this is a tailwind for a number of companies, the change in ad spend location is a growing headwind for “legacy” media companies. No wonder CBS (CBS), Comcast’s (CMCSA) NBC and others are looking to join the streaming video fray. 

eMarketer’s forecast depicts one of the core thesis items behind our holding shares of Alphabet Inc. (GOOGL) — namely, that digital advertising will continue to take share of total media spending. Per eMarketer’s forecast, digital advertising will grow to more than 60% of media spending by 2023, up from roughly 46% of advertising last year. While those outer years in the forecast range may be off by a point or two, it’s the direction and year-over-year share gains by digital advertising that matter for our Google shares as well as our (AMZN) shares.

Digging into eMarketer’s forecast, it sees Google remaining the top digital ad seller dog in 2019 with 31% market share. Behind it will be Facebook (FB) and its various properties and then Alibaba (BABA). In fourth place is Amazon, which eMarketer sees as generating $14 billion in ad revenue this year. To most companies, $14 billion would be the business, but at Amazon it should account for roughly 5% of its 2019 revenue. And while it is on the smaller side for the company, it’s bound to be rather profitable.

We are seeing some shifting of ad spend among Google, Facebook and Amazon, with Amazon being the up and comer. That said, the digital ad spend tide is still rising, and with concerns over privacy for Facebook and others the odds are better than good that both Google and Amazon will continue to ride that tide over the next few years. Longer term, as the shift to digital advertising continues, we will see slower growth rates much like any maturing industry, but we’re far from that point today.

  • Our price target on Thematic King Amazon (AMZN) shares remains $2,250.
  • Our price target on Alphabet/Google (GOOGL) shares remains $1,300.

Weekly Issue: A number of Thematic Leaders delivered outsized returns during Q1

Weekly Issue: A number of Thematic Leaders delivered outsized returns during Q1

Key points inside this issue

  • Despite a slowing global economy, the March quarter was a barn burner for stocks, but risks remain heading into the March quarter earnings season.
  • Our price target on Apple (AAPL) remains $225. 
  • Our price target on shares of Living the Life Thematic Leader Del Frisco’s Restaurant Group (DFRG) remains $14.
  • Our price target on Universal Display (OLED) shares of $150 is under review. 

Last week brought the March quarter to a close, and even though Friday’s personal income and spending data confirmed a slowing economy, it was the best quarter in nearly a decade for stocks. 

The bulk of the double-digit gains across all of the major domestic stock market indices — the Dow Jones Industrial Average, S&P 500, Nasdaq Composite Index, and the Russell 2000 — came early in the quarter due to positive expectations for U.S.-China trade talks, even as the market shrugged off the federal government shutdown. As the quarter wore on, data pointed to a slowing global economy, with more pronounced weakness in China, Japan and Europe, leaving the U.S. the best house on the slowing economic block. Even so, the domestic data point to a markedly slower U.S. economy compared to the second half of 2018, which in part reflects the anniversary of tax reform, but also consumers that increasingly appear to be hitting a spending wall.

Companies are also contending with higher wage costs, due in part to minimum wage hikes, as well as certain higher input costs. And of course, there is the current trade war with China that is also presenting a headwind, as is the slowing economies in Europe and Japan, especially given the year-over-year strength in the dollar, as you can see in the chart below.

In sum, we’ve seen a number of these headwinds result in reduced earnings expectations for the current quarter, and we’re now beginning to see companies once again trim back expectations. Last Thursday night DowDuPont Inc. (DWDP) slashed its sales and profits forecasts, joining the ranks of Infineon Technologies AG (IFX), Samsung Electronics Co., Ltd., Osram and others. This week, it was Walgreens Boots Alliance (WBA) that shared it had “the most difficult quarter we have had since the formation of Walgreens Boots Alliance.

On Monday we received a slew of economic data that included the March Manufacturing PMI data for China, Japan, the eurozone and the U.S. as well as the March ISM Manufacturing Index and February Retail Sales figures. There were bright spots inside this sea of data, most notably the March ISM Manufacturing Index that surprised modestly to the upside and showed a pickup in orders and employment.

That positive report was tempered by the IHS Markit Manufacturing PMI for the U.S., which showed a month-over-month decline in March and hit its lowest level since mid- 2017. As that report noted, “New order growth has fallen close to the lows seen in the 2016 slowdown, often linked to disappointing exports, tariffs and signs of increasing caution among customers.” This trend points to continued slow growth ahead for the domestic economy, though the latest data as a whole still leave the U.S. as the fastest-growing economy compared to China, Japan and the eurozone.

As for the February Retail Sales Report, it once again missed expectations, declining 0.2% month over month. This marks the third flat to down sequential comparison for this data set in the last four months. Viewing the data on a year-over-year basis, retail sales for the month rose 2.1%, which confirms a slower but still growing U.S. economy. While we don’t want to put too sunny of a view on it, the February year- over-year comparison was ahead of the 2.0% growth pace of the trailing three months. Still, there was no question the year-over-year rate of spending in February slowed compared to January.

While we don’t want to put too sunny of a view on it, the February year- over-year comparison was ahead of the 2.0% growth pace of the trailing three months. Still, there was no question the year-over-year rate of spending in February slowed compared to January.

In my view, this looks to be setting up a volatile earnings season, with earnings guidance that is likely to disappoint and lead to downward revisions for the June quarter as companies reset expectations. We will continue to be prudent, longer-term focused investors that take our cues from our 10 investing themes and the confirming signals to be had.

Tematica Investing

As we put the March quarter in the rear-view mirror, the market will continue to look for hope in a U.S.-China trade deal but given the factors outlined above, I see greater risk to the downside, generally speaking, than upside, as we begin the March-quarter earnings season. The stalwart among them was Clean Living Leader Chipotle Mexican Grill (CMG), as its shares rose more than 60% during the first three months of the year. Digital Lifestyle Leader Netflix (NFLX) as well as New Global Middle Class Leader, Alibaba (BABA), soared more than 30% during the quarter, and Thematic King Amazon (AMZN) climbed 20%. 

The quarter wasn’t without its challenges given declines experienced at Aging of the Population Leader AMN Healthcare (AMN), but as I am seeing with my 87 year old father, the need for elder care is pronounced and bodes well for nursing demand in the coming years. We will continue to hold AMN shares. Another laggard is Dycom Industries (DY), better known as the Digital Infrastructure Leader, which is positioned to benefit from the 5G and gigabit network buildout. We’re entering the seasonally strong time of the year for Dycom, which also brings us closer to initial 5G launches from AT&T (T), Verizon (VZ), T-Mobile USA (TMUS) and others. As with AMN shares, we will continue to hold DY shares as well. 

Now let’s dig into several Thematic Leaders and Select List positions that made news over the last week. 

Apple’s video and gaming efforts are interesting but not in the short-term

During the March quarter, Apple’s (AAPL) shares rebounded hard, rising just over 20%. Some of that climb was due to the excitement ahead of Apple’s services focused event last week, which candidly was largely as expected given prior news leaks. Leading up to the event we saw iPad, Mac and AirPod refreshes, but the event itself focused on Apple Card, Apple News+ and AppleTV+. The one surprise was the announcement of a streaming gaming service, which like AppleTV+ will debut later this year. 

As such while they are positives for the Services business, they will have little impact on the company’s bottom line near-term. That said, Canaccord Genuity upped its price target to $230 from $185 this week. The reality of the situation is that as much as we like content and Apple is looking to use it to make its devices and ecosystem even stickier with customers inside the Digital Lifestyle, in the near-term the primary driver of the company’s profits will continue to be the iPhone. 

  • Our price target on Apple (AAPL) remains $225. A key point to that target is the eventual upgrade cycle tied to 5G and the iPhone, which given our Dycom comments above, increasingly looks like it will happen in the second half of 2020.

Frustrated with Del Frisco’s Restaurant Group, but holding steady

If you’re growing frustrated with this Thematic Leader, you are not alone. During the March quarter, DFRG shares fell roughly 10%, but the inter quarter swing was far greater than that. What’s weighing on the shares is lack of news on the company’s strategic review process. Per some reports, the company could be cleaved into two parts to different buyers, which if true would explain the pronounced timetable.

From a fundamental perspective, while overall restaurant traffic and other metrics fell in February according to data published by TDN2K, the bulk of that decline was at fast casual restaurants, to which we have no exposure. Digging into the data, we find  fine dining was the best-performing industry segment during February for same-store sales growth. While I like such confirming data, as I noted above the DFRG share price will continue to be driven by any and all strategic review developments. This will continue to be our point of focus for now.

 Our plan is to hold DFRG as the takeout story evolves further, but as we have said previously, odds are we will use a deal- related pop in the stock to exit the position. 

  • Our price target on shares of Living the Life Thematic Leader Del Frisco’s Restaurant Group (DFRG) remains $14.

Universal Display should continue to shine

Universal Display (OLED) shares shined bright during the first quarter rising easily more than 50%. Yesterday, there were thesis confirming reports for the adoption of organic light emitting diode display that will drive demand for Universal’s chemical and IP licensing businesses. Those reports centered on Apple (AAPL) shifting its entire production of iPhones to organic light-emitting diode displays in 2020.

These same reports also suggest Apple will have three different- size iPhones, measuring 5.42 inches, 6.06 inches and 6.67 inches. While the varied iPhone sizing is new, we heard similar hints about the switch in display technology several months ago. We see this as follow up to that, which in our view increases the likelihood of this happening.

We’d also note the timing of these models and the display transition seem to coincide with the potential debut of a 5G iPhone. In light of the incremental RF chips the 5G model will contain, it makes sense that Apple would look to adopt this display technology for both space as well as power savings.

While we like seeing our investment thesis confirmed here, I’d note that not only have OLED shares climbed substantially over the last three months, but the transition to all organic light-emitting diode displays at Apple, and most likely others, is several quarters out. We will continue to be long- term investors in OLED shares. However, given market conditions and the upcoming earning season we could see OLED shares give some of its gains back in the near-term. We’ll continue to focus on the long-term opportunity not only in the smartphone market but in automotive and eventually the general illumination market. 

  • Our price target on Universal Display (OLED) shares of $150 is under review. 
Weekly Issue: More Data Points To An Economic Slowdown Ahead

Weekly Issue: More Data Points To An Economic Slowdown Ahead

Key points in this issue:

  • The Fed, recent economic data and downside guidance are setting up a rocky March quarter earnings season. 
  • We will continue to hold shares of Guilt Pleasure thematic leader Del Frisco’s Restaurant Group (DFRG) as we patiently wait for the next step of its strategic review process. Our price target of $14 remains in place. 
  • Be sure to check back on later this week when I follow up on the announcements that Select List resident Apple (AAPL) made yesterday. There we are a number of things to cover, several of which position Apple’s business inside the Digital Lifestyle tailwind. 

Data points to a slower economy ahead

Stocks finished last week on different footing compared to the start of the week. I type this, however, there is an attempt at a market rebound. While the major market indices trended higher ahead of Federal Reserve Chair Jerome Powell’s post-monetary policy press conference last Wednesday, the revelation the Fed would adopt a far more dovish stance, with no expected rate hikes in 2019, took the market by surprise. I talked about this on last week’s Cocktail Investing podcast, which if you missed it you can find it here.

As you can see in the chart below, the market initially liked what it read in the FOMC statement – dovish as expected – but as it digested the Fed’s latest economic projections and Powell’s comments it traded off its 2 PM surge. There’s dovish and then there is, “Uh oh, they are worried!” To better understand what put a bitter aftertaste in the market’s mouth let’s have a blow by blow account of what it heard.

First, let’s turn to the Fed’s monetary policy press release. Right off the bat, it agreed with the data we’ve been getting of late that “growth of economic activity has slowed from its solid rate in the fourth quarter” due to in part to slower household spending and business fixed investment. We touched on this in our note yesterday, which means those comments were of little surprise as was the lack of rate hike as the Fed maintained its target range for the federal funds rate.

Now here comes the dovish statement that popped the market – “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.” In other words, the Fed’s patience means a more dovish stance in the near term and basically took any more hikes in 2019 off the table with just one possible in 2020.

Now let’s turn to the Fed’s latest iteration of economic projections, which show the Fed has reduced its 2019 GDP forecast to 2.1% from 2.3% in December and 2.5% in September. Interesting, given the CNBC March Fed Survey findings we shared yesterday that put 2019 GDP at 2.3%. We say interesting because the Fed tends to be the cheerleader for the economy, yet its forecast is below the CNBC consensus, but in line with the Economic Forecast Survey published by The Wall Street Journal. The Fed also trimmed its forecast for GDP in 2020 to 1.9% from 2.0% and left its 2020 view unchanged at 1.8%. No matter how you slice it, it’s slower growth ahead compared to what we saw in the second half of 2018. 

Inside this forecast, the Fed also took a knife to its federal funds forecast for 2019 through 2021. For this year it now sees the federal funds rate at 2.4%, pretty much in between the 2.25% to 2.50% range it said it would maintain. For 2020-2021, the Fed now forecasts the federal funds rate will remain at 2.6%, down from its prior forecast of 3.1%. In other words, the prior view to boost rates to cool the economy and keep inflation tame is no longer. This goes hand in hand with the revised GDP forecast and comments issued in the formal press release. 

What’s different this time around is the why as the Fed is reacting to the slowing economy and is aware that a more aggressive interest rate policy could erode the expected speed of GDP in the coming quarters. What we have here is a Fed that is looking to avoid, as best it can, one of the classic mistakes of the past, which is boosting interest rates into a slowing economy or recession. 

Now let’s turn to the press conference to determine what was said that put that after taste in the market’s mouth. During Powell’s prepared remarks, his message was summed up in the following words – “We continue to expect that the American economy will grow at a solid pace in 2019, although likely slower than the very strong pace of 2018. We believe that our current policy stance is appropriate.” A pretty succinct was of summarizing the press release and economic projections. 

Powell also addressed the Fed’s Balance Sheet Normalization Principles and Plans, noting the news the Fed intends “to slow the runoff of our assets starting in May, and to cease runoff entirely in September of this year.” In other words, a more dovish stance at the Fed and significantly so compared to that coming out of its last few FOMC meetings. 

To recap and put this all of this into context, the “normal” federal funds rate for this business cycle sits between 2.25% and 2.5% versus 2.75% at the end of the Fed’s last tightening cycle in 2006 and 4% at the end of 2000 cycle – that’s not a whole lot of monetary ammunition for the next downturn.

By September the Fed will still hold over $3.5 trillion in bonds which equates to about 17% of GDP versus just 6% back in 2006. 

Materially lower “normal” rates and a balance sheet that is nearly 3x heavier after over 10 years since the last recession, unprecedented monetary stimulus, solid tax cuts and a level of government spending the likes of which have not been seen outside of a recession or a war. Yeah, the markets got spooked.

This brings us to the likely question that spooked the markets – what is the Fed seeing that it has taken on a more pronounced dovish tone? 

More than likely it viewed the slowing global economy, the pushouts in the US-China trade conversation and the potential for a Brexit delay as fanning the flames of uncertainty. Generally speaking, during periods of uncertainty both consumers and businesses tend to tighten their belts, could be another reason why March quarter guidance could be weaker than expected. 

Those slower growing economy concerns were back in action Friday morning following the publication of March Flash PMI data for Japan, the EU and the U.S.

For Japan, the Flash Manufacturing PMI remained in contraction territory, with new order activity falling at a faster rate pointing to a “sustained downturn.” 

Later this week we will close the books on the March quarter and prepare for the upcoming earnings season that is only a few weeks away. We’ll continue to listen to the Thematic Signals and other thematic signposts as we navigate what is likely to be another challenging period for the overall stock market. 

Tematica Investing

Holding steady with Del Frisco’s shares

In aggregate our Thematic Leaders continue to perform well so far this year despite the recent fall off in Guilty Pleasure leader Del Frisco’s Restaurant Group (DFRG). Following its recent earnings report that shed no light on where the company is in its strategic review process, the shares continued to move lower over the last several days bringing the decline over the last month to more than 25%. Candidly, I am growing frustrated with this leader, but I know it’s simply the lack of news that is weighing on the shares. There have been a few reports suggesting the company could be cleaved into two parts to different buyers, which if true would explain the pronounced timetable. 

Despite this frustration, and especially because the shares are deep into in oversold territory, our plan is to hold DFRG as the takeout story evolves further. 

  • We will continue to hold shares of Guilty Pleasure thematic leader Del Frisco’s Restaurant Group (DFRG) as we patiently wait for the next step of its strategic review process. Our price target of $14 remains in place. 

Be sure to check back on later this week when I follow up on the announcements that Select List resident Apple (AAPL) made yesterday. There we are a number of things to cover, several of which position Apple’s business inside the Digital Lifestyle tailwind.

Weekly issue: Downside Protection Critical Amid These Uncertain Conditions

Weekly issue: Downside Protection Critical Amid These Uncertain Conditions

Key points inside this issue

  • Ahead of the Fed’s latest dot blot, 2019 GDP expectations move lower.
  • With uncertainties again on the rise, we reiterate our Buy rating on the ProShares Short S&P 500 ETF (SH) ahead of the upcoming March quarter earnings season.


Weakening GDP Expectations for the Remainder of 2019

Looking back over the last few weekly issues, it would be fair to say they were a little wordy. What can I say, between the economic data and earnings season, plus thematic data points, there was a lot to share over the last few weeks. Today, however, I’m going to cut to the point with my comments, largely because all investor eyes and ears are waiting to see and hear what Fed Chair Jerome Powell has to say about the speed of the US economy as they look for signs over what is coming next out of the Fed.

We’ve talked quite a bit about the slowing speed of the global economy, and even though there have been some individual bright spots across the aggregated hard and soft economic data from both government and third-party sources, the slowing speed is hard to ignore. Based on the published data, domestic GDP hit 3.1% last year, and as we’ve shared recently we’ve started to see the expectations for 2019 move lower in recent weeks. Per the March CNBC Fed Survey of 43 economists and Fed watcher findings, GDP for 2019 is now expected to clock in around 2.3% — not quite cut in half compared to 2018, but dramatically lower and significantly lower than folks were looking for in the back half of 2018.

When the Fed issues its post FOMC meeting statement today, the focus will more than likely not be on the interest rate decision – almost no one expects a hike. Instead, rapt attention will be paid to the Fed’s updated economic dot plot, which will reveal how it sees the US economy shaping up. Let’s remember that one unofficial aspect of the Fed’s job is to be a cheerleader for the economy, so it becomes a question of “if they are cutting their GDP forecast” how deep of a cut could we really see?

Culprits of the slowing economy and these cuts include aspects of our Middle-Class Squeeze investing theme as consumers in the US grapple with debt levels that have risen precipitously over the last several years. The consumer spending tailwind associated with our Living the Life investing theme appears to be slowing some given the rising debt levels of Chinese consumers. Governments have also run up debt in recent years as the current business cycle has grown longer in the tooth. And of course, there is the impact of currency as well as political and trade uncertainties, including the pushout of US-China trade talks to June.


Downside Protection is Key Under These Circumstances

In a little over 10 days, we will be exiting March, entering the second quarter and beginning the earnings season dance all over again. My concern is that given the above and the several unknowns therein, we are poised to see another earnings season during which aggregate expectations will be adjusted lower. Case in point, with the  US-China trade agreement timetable slipping and slipping, it becomes rather difficult for a company to factor any resolution into its guidance, especially when the terms of the agreement are unknown.

Despite all of the above, the domestic stock market has continued to chug higher, once again approaching overbought levels, even though 2019 EPS cuts for the S&P 500 have made the market even more expensive than it was as we exited 2018.

The potential poster child for this is FedEx (FDX), which saw its shares take a fall last night after the company cut its annual profit forecast for the second time in three months due to slowing global growth, rising costs from a 2016 acquisition in Europe and questions over its ability to withstand U.S.-China trade tensions and uncertainty over the U.K.’s exit from the European Union.

Not to go all Groundhog Day on you, but this looks increasingly like the situation we saw in December when I added the ProShares Short S&P 500 ETF (SH) to the Select List. If we didn’t have those shares to offer some downside protection for what lies ahead, I would be adding them today. If you don’t have any of those shares in your holdings, my advice would be to add some. Much like insurance, you may not know exactly when you’ll need it, but you’ll be happy to have it when something goes bad.

  • With uncertainties again on the rise, we reiterate our Buy rating on the ProShares Short S&P 500 ETF (SH) ahead of the upcoming March quarter earnings season.



Weekly Issue: Talking Thematics, Boeing and Retail Sales

Weekly Issue: Talking Thematics, Boeing and Retail Sales

Key points inside this issue

  • We are issuing a Buy on and adding shares of Energous Corp. (WATT) to the Select List as part of our Disruptive Innovators investing theme with an $11 price target.
  • We will continue to patiently hold Thematic Leader Del Frisco’s Restaurant Group (DFRG) shares as the Board continues to review potential strategic alternatives.


I’m just back from some meeting in New York, and it was a busy trip that included visits with Yahoo Finance and Cheddar to discuss the January retail sales report and the gyrations in the Dow Jones Industrial Average given the issues and concerns that have erupted with Boeing (BA) following another 737 MAX aircraft crash over the weekend. You can watch my appearance on Yahoo Finance here and the one with Cheddar here, but quickly on those two items, while the January retail sales report was better than expected, the headline figure for December was revised lower from the first negative print we received.

Also, we’ve started to get February same-store comp sales and from a growing number of retailers, those figures have been negative. And you’ve probably noticed that we are once again seeing a sea of store closures being announced by retailers. If you haven’t, I walked through some of these on last week’s Cocktail Investing podcast, which you can listen to here. As I pointed out on my appearances on Yahoo Finance and Cheddar, we are seeing a bifurcation in the retail land. Those that are riding the tailwinds associated with our Living the Life and Middle-Class Squeeze investing themes are thriving, while those caught in between – Macy’s (M), Gap (GPS), L Brands (LB) and others – are struggling once again. We here at Tematica have talked about rising consumer debt and delinquency levels, and I continue to see those increasingly cash-strapped consumers turning to off-price retailers and warehouse clubs, like Middle-Class Squeeze leader Costco Wholesale (COST) in the coming months.

With regard to Boeing, while it isn’t a Thematic Leader or on the Select List, the demand for its aircraft is being powered by international air travel, particularly out of Asia, which fits very well with our New Global Middle-Class investing theme. The issue plaguing the company and its shares is two 737 MAX planes have crashed in a relatively short time, and this has led several countries to ground those planes as issues behind the most recent crash are sought. This has raised several questions for Boeing as the 737 family is an important one, accounting for 80% of its aircraft backlog entering 2019 and 58% of its January order book. How long will those planes be grounded? What does it mean for future 737 family orders and production levels that drive revenue, profits, and earnings?

In the past Boeing has quickly dealt with situations such as these, and it has already announced an extensive change to the flight-control system in the 737 MAX aircraft. I’ll continue to watch these developments and gauge the impact to be had on2019 expectations. Odds are they will be coming in from where they were just a few weeks ago. In the past, these situations, while dreadful, have offered a favorable entry point to BA shares provided the timing is right. Right now, it seems to be a tad too early, but with upside to $450, it’s one to watch closely.

On a side note, the Boeing issue highlights a key difference in how the major market indices are constructed. BA shares account for just under 10% of Dow Jones Industrial Average, which means the recent stock pressure has weighed on that index heavily. This explains the wide difference this week between how the Dow has performed vs. the S&P 500, which only has 0.9% exposure to Boeing shares. That’s a huge difference, and it points to understanding the ins and outs of the indices for not only the market but for any passive ETFs that one may own. In the case of Boeing, there are a number of ETFs that hold the shares, but one of the ones with sizable exposure is the ETFMG Drone Economy Strategy ETF (IFLY). That ETF, which looks to invest in drones, holds 4.96% of its assets in BA shares, even though its revenues from drones and other autonomous systems are so small they aren’t even broken out by the company in SEC filings.


Tematica Investing


Powering up the Select List with WATT shares

In our increasingly connected society, two of the big annoyances we must deal with are keeping our devices charged and all the cords we need to charge them. When I upgraded my iPhone to one of the newer models, I was pleasantly surprised by the ease of charging it wirelessly by laying it on a charging disc. Pretty easy.

I’m hardly alone in appreciating this convenience, and we’ve heard that companies ranging from Tesla Inc. (TSLA) to Apple Inc. (AAPL) are looking to bring charging pads to market. That means a potential sea change in how we charge our devices is in the offing, which means a potential growth market for a company that has the necessary chipsets to power one or more of those pads. In other words, if there were no such chipsets, we would not be able to charge wirelessly.

Off to digging, I went to see if there is a pure-play company that fits this Disruptive Innovator investment theme charge (and yes, that was a very poor pun on my part.) What I turned up was Energous Corp. (WATT) and its WattUp solution. WattUp consists of proprietary semiconductor chipsets, software and antennas that enable radio frequency (RF)-based, wire-free charging of electronic devices. Like the charging disc I have, and the ones depicted by Apple, WattUp is both a contact-based charging and at-a-distance charging solution, which means all we need do is lay our wireless devices down be it on a disc, pad or other contraption to charge them. In November 2016, Energous entered into a Strategic Alliance Agreement with Dialog Semiconductor (DLGNF), under which Dialog manufactures and distributes IC products incorporating its wire-free charging technology.

Dialog happens to be the exclusive supplier of these Energous products for the general market and Dialog is also a well-known power management supplier to Apple across several products, including the iPhone. Indeed, last week Dialog bucked the headline trend of late and shared that it isn’t seeing a demand hit from Apple after fellow suppliers Lumentum Holdings Inc. (LITE) and Qorvo Inc. (QRCO) cut guidance earlier this week.

On its September quarter earnings call, Dialog shared it was awarded a broad range of new contracts, including charging across multiple next-generation products assets, with revenue expected to be realized starting in 2019 and accelerating into 2020. I already can feel several mental carts getting ahead of the horse as some think, “Ah, Energous might be the technology that will power Apple’s wireless charging solution!”

Adding fuel to that fire, on its September quarter earnings conference call Energous shared that “given the most recent advances in our core technology” its relationship with its key strategic partner – Dialog – “has now progressed beyond development, exploration and testing to actual product engineering.”

Since then, there have been several additional developments:

  • In late December, Energous announced its first commercial product to receive FCC approval, the WattUp-enabled personal sound amplification products (PSAPs) from Delight. Energous’ WattUp wireless technology allows the Delight PSAP to charge on a charging pad. The products are now certified to be marketed and sold in the United States.
  • At CES in January, Energous launched Wireless Charging 2.0 and demonstrated with Deutsche Telekom (DTEGY) a transmitter design that can charge multiple electronic devices at a distance.
  • We are hearing renewed chatter that Apple’s (AAPL) delayed wireless charging solution, known as the Airpower charging mat, is likely to hit shelves in the coming months. As I pointed out, Apple has long used Dialog Semiconductor (DLGNF) for its power solutions and Dialog is the exclusive supplier for Energous products. In early January, Apple supplier Luxshare Precision initiated AirPower production and that would seem to confirm rumored timetables that AirPower would begin shipping during the first half of 2019.
  • In the company’s December quarter earnings release, Energous shared that on the back of a favorable showing at the CES 2019 and Mobile World Congress 2019, “no less than 10 companies currently tracking for product launches to the consumer in 2019 with chip sales starting in the first half of the year and ramping in the second half.”

Taken together these recent developments point to robust revenue growth for Energous (WATT) compared to the $1.1 million-$1.4 million range between what was reported in 2017 and what’s expected for 2018. Current consensus estimates have the company delivering revenue of $94 million in 2020, which reflects a full year of shipping product. Two points of caution on that forecast: First, it comes from a combination of two Wall Street analysts, which is not a wide enough number that inspires 100% confidence; Second, Energous is on the cusp of going from essentially a start-up company to a real one, and odds are there will be fits and starts, delays and pushouts along the way. This will require us to be patient with the shares, but it also means continuously evaluating the competitive landscape.

As that revenue ramp and bottom-line improvement come to fruition, valuation metrics are likely to move higher for WATT shares. There is also potential upside following the eventual teardown analysis of Apple’s Airpower charging mat, which could very well bring the Apple halo to WATT.

So why now with WATT shares?

Alongside the company’s December quarter earnings report, it also completed a $25 million common stock offering of 3.3 million shares priced “in the hole” at $7.70. I say “in the hole” because prior to that offering the shares were trading well above $9. For some, that was clearly a disappointment, especially given the $20.1 million the company had in cash on its balance sheet exiting 2018. Odds are the company entered into this transaction in order to have sufficient capital as it heads into the oncoming production ramp to meet demand from these “no less than 10 customers.” Not a great transaction, but also not a horrible thing given that it likely heads off an even more painful one later on. For us, it’s given us the opportunity to get into WATT shares at a far better price point.

Our 12-18-month price target on WATT shares is $11, which equates to an enterprise value to 2020 revenue multiple of 4.0x vs. the current 2.4x multiple. If you’re thinking the combination of revenue growth and that valuation framework could make Energous a takeout candidate, I would have to agree.

  • We are issuing a Buy on and adding shares of Energous Corp. (WATT) to the Select List as part of our Disruptive Innovators investing theme with an $11 price target.


Del Frisco’s delivers, but no word on the strategic alternatives

Yesterday, Living the Life Thematic Leader Del Frisco’s (DFRG) reported its December quarter results, which were modestly ahead of expectations. On the company’s earnings call it reviewed the usual metrics and shared a long-term favorable outlook, which candidly was expected. What the company did not say, however, was anything about the strategic initiatives it is reviewing. Recall that several months ago, the company added a new Board member with investment banking experience to spearhead this activity. Given the level of steak house M&A that has happened in recent years, due in part to the more defensive nature of higher-end dining vs. casual restaurants, they’ve been a sought-after asset.

With Just One More Restaurant, the company that licenses the Palm Steakhouse name, filing for Chapter 11 late last week due to fiduciary misconduct, there is one less prospect to be had. Much like a game of musical chairs, as the number of seats or in this case steak house businesses drop, they become more valuable. We will continue to patiently hold DFRG shares as the Board continues to review the alternatives. Should a transaction fail to emerge, I am inclined to revisit the company’s position on the Thematic Leader board.

  • For now, we will continue to patiently hold Thematic Leader Del Frisco’s Restaurant Group (DFRG) shares as the Board continues to review potential strategic alternatives.



Doubling Down on Digital Infrastructure Thematic Leader

Doubling Down on Digital Infrastructure Thematic Leader

Key point inside this issue

  • We are doubling down on Dycom (DY) shares on the Thematic Leader board and adjusting our price target to $80 from $100, which still offers significant upside from our new cost basis as the 5G and gigabit fiber buildout continues over the coming quarters.

We are coming at you earlier than usual this week in part to share my thoughts on all of the economic data we received late last week.


Last week’s data confirms the US economy is slowing

With two-thirds of the current quarter behind now in the books, the continued move higher in the markets has all the major indices up double-digits year to date, ranging from around 11.5-12.0%% for the Dow Jones Industrial Average and the S&P 500 to nearly 18% for the small-cap heavy Russell 2000. In recent weeks we have discussed my growing concerns that the market’s melt-up hinges primarily on U.S.-China trade deal prospects as earnings expectations for this year have been moving lower, dividend cuts have been growing and the global economy continues to slow. The U.S. continues to look like the best economic house on the block even though it, too, is slowing.

On Friday, a round of IHS Markit February PMI reports showed that three of the four global economic horsemen — Japan, China, and the eurozone — were in contraction territory for the month. New orders in Japan and China improved but fell in the eurozone, which likely means those economies will continue to slug it out in the near-term especially since export orders across all three regions fell month over month. December-quarter GDP was revealed to be 2.6% sequentially, which equates to a 3.1% improvement year over year but is down compared to the 3.5% GDP reading of the September quarter and 4.2% in the June one.  Slower growth to be sure, but still growing in the December quarter.

Before we break out the bubbly, though, the IHS Markit February U.S. Manufacturing PMI fell to its lowest reading in 18 months as rates of output and new order growth softened as did inflationary pressures. This data suggest the U.S. manufacturing sector is growing at its slowest rate in several quarters, as did the February ISM Manufacturing Index reading, which slipped month over month and missed expectations. Declines were seen almost across the board for that ISM index save for new export orders, which grew modestly month over month. The new order component of the February ISM Manufacturing Index dropped to 55.5 from 58.2 in January, but candidly this line item has been all over the place the last few months. The January figure rebounded nicely from 51.3 in December, which was down sharply from 61.8 in November. This zig-zag pattern likely reflects growing uncertainty in the manufacturing economy given the pace of the global economy and uncertainty on the trade front. Generally speaking though, falling orders translate into a slower production and this means carefully watching both the ISM and IHS Markit data over the coming months.

In sum, the manufacturing economy across the four key economies continued to slow in February. On a wider, more global scale, J.P. Morgan’s Global Manufacturing PMI fell to 50.6 in February, its lowest level since June 2016. Per J.P. Morgan’s findings, “the rate of expansion in new orders stayed close to the stagnation mark,” which suggests we are not likely to see a pronounced rebound in the near-term. We see this as allowing the Fed to keep its dovish view, and as we discuss below odds are it will be joined by the European Central Bank this week.

Other data out Friday included the December readings for Personal Income & Spending and the January take on Personal Income. The key takeaway was personal income fell for the first time in more than three years during January, easily coming in below the gains expected by economists. Those pieces of data not only help explain the recent December Retail Sales miss but alongside reports of consumer credit card debt topping $1 trillion and record delinquencies for auto and student loans, point to more tepid consumer spending ahead. As I’ve shared before, that is a headwind for the overall US economy but also a tailwind for those companies, like Middle-class Squeeze Thematic Leader Costco Wholesale (COST), that help consumers stretch the disposable income they do have.

We have talked quite a bit in recent Tematica Investing issues about revisions to S&P 500 2019 EPS estimates, which at last count stood at +4.7% year over year, down significantly from over +11% at the start of the December quarter. Given the rash of reports last week – more than 750 in total –  we will likely see that expected rate of growth tweaked a bit lower.

Putting it all together, we have a slowing U.S. and global economy, EPS cuts that are making the stock market incrementally more expensive as it has moved higher in recent weeks, and a growing number of dividend cuts. Clearly, the stock market has been melting up over the last several weeks on increasing hopes over a favorable trade deal with China, but last week we saw President Trump abruptly end the summit with North Korea’s Kim Jong Un with no joint agreement after Kim insisted all U.S. sanctions be lifted on his country. This action spooked the market, leading some to revisit the potential for a favorable trade deal between the U.S. and China.

Measuring the success of any trade agreement will hinge on the details. Should it fail to live up to expectations, which is a distinct possibility, we could very well see a “buy the rumor, sell the news” situation arise in the stock market. As I watch for these developments to unfold, given the mismatch in the stock market between earnings and dividends vs. the market’s move thus far in 2019 I will also be watching insider selling in general but also for those companies on the Thematic Leader Board as well as the Tematica Select List. While insiders can be sellers for a variety of reasons, should we see a pronounced and somewhat across the board pick up in such activity, it could be another warning sign.


What to Watch This Week

This week we will see a noticeable drop in the velocity of earnings reports, but we will still get a number of data points that investors and economists will use to triangulate the speed of the current quarter’s GDP relative to the 2.6% print for the December quarter. The consensus GDP forecast for the current quarter is for a slower economy at +2.0%, but we have started to see some economists trim their forecasts as more economic data rolls in. Because that data has fallen shy of expectations, it has led the Citibank Economic Surprise Index (CESI) to once again move into negative territory and the Atlanta Fed’s GDPNow current quarter forecast now sat at 0.3% as of Friday.

On the economic docket this week, we have December Construction Spending, ISM’s February Non-Manufacturing Index reading, the latest consumer credit figures and the February reports on job creation and unemployment from ADP (ADP) and the Bureau of Labor Statistics. With Home Depot (HD) reporting relatively mild December weather, any pronounced shortfall in December Construction Spending will likely serve to confirm the economy is on a slowing vector. Much like we did above with ISM’s February Manufacturing Index we’ll be looking into the Non-Manufacturing data to determine demand and inflation dynamics as well as the tone of the services economy.

On the jobs front, while we will be watching the numbers created, including any aberration owing to the recent federal government shutdown, it will be the wage and hours worked data that we’ll be focusing on. Wage data will show signs of any inflationary pressures, while hours worked will indicate how much labor slack there is in the economy. The consumer is in a tighter spot financially speaking, which was reflected in recent retail sales and personal spending data. Recognizing the role consumer spending plays in the overall speed of the U.S. economy, we will be scrutinizing the upcoming consumer credit data rather closely.

In addition to the hard data, we’ll also get the Fed’s latest Beige Book, which should provide a feel for how the regional economies are faring thus far in 2019. Speaking of central bankers, next Wednesday will bring the results of the next European Central Bank meeting. Given the data depicted in the February IHS Markit reports we discussed above, the probability is high the ECB will join the Fed in a more dovish tone.

While the velocity of earnings reports does indeed drop dramatically next week, there will still be several reports worth digging into, including Ross Stores (ROST), Kohl’s (KSS), Target (TGT), BJ’s Wholesale (BJ), and Middle-class Squeeze Thematic Leader Costco Wholesale (COST) will also issue their latest quarterly results. Those reports combined with the ones this week, including solid results from TJX Companies (TJX) last week should offer a more complete look at consumer spending, and where that spending is occurring. Given the discussion several paragraphs above, TJX’s results last week, and the monthly sales reports from Costco, odds are quite good that Costco should serve up yet another report showcasing consumer wallet share gains.

Outside of apparel and home, reports from United Natural Foods (UNFI) and National Beverage (FIZZ) should corroborate the accelerating shift toward food and beverages that are part of our Cleaner Living investing theme. In that vein, I’ll be intrigued to see what Tematica Select List resident International Flavors & Fragrances (IFF) has to say about the demand for its line of organic and natural solutions.

The same can be said with Kroger (KR) as well as its efforts to fend off Thematic King Amazon (AMZN) and Walmart (WMT). Tucked inside of Kroger’s comments, we will be curious to see what the company says about digital grocery shopping and delivery. On Kroger’s last earnings conference call, Chairman and CEO Rodney McMullen shared the following, “We are aggressively investing to build digital platforms because they give our customers the ability to have anything, anytime, anywhere from Kroger, and because they’re a catalyst to grow our business and improve margins in the future.” Now to see what progress has been achieved over the last 90 or so days and what Kroger has to say about the late-Friday report that Amazon will launch its own chain of supermarkets.


Tematica Investing

As you can see in the chart above, for the most part, our Thematic Leaders have been delivering solid performance. Shares of Costco Wholesale (COST) and Nokia (NOK) are notable laggards, but with Costco’s earnings report later this week which will also include its February same-store sales, I see the company’s business and the shares once again coming back into investor favor as it continues to win consumer wallet share. That was clearly evident in its December and January same-store sales reports. With Nokia, coming out of Mobile World Congress 2019 last week, we have confirmation that 5G is progressing, with more network launches coming and more devices coming as well in the coming quarters. We’ll continue to be patient with NOK shares.


Adding significantly to our position in Thematic Leader Dycom Industries

There are two positions on the leader board – Aging of the Population AMN Healthcare (AMN) and Digital Infrastructure Dycom Industries (DY) – that are in the red. The recent and sharp drop in Dycom shares follows the company’s disappointing quarterly report in which costs grew faster than 14.3% year over year increase in revenue, pressuring margins and the company’s bottom line. As we’ve come to expect this alongside the near-term continuation of those margin pressures, as you can see below, simply whacked DY shares last week, dropping them into oversold territory.


When we first discussed Dycom’s business, I pointed out the seasonal tendencies of its business, and that likely means some of the February winter weather brought some added disruptions as will the winter weather that is hitting parts of the country as you read this. Yet, we know that Dycom’s top customers – AT&T (T), Verizon (VZ), Comcast (CMCSA) and CenturyLink (CTL) are busy expanding the footprint of their connective networks. That’s especially true with the 5G buildout efforts at AT&T and Verizon, which on a combined basis accounted for 42% of Dycom’s January quarter revenue.

Above I shared that coming out of Mobile World Congress 2019, commercial 5G deployments are likely to be a 2020 event but as we know the networks, base stations, and backhaul capabilities will need to be installed ahead of those launches. To me, this strongly suggests that Dycom’s business will improve in the coming quarters, and as that happens, it’s bound to move down the cost curve as efficiencies and other aspects of higher utilization are had. For that reason, we are using last week’s 26% drop in DY shares to double our position size in DY shares on the Thematic Leader board. This will reduce our blended cost basis to roughly $64 from the prior $82. As we buy up the shares, I’m also resetting our price target on DY shares to $80, down from the prior $100, which offers significant upside from the current share price and our blended cost basis.

If you’re having second thoughts on this decision, think of it this way – doesn’t it seem rather strange that DY shares would fall by such a degree given the coming buildout that we know is going to occur over the coming quarters? If Dycom’s customers were some small, regional operators I would have some concerns, but that isn’t the case. These customers will build out those networks, and it means Dycom will be put to work in the coming quarters, generating revenue, profits, and cash flow along the way.

In last week’s Tematica Investing I dished on Warren Buffett’s latest letter to Berkshire Hathaway (BRK.A) shareholders. In thinking about Dycom, another Buffett-ism comes to mind – “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” Since this is a multi-quarter buildout for Dycom, we will need to be patient, but as we know for the famous encounter between the tortoise and the hare, slow and steady wins the race.

  • We are doubling down on Dycom (DY) shares on the Thematic Leader board and adjusting our price target to $80 from $100, which still offers significant upside from our new cost basis as the 5G and gigabit fiber buildout continues over the coming quarters.


As the pace of earnings slows, over the next few weeks I’ll not only be revisiting the recent 25% drop in Aging of the Population Thematic Leader AMN Healthcare to determine if we should make a similar move like the one we are doing with Dycom, but I’ll also be taking closer looks at wireless charging company Energous Corp. (WATT) and The Alkaline Water Company (WTER). Those two respectively fall under our Disruptive Innovators and Cleaner Living investing themes. Are they worthy of making it onto the Select List or bumping one of our Thematic Leaders? We’ll see…. And as I examine these two, I’m also pouring over some candidates to fill the Guilty Pleasure vacancy on the leader board.



Weekly Issue: Factors making the stock market melt up a head-scratcher

Weekly Issue: Factors making the stock market melt up a head-scratcher

Key points inside this issue

  • Our long-term price target on Disruptive Innovator leader Nokia (NOK) shares remains $8.50.
  • We will continue to be long-term shareholders with Disruptive Innovator Select List resident Universal Display (OLED). Given the improving outlooks, our near-term price target for OLED shares is getting lifted to $150 from $125, and I will revisit that target as we move through the balance of 2019.


Reading the latest from the Oracle of Omaha

Over the weekend, the Oracle of Omaha, Warren Buffett, released his annual letter to shareholders of Berkshire Hathaway (BRK.A). This letter has become a must-read among institutional and individual investors alike because it not only reveals changes in Berkshire’s top investment portfolio positions, but it also has contained ample comments on the economy and markets as well as an investing lesson or two.

Out of the gate, we learned that once again Team Buffett outperformed the major stock market indices in 2018. As Buffett got underway, he casually reminded readers to be buyers of “ably managed businesses, in whole or part, that possess favorable and durable economic characteristics” and to do so at sensible prices. While it may seem somewhat self-serving this sounds very much like our thematic investing strategy that looks to identify companies benefitting from structural economic, demographic, psychographic and technological changes at prices that offer commanding upside vs. potential downside.

In the past, Buffett has commented that stocks are akin to pieces of paper and it’s the businesses behind them that are the drivers of revenue and profits. It’s an idea we are very much in tune with as we view ourselves as buyers of thematically well-positioned business first, their shares second. No matter how attractive a stock’s price may be, if its business is troubled or facing thematic headwinds, it can be a tough pill to swallow.

As Buffett later noted, “On occasion, a ridiculously high purchase price for a given stock will cause a splendid business to become a poor investment — if not permanently, at least for a painfully long period.” I certainly agree with that statement because buying a stock at the wrong price can make for a painful experience. There are times, to be patient, but there are also times when the thesis behind owning a stock changes. In those times, it makes far more sense to cut bait in favor of better-positioned companies.

Buffett then shared that “prices are sky-high for businesses possessing decent long- term prospects,” which is something we’ve commented on several times in recent weeks as the stock market continued to melt up even as earnings expectations for the near term have moved lower. We’ll continue to take the advice of Buffett and focus on “calculating whether a portion of an attractive business is worth more than its market price,” for much like Buffett and his team work for Berkshire shareholders, Tematica and I work for you, our subscribers.

Mixed in among the rest of the letter are some on Buffett’s investing history, which is always an informative read, and a quick mention that “At Berkshire, we hope to invest significant sums across borders” and that it continues to “hope for an elephant-sized acquisition.” While I can’t speak to any acquisition, especially after the debacle that is now recognized as Kraft Heinz (KHC), the focus on investing across borders potentially speaks to our New Global Middle-class and Living the Life investing themes. Given Buffett’s style, I suspect Team Buffett is more likely to tap into the rising middle-class over luxury and travel.

Several times Buffett touched on his age, 88 years, as well as that of its key partner Charlie Munger, who is 95. There was no meaningful revelation on how they plan to transition the management team, but odds are that will be a topic of conversation, as will Kraft Heinz Co. (KHC) at the annual shareholder meeting that is scheduled for Saturday, May 4. More details on that can be found at the bottom of the 2018 shareholder letter.

If I had to describe the overall letter, it was a very solid one, but candidly not one of the more memorable ones. Perhaps that reflects 2018 as a whole, a year in which all major market indices fell into the red during the last quarter of the year, and a current environment that is characterized by slowing global growth.


More signs that the domestic economy is a-slowin’

In recent issues of Tematica Investing and in the recent Context & Perspectives pieces penned by Tematica’s Chief Macro Strategist Lenore Hawkins, we’ve shared how even though the U.S. economy looks like the best one on the global block, it is showing signs of slowing. We had further confirmation of that in the recent December Retail Sales Report as well as the January Industrial Production data that showed a drop in manufacturing activity. The December Durable Orders report that showed orders for non-defense capital goods excluding aircraft dropped 0.7% added further confirmation. Moreover, the report showed a downward November revision for the category to a fall of 1.0% vs. the prior 0.6% decline.

Much the way we focus on the order data inside the monthly ISM and IHS Markit PMI reports, the order data contained inside the monthly Durable Orders report gives us a sense of what is likely to come in near-term. These declining orders combined with the January declines in Industrial Production suggest slack is growing in the manufacturing economy, which means orders for new production equipment are likely to remain soft in the near-term. 

This past Monday we received another set of data that point to a slowing U.S. economy. We learned the Chicago Fed National Activity Index (CFNAI) fell to -0.43 in January from +0.05 in December. This index tracks 85 indicators; we’d note that in January, 35 of those indicators made positive contributions to the index, but that 50 made negative contributions, which produced the month-over-month decline.

Before we get all nervous over that negative January reading for the CFNAI, periods of economic expansion have been associated with index values above -0.70, which means the economy continued to expand in January, just at a much slower pace compared to December. Should the CFNAI reading fall below -0.70 in February or another coming month, it would signal a contraction in the domestic economy.

In response, Buffett likely would say that he and the team will continue to manage the portfolio for the long term, and that’s very much in sync with our thematic investing time frame.


Watch those dividends… for increases and for cuts!

Ahead of Buffett’s shareholder letter, shares of Kraft Heinz (KHC) tumbled in a  pronounced manner following several announcements, one of which included the 35% cut in its quarterly dividend to $0.40 per share from $0.625 per share. That’s a huge disappointment given the commonplace expectation that a company is expected to pay its dividend in perpetuity. It can increase its dividend or from time to time declare a special dividend, but as we’ve seen time and time again, the cutting of a company’s dividend is a disaster its stock price. We’ve seen this when General Motors (GM) and General Electric (GE) cut their respective dividends and again last week when Kraft made a similar announcement.

Those three are rather high profile and well-owned stocks, but they aren’t the only ones that have cut quarterly dividend payments to their shareholders. In December, L Brands (LB), the company behind Victoria’s Secret and Bath & Body Works, clipped its annual dividend by 50% to $1.20 per share from $2.40 per share and its shares dropped from $35 to $24 before rebounding modestly. On the company’s fourth-quarter earnings conference call, management of Century Link (CTL)  disclosed it would be cutting the telecom service provider’s annual dividend from $2.16 to $1.00 per share. Earlier this month, postal meter and office equipment company Pitney Bowes (PBI) declared a quarterly dividend of $0.05 per share, more than 73% fall from the prior dividend of $0.1875 per share. Other dividend cuts in recent weeks were had at Owens & Minor (OMI), Manning & Napier (MN), Unique Fabricating (UFAB), County Bancorp (ICBK), and Fresh Del Monte (FDP).

What the majority of these dividend cuts have in common is a challenged business, and in some cases like that for Pitney Bowes, the management team and Board have opted to carve out a new path for its capital allocation policy. For Pitney, it means shifting the mix to favor its share buyback program over dividends given the additional $100 million authorization that was announced which upsized its program to $121 million.

As I see it, there are several lessons to be had from these dividends:

One, outsized dividend yields as was the case back in September with L Brands can signal an opportunity for dividend income-seeking investors, but it can also represent a warning sign as investors exit shares in businesses that look to have operating and/or cash flow pressures.

This means that Two, we as investors always need to do the homework to determine what the prospects for the company’s business. As we discussed above, Buffett’s latest shareholder letter reminds investors to be buyers of “ably-managed businesses, in whole or part, that possess favorable and durable economic characteristics” and to do so at sensible prices. Through our thematic lens, it’s no surprise that L Brands and Pitney Bowes are hitting the headwinds of our Digital Lifestyle investing theme, while Kraft Heinz is in the grips of the consumer shift to Cleaner Living. Perhaps Kraft should have focused on something other than cost cuts to grow its bottom line.

Third, investors make mistakes and as we saw with the plummet in the share price at Kraft Heinz, it can happen to Buffett as well. There’s no shame in making a mistake, so long as we can learn from it.

Fourth and perhaps most important, while some may look at the growing number of dividend cuts on a company by company basis, if we look at them in aggregate the pace is greater than the number of such cuts, we saw in all of 2018. While we try not to overly excited one way or another, the pace of dividend cuts is likely to spur questions over the economy and where we are in the business cycle.


Putting it all together

As we move into March, more than 90% of the S&P 500 group of companies will have reported their quarterly results. As those results have been increasingly tallied over the last few weeks, we’ve seen EPS expectations move lower for the coming quarters and as of Friday’ stock market close the consensus view is 2019 EPS growth for the S&P 500 will be around 4.7%. That is significantly lower than the more than 11% EPS growth that was forecasted back at the start of the December quarter.

For those keeping score, the consensus for the current quarter points to a 2% growth rate. However, we’re starting to see more analysts cut their outlooks as more figures are reported. For example, JPMorgan (JPM) now sees the current quarter clocking in at 1.5% due to slower business investment spending. For now, JP sees a pick-up in the June quarter to a 2.25% forecast. But in our view, this will hinge on what we see in the coming order data.

Putting it all together, we have a slowing economy, EPS cuts that are making the stock market incrementally more expensive as has moved higher over the last 9 weeks, marking one of the best runs it has had in more than 20 years, and a growing number of dividend cuts. Sounds like a disconnect in the making to me.

Clearly, the stock market has been melting up over the last several weeks on increasing hopes over a favorable trade deal with China, but as I’ve been saying for some time, measuring the success of any trade agreement will hinge on the details. Should it fail to live up to expectations, which is a distinct possibility, we could very well see a “buy the rumor, sell the news” situation arise in the stock market.

We will continue to tread carefully in the near-term, especially given the likelihood that following the disappointing December Retail Sales report and consumer-facing data, retailers are likely to deliver underwhelming quarterly results. Despite favorable weather in December, we saw that yesterday with Home Depot (HD),  and historically it’s been a pretty good yardstick for the consumer. In all likelihood as the remaining 10% of the S&P 500 companies report, we’re going to see further negative revisions to that current 4.7% EPS growth rate for this year I talked about.


Tematica Investing

A few paragraphs above, I touched on the strength of the stock market thus far in 2019, and even though concerns are mounting, we have seen pronounced moves higher in a number of the Thematic Leaders as you can see in the chart below. We’ll continue to monitor the changing landscapes and what they may bring. For example, in the coming weeks both Apple and Disney (DIS) are expected to unveil their respective streaming services, and I’ll be listening closely for to determine what this means for Digital Lifestyle leader Netflix (NFLX).

Nokia and Mobile World Congress 2019

We are two days into Mobile World Congress 2019, arguably THE mobile industry event of the year and one to watch for our Digital Lifestyle, Digital Infrastructure, and Disruptive Innovator themes. Thus far, we’ve received a number of different device and network announcements from the event.

On the device side, more 5G capable handsets have been announced as well as a number of foldable smartphones that appear to be a hybrid between a large format smartphone and a tablet. Those foldable smartphones are sporting some hefty price tags as evidenced by the $2,600 one for Huawei’s model. Interesting, but given the size of the device as well as the price point, one has to question if this is a commercially viable product or simply a concept one. Given the pushback that we are seeing with big-ticket smartphones that is resulting in consumers not upgrading their smartphones as quickly as they have in the past, odds are some of these device announcements fall more into the concept category.

On the network side, the news to center on comes from Verizon (VZ), which said it expects to have its 5G network in 30 U.S. cities by the end of 2019. That’s hardly what one would call a vibrant, national 5G network, and makes those commercial 5G launches really a 2020 event for the mobile carriers and consumers. It does mean that over the next several quarters, those mobile operators will continue to build out their 5G networks, which is positive for our shares of Nokia (NOK). As the 5G buildout moves beyond the U.S. into Europe and Asia, this tailwind bodes rather well for the company and helps back its longer-term targets. 

This 5G timetable was also confirmed by comments from Intel (INTC) about the timing of 5G chipsets, which are now expected to be available by the end of 2019 and are not likely to hit devices until 2020. Given the timing of CES in early January and the Mobile World Congress 2020 in February, odds are it means we will see a number of device announcements in early 2020 that will hit shelves in the second half of the year. Many have been wondering when Apple (AAPL) will have a 5G powered iPhone, and based on the various chipset and network comments, odds are the first time we’ll hear about such a device is September-October 2020. 

If history is to be repeated, we are likely to see something similar to what we saw with the first 3G and 4G handsets. By that, we mean a poor consumer experience at least until the 5G networks are truly national in scale and the chipsets become more efficient. One of the issues with each additional layer of mobile technology is it requires additional radio frequency (RF) chips, which in turn not only consume more power but also present internal design issues that out of the gate could limit the size of the battery. Generally speaking, early versions of these new smartphones tend to have less than desirable up-times. This is another reason to think Apple will not be one of those out of the gate 5G smartphone companies, but rather it will repeat its past strategy of bringing its product to market at the tipping point for the chipsets and network deployments. 

Circling back to our Nokia shares, while there are just over a handful of 5G smartphones that have been announced, some of which are expected to become available later this year, over the coming 18 months we will see a far greater number of 5G devices. This should drive Nokia’s high margin, IP licensing business in the coming quarters. As this occurs, Nokia’s mobile infrastructure should continue to benefit from the growing number of 5G networks being built out, not only here in the US but elsewhere as well.

  • Our long-term price target on Disruptive Innovator leader Nokia (NOK) shares remains $8.50


Universal Display shares get lit up

Last week I previewed the upcoming earnings report from Select List resident Universal Display (OLED) and following that news the shares were off with a bang! Universal posted earnings of $0.40 per share, $0.08 per share better than the consensus expectations, on revenue that matched the Wall Street consensus of $70 million. Considering the tone of the smartphone market, I view the company’s quarterly results as “not as bad a feared” and, no surprise, the guidance reflects the continued adoption of organic light-emitting displays across a growing number of devices and vendors. For the current year, Universal has guided revenue to $325 million-$350 million, which is likely to be a step function higher as we move through the coming quarters reflecting the traditional year-end debut of new smartphones, TVs and other devices.

Longer-term, we know Apple (AAPL) and others are looking to migrate more of their product portfolios to organic light-emitting diode displays. This shift will drive capacity increases in the coming several quarters — and recent reports on China’s next round of display investing seems to confirm this happening per its latest Five-Year Plan. As we have seen in the past, this can lead to periods of oversupply and pricing issues for the displays, but the longer-term path as witnessed with light-emitting diodes (LEDs) is one of greater adoption. 

As display pricing improves as capacity grows, new applications for the technology tend to arise. Remember that while we are focused on smartphones and TVs in the near-term, other applications include automotive lighting and general lighting. Again, just like we saw with LEDs.

  • We will continue to be long-term shareholders with Disruptive Innovator Select List resident Universal Display (OLED). Given the improving outlooks, our near-term price target for OLED shares is getting lifted to $150 from $125, and I will revisit that target as we move through the balance of 2019.