Market Update 3/7/15, Its Always About Earnings. Lemonade From Lemons. 3 comments

Time to go back and review some earnings ‘history. I’ve stated that I expected $120 in S & P earnings for 2014 and by March 31 we will see how accurate that estimate is. IF so that is about a 9-10% increase from the 2013 actual earnings of $110. That 9-10% in earnings growth translated to a 11.3% return for the S & P 500.

S&P 500 investors basically saw a return for the SP 500 that represented earnings growth for the entire calendar year, plus a tad of PE expansion.

The current 2015 SP 500 bottom-up estimate for the SP 500 has come down considerably from $134, and now stands @ $120.58 per share. So, analysts are telling us that we should expect flat growth for 2015. That of course does include all sectors, encompassing the energy component and its associated drag on the total. That drag is now expected to be a staggering 54% for 2015. The energy sector is roughly 10% of the SP 500 by market cap and earnings weight, so we can assume the energy sector’s drag on the SP 500 is approximately 5.4%. Added back to the bottom-up estimate, the analyst community is currently expecting between 5% — 6% earnings growth for the rest of SP 500 for 2015.

I believe that represents the worst case scenario. Estimates look low. No CEO in their right mind is going to play up the rest of this year when we have Foreign exchange issues and the like to use as an excuse. I also get the feeling that there is way too much pessimism thrown in due to that. The same with energy. At present I am going to go with some of the views that I have seen that indicate the pessimism is overdone. energy might not be as horrible as anticipated and the actual earnings number will come in around $124. Primarily due to a boost from technology, consumer disc. Financials and Transports.

I base a lot of my comments from data on a view of earnings that I happen to agree with.

Cumberland Advisors. wrote their views recently compiling data from Fundsrtat;

The negative impact on S&P 500 earnings in 2015 will be $4.63. The positive impact on S&P 500 earnings will be $10.04. Thus the net impact is a positive $5.41. That is, the overall impact of lower energy prices on S&P 500 earnings in 2015 will be an improvement of $5-plus per S&P 500 share. Energy prices fall; the Energy sector is hurt; the rest of the economy improves; the net effect is positive.

That is the conclusion of Fundstrat. I’ll agree, and I’ll point to the fact that the transport sector which will most assuredly benefit from lower energy costs is 3x the size of energy in the makeup of the S & P. therein lies a potential offset that some may be overlooking.

The question that many will wrestle with — how does one price this shift of $5 in S&P earnings? Is it temporary, or is it more permanent? If temporary, the pricing change is small. If permanent, one could price it at 18-20 times, or a 5% permanent upwards shift in the S&P 500 Index trend baseline. Stay Tuned.

And back to a quick look at how the picture looks now From Factset;

Here is the weekly data as of 2/27/15 :

Forward 4-qtr estimate: $120.14

P.E ratio: 17.6(x)

PEG ratio: 15.7(x)

SP 500 earnings yield: 5.71%

y/y growth in forward estimate: 1.12%

Back to those lousy energy earnings. I have stated here on this blog and with commentary here on SA, that it is my opinion that the Dec lows that were set by the energy stocks were the line in the sand. The premise being that oil ‘stocks’ usually bottom 1- 2 months before crude oil. Well here we are 2+ months removed form those Dec 19 closing lows and they have indeed held.

Might that be a sign that crude has bottomed and can start to build a base and creep higher. Perhaps, we can be a little more confident that we have seen the lows in crude and also the lows in the stock prices. Not everyone agrees,as it surely seems that EVERYONE has now jumped on the fact that all of the storage facilities are filling up so rapidly that there is NO place to put the oil.

HMMMM. everyone. Might this ‘everyone be the same everyone that is depicted in the chart below.

Before we get to that — At the moment there is a disconnect between how some of the Energy companies are trading given the way their valuations and EPS estimates are falling apart. One would have to agree that they are holding up pretty well, and that goes back to my theory of those Dec stock lows signaling that Crude has bottomed.

From a sentiment viewpoint, I also note how that the current prices sported by many oil companies is frustrating the folks that are bearish on oil stocks. They will indicate whenever possible that the oil names have much more pain to come because of the huge estimated earnings drop. Hmmm, well that also lines up with the chart from Bespoke shown below

Comments From Bespoke:

As of the end of January, the average stock in the Energy sector had 9.88% of its floating shares sold short. As the chart below illustrates, this is the highest level of short interest for the sector since at least 2008.

The fact that average short interest levels in the Energy sector are approaching 10% is noteworthy to say the least. It’s safe to say that in the Energy sector, we haven’t seen these levels in at least a decade, and for the market overall, the only time we saw double-digit levels of short interest for any sector was back during the Financial crisis. Needless to say, a lot of investors are extremely bearish on Energy right now,

That is telling. it paints a picture that shows how everyone is lined up on one side of the boat with this trade.

I’ll now suggest the opposite of what the sentiment is indicating and show that there are two possibilities of what the short term may hold for oil stocks — this first one is my belief and the backdrop I’m working with at present, given the data I’ve processed :

The trading action in the energy stocks is correct given what I believe the Dec lows indicate and the earnings are being set unrealistically low.

OR the sentiment is correct & the Energy sector has another leg lower ahead. Read the Bespoke commentary once again — Highest level of short interest since 2008

Allow me to add that during December 2008 crude oil traded down to $30.28 a barrel. Oil stocks bottomed. they retested those lows and held them in March 2009 with oil @ 46. They never looked back after that. Please read the Bespoke commentary again — Highest level of short interest since 2008

Fast forward — Dec. 19,2014, Oil stocks bottom, Jan 30,2015 those lows are tested. they hold. another retest. anything is possible, but I have a hard time lining up my theories on the short side of the boat that houses everyone.

Now, let’s say that My opinion & thesis is wrong, and oil does have another leg lower. What alternatives are out there ?

Making lemonade from lemons

A comment I made last Thursday on another blog here :

For anyone that is truly of the belief that oil is headed for another leg down, a suggestion —think of what $30 oil means to the airlines. cruise lines — the associated price of gas with $30 oil and that affect on the consumer disc. retail & restaurant stocks. There is a plethora of opportunity, IF the dire oil forecast come to pass.

By doing this you will effectively be adding insurance to your oil exposure in quality names that aren’t very expensive. Many are selling at a discount to their norms and the S & P

And more food for thought

Exactly where do we see oil stocks going if oil drops from here ?

My thoughts from this past week

Now it may be at present. next week or next month or two. BUT rest assured that side of the boat (the shorts) is overloaded, History tells me it’s prudent to be on the other side and not with them.

As a Long term investor, I just need to be in the ballpark with my timing in the energy sector and we are already in the ball park and possibly ready to run around the bases..

So, unless one wants to tell me we are ready for another 2088-2009 scenario with the economy ,

If not, then please tell me who sees CVX or a similar oil name trading to a 5% yield. in this rate environment.

How much downside is left then? Is CVX or similar large cap energy name yielding 4%, increasing dividends for 27 straight years, right thru the financial crisis,

in the ballpark ?

On the Economic Front ;

Recently, some good stuff, some not so good data as well, has been reported on the economy. Overall, of the 27 economic indicators released that I checked. 15 were weaker than expected. Nevertheless, speaking to the good, the GDP was better than estimated (+2.2% vs. +2.1%e), Durable Goods orders beat expectations (+2.8% vs. +2.0e) but missed excluding transportation, Univ. of Michigan consumer confidence improved (95.4 vs. 94est.), New Home sales were above estimates (+3.2% above the y/y estimates), Home Purchases Applications rose by 4.6% after four weeks of declines, and there was a rise in the Market PMI Services Index for February to 57 for its best reading since October 2014.

On the negative side, the Chicago Manufacturing PMI bombed (45.8 from 59.4), the Dallas Manufacturing Index slid (-11.2 from — 4.4), the Richmond Manufacturing Index fell to zero from +6, Initial Jobless Claims increased (313k vs. 282k the prior week), Existing Home Sales were 130,000 less than expected (the lowest since April), the February Consumer Conference Confidence Board fell to 96.4 from 103.8, and 2014’s annualized GDP growth averaged only 2.45%

Ok, my take on the GDP number- It isn’t a sign of weakness. The GDP revision was due largely to slower inventory growth, which is a good thing — leaner inventories pave the way from better production. The trade deficit was a bit wider, but not as much as anticipated. Domestic Final Sales, the preferred measure of underlying domestic demand, was revised higher — and if you exclude government, a 3.5% annual rate, vs. +3.3% in 3Q14 economic growth DID NOT weaken in 4Q14.

However, if you look at the numbers, at 2.2% for the 4Q14, the nation’s GDP lost roughly 280 basis points (bp) of growth from the 3Q14’s

5% growth rate.

Lets’ see where that shortfall was, Personal Consumption Expenditures were up (+62 bp), Gross Private Investment lost 34 bp, Net Exports of Goods and Services swooned by 193 bp, and Government Consumption Expenditures and Gross Investment declined 112 bp.

There, ladies and gents, is the 277 bp difference. I suspect the wicked weather, the West Coast dock workers’ strike, and the strong U.S. dollar had a hand in the GDP’s descent, but it sure looks like spending was down on durables. Now one quarter’s report does not a trend make, so it will be interesting to see what happens in this year’s first quarter.

Clearly the balance sheets of Corporate America are still strong. From the Washington Post

Stock Buybacks at $104 Billion Set U.S. Record

Stock buybacks. vaulted to a record in February, with chief executive officers announcing $104.3 billion in planned repurchases. That’s the most since TrimTabs Investment Research began tracking the data in 1995 and almost twice the $55 billion bought a year earlier.

The technical side of the market :

With the recent highs that all of the major indexes have tagged recently, there continues to be no confirmation for the Dow Transports. And many are now citing an issuer with Dow Theory given the fact the D-J Transports have also broken below their near-term uptrend line.

Relax, no need to panic just yet as this potentially could be an upside non-confirmation leading to a larger pullback if the SPX’s 2080 — 2100 support zone is violated. Remember there was a downside non-confirmation in late January of this year when the Transport index broke below their December 2014 closing low, but the Industrials did not, and that led to a Dow rally of more than 1000 points. And remember that we had yet another non confirmation that was indeed rectified in 2014.

These upside non confirmations do not imply a Dow Theory sell signal. For that to develop, both Dow averages would need to close below their respective 12/16/14 closing lows of 17068.87 and 8740.52 and we are nowhere near those levels.

Another green arrow posted on my chart last week, and it looks like it was premature by a day or so. These green arrows in the past have signaled overbought conditions that tell us it’s not the best time to add positions. IF one is contemplating adding a new idea, it should possess a solid technical ‘entry point along with improving fundamentals, hence my addition of STE last week.

Another glimpse of the chart presented now shows a lot of the overbought extended nature of the S & P wiped out in one day. The Average now sits just above its 50 day MA and coincidentally just above the 2064 breakout zone that vaulted the S & P to new highs. Possibilities now — consolidation right around these levels working the remainder of the overbought situation, perhaps further weakness taking the S & P down to test the 2020 level.

Friday’s huge selloff in the equity market occurred as many are worried about what the recent strong Jobs report, reported earlier in the day, means to the Fed and the potential for rate increases. If market participants were selling their shares on Friday because they are fearful of rising rates, history tells us they just made a big mistake.

Notice I said ‘market participants, instead of investors. This was indeed a knee jerk reaction to how they connected that report to rising rates. Add this hysterical reaction to an overbought condition and the result is a 30 point decline in the S & P .

This is what I did (and I would suspect what other investors did) when I read the Bureau of labor statistics (BLS ) report and then connected the dots that I saw.

From the BLS

Total nonfarm payroll employment rose by 295,000 in February, compared with an average monthly gain of 266,000 over the prior 12 months. Job gains occurred in food services and drinking places, professional and business services, construction, health care, and in transportation and warehousing.

My key takeaways..

Employment in retail trade continued to trend up in February (+32,000) and has grown by 319,000 over the year.

Food services and drinking places added 59,000 jobs. The industry had added an average of 35,000 jobs per month over the prior 12 months.

Connect the dots.

• restaurants & retail hiring
• means business is increasing,
• profits should follow,
• stock prices follow earnings.

This was telegraphed at the beginning of the year, the Gasoline effect that many scoffed at, now comes as no surprise, it appears to be coming to fruition.

• Select a few retail, restaurant stocks,
• Complete due diligence,
• add that as a theme for 2015,(It’s no too late)
• Increase the profits in a stock portfolio.

Don’t overlook a favorite healthcare company as well —that strong sector trend continues. Despite a lot of people indicating that it can’t.

Some ideas — my favorites at the moment

Retail sector — KATE

Consumer Disc. — the cruise lines — CCL. NCLH

Conclusion — Some words of wisdom

To build wealth over time — Dividend growth and business growth is so much more important then yield

Charlie Munger, Berkshire Hathaway -

Great investing requires a lot of delayed gratification. He goes on to note, It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.

Excerpt from the 2014 Berkshire Hathaway Annual Letter to Shareholders

Warren Buffet ,

Indeed, who has ever benefited during the past 238 years by betting against AmericaThough the preachers of pessimism prattle endlessly about America’s problems, I’ve never seen one who wishes to emigrate.

Disclosure: The author is long BLMN.