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The Fed in the Wings

October 21, 2016, 12:57 pm

The Federal Reserve’s next move is at the top of investors’ watch list right now. While the central bank could throw an interest rate wrench into the calculations before the election, it’s highly unlikely. Wall Street sets the chances of action during the Fed’s November 1-2 meeting at below 10% simply because it hasn’t happened in an election year since 1980, and it would take a whole lot of inflation over the next week and a half to force Chair Janet Yellen’s hand.

Instead, it’s more likely the can will be kicked until the final meeting of 2016 on December 14 – a full year after the initial tightening move that wracked the market. I think the first hike hurt simply because the math was less certain after the better part of a decade with interest rates effectively at zero. After all, we didn’t exactly know what unexpected challenges a move up from zero could create for the yield curve a year ago. But investors can more readily figure out what a hike from 0.25% to 0.5% means for interest rates. And even then, we know rates are going to stay at historically-low levels for some time to come.

Right now it’s close to a coin flip whether an increase will come in December, so that represents additional uncertainty for risk-averse investors. If we have better clarity as we approach December, look for winners and losers to emerge as Wall Street gets ahead of the Fed. Banks and brokerage stocks will rise or falter. Debt-laden companies and stocks like utilities that compete with bonds will go the other direction.

But December is a long way away and we’ll be seeing a lot of economic data between now and then. By the time the quarter is winding down, I think we’ll see the markets rallying in relief over decent earnings and an election that we all realize we can survive.

An average year on Wall Street gives stock investors about 8%-11%, which is a number we actually haven’t seen in some time. “Average” would feel really good and we’re already halfway there for 2016. Earnings season has already gotten off to a relatively smooth start, so we could see a decent rally as the risks lessen.

After all, stocks aren’t at historically unsustainable valuations yet. We’ve come as far as we have on sentiment so guarded it practically passes for cynicism. A little hope would be a boost, and it could come from the economic data, corporate results or a new mood in Washington. However it plays out, it will be an interesting finish to 2016.

Now Is the Time to Get Ready

October 18, 2016, 8:40 am

A soft start to earnings season, a vicious political week and a deeply divided Federal Reserve have fed a lot of chatter about stocks running out of steam. And sure enough, the market moved in yet another near-circle last week, taking five days to end a fraction below where it started. Even with intraday volatility picking up, the S&P 500 hasn’t broken out of a tight 3.7% range once in the last 14 weeks.

You know the factors that have been holding the big benchmark back. There is plenty of angst circulating around the election, now just a little over three weeks away. There is the ever-present question of when the Fed will raise interest rates again and whether they will be too soon or too late. Recent earnings announcements and preannouncements have sparked the equally ever-present questions about the strength of the global economy.

There is no doubt that the lack of direction these last few months has been frustrating. No clear trends have also made it harder for some investors to generate a steady stream of profitable trades. So I just wanted to emphasize to all investors that you need to be patient just a little bit longer. We may need to get through the next few weeks of earnings and the increasingly unbelievable presidential election before we see real movement. The market hates uncertainty, and a lot of it will be resolved in the next three weeks. That would leave the Fed in December as a question mark, but I believe the market is better prepared for a quarter of a point rate increase this year, and I don’t expect that decision to weigh on the indices the way it did a year ago.

In the meantime, while the directionless market has been frustrating on one level, it also means that Wall Street is hanging in there. The S&P 500’s high from last year was 2,135, and it broke above that level in July of this year. Since the breakout, 2,119 was the lowest it had traded prior to last week’s dip to 2,114. As long as the S&P can continue closing above that lower end of its current range, my outlook will remain bullish in both the short and long term.

A breach could send the index down to its 200-day moving average at 2,068, which is actually not terrible either – just a 5.7% drop from all-time highs. That’s not a horrible market, contrary to what you might hear in the financial media. The noise is out of control right now.

The headlines would have you believe we’re in the midst of a bear market or correction. But in reality, the S&P 500 is above short-term support and trading just a couple of percentage points below an all-time closing high. That’s a solid base for a rally as we get into the seasonally-strong time of the year. The election will finally be behind us and the market will start looking ahead to improved earnings expectations for 2017.

I see a lot of great set-ups coming between now and the end of the year. Given how the indices are acting, your highest priority right now is to be disciplined on cutting dead money so that you have the flexibility to jump on the best-acting names when they start to move.

Is Now the Time to Buy NFLX?

October 14, 2016, 2:19 pm

Netflix (NFLX) has always been a Wall Street darling. As a disruptive first-mover in the world of cord-cutting and streaming, it’s the kind of company driven more by its narrative than anything else. Last year it was even the top-performing stock in the entire S&P 500. But despite the site’s popularity and the company’s massive market share, some investors are starting to back away from what has now become one of the most overvalued names in the index.

NFLX has dropped like a rock so far in 2016, down over 11% year-to-date. And yet, at a share price around $100, the stock is trading at a nose-bleeding 207X anticipated earnings over the next 12 months. The problem is that the company’s growth is already baked in, plus a big premium for its position as a trailblazing innovator. This is one of those moments when so much air has been whipped into expectations that it only takes a miniscule shift in the fundamentals for the whole thing to cave in.

NFLX is asking investors to put a lot of trust in management. But given its lackluster performance so far this year—missing expectations for both the first and second quarters—it’s no surprise that many are feeling unsure.

I don’t think anyone doubts that NFLX is winning its competitive battle with other on-demand streaming services offered by companies like Amazon (AMZN). Analysts expect NFLX to tack on more than 100 million more subscribers over the next decade, thanks in part to the huge budget (over $6 billion this year alone) it dedicates to creating content.

However, at $100 a share, the math is pushing closer to the edge of the reason. Its subscriber growth just isn’t enough to support such a lofty valuation, and it’s tough to sell further upside when you’re already scraping the ceiling. Even if NFLX were trading around $90, which is where Deutsche Bank (DB) finds fair value, we’d still be looking at an implied multiple around 187X forward earnings. Still, at the very least that price point would be enough to relieve the angst of any potential misses in the future.

If NFLX can get subscriber growth to match expectations, the stock could still be a winner—but I think buying ahead of its third-quarter report would be a very risky move. Until the share prices re-enter the realm of reason, traders interested in investing should tread very cautiously.

Protecting Your Profits Post-Hurricane

October 11, 2016, 3:00 pm

Major weather events like Hurricane Matthew put billions of dollars in coastal real estate at risk, though thankfully most homes seem to have survived with cosmetic damage. However, they can also have an impact on the market one way or another, and it’s a major factor to consider when trading before and after the storm.

One handy rule of thumb is to sell insurance stocks and buy into home repair going into a storm. Companies like Home Depot (HD) and Lowe’s (LOW) are certainly getting a sales boost right now, and their results will continue to improve as people fix damaged properties. This bump in performance is critical given their already-thin margins.

In the long term, big storms tend to leave stronger insurance carriers behind. Grandfathered policies terminate whenever a house is totaled, which ends the carrier’s responsibility to protect a vulnerable piece of land. Thus, for properties where it makes sense to write new policies, the new construction practically guarantees higher assessed values and bigger premiums. The end result is that margins improve once the claims are paid and people rebuild their homes.

Generally, Wall Street discounts insurance carriers too heavily, creating bargains in the storms’ wake. Companies like Universal Insurance (UVE) and Heritage Insurance Holdings (HRTG) may become solid buys once the total damage is evaluated.

It’s a similar story for companies that focus on infrastructure. Many bridges and roads were knocked out in the Caribbean and the Southeastern U.S., so companies that sell cement, asphalt and other construction materials are going to see huge opportunities in the next year. Vulcan Materials (VMC) in particular is a key player from Georgia down to the Gulf Coast.

But the real impact on the economy comes from the interruption in business. Florida still generates most of its revenue from tourism at $67 billion a year, and of course the state will feel the pain. (To give some perspective, Orlando’s Disney Resorts have only been closed three times in its history prior to this past weekend.) Many cruise ships that usually leave Florida ports on weekends were also delayed or cancelled. Plus, over 3,000 flights were cancelled, along with interruptions in trucks and rail transportation.

Natural disasters like hurricanes can be very tragic, and my thoughts are with everyone impacted by this latest storm. For investors, it’s also important to  protect your portfolio and investments by taking the necessary precautions. And investors stand to make a profit as well if they are able to take advantage of the market as it shifts to adapt and heal. The country always snaps back after a major disaster, and the market will, too.

Navigating the Political Crosscurrents

October 7, 2016, 11:27 am

As someone who has been in the markets for 25 years now, I’m used to keeping an eye on crosscurrents that move stocks. Even so, there are some big ones here in the fourth quarter, from upcoming earnings to the election to the Fed possibly raising interest rates.

I know many of you are concerned about the election, and I get it. I won’t go into politics, so let me stay focused on how the market responds to election developments.

I was recently reading through old newsletter issues from the last presidential election in 2012, and there were some pretty big headlines then, too. The so-called fiscal cliff was looming, and gridlock on Capitol Hill was concerning a lot of folks. There were also concerns about a soft global economy and Europe’s ongoing debt crisis.

From a personal standpoint, I remember well that when Election Day itself rolled around, we were dealing with the destruction Hurricane Sandy left in its wake.

I was as scared as I have ever been when Sandy reached its full fury. Our building had five feet of water flowing through the lobby, and we spent the night in the dark with our windows taped up, genuinely concerned that they might blow out. We of course lost power, as did so many others, but the fact that we had survived made it a time for counting blessings. My heart ached for those who lost loved ones, or their homes, or precious possessions.

I wrote at the time: “There is much to be done, and it will be a long time before many people’s lives get back to ‘normal.’ But I know we as a country and as individuals will do whatever it takes. Americans have proven throughout history that we are not defeated by tragedies, and we get through them by helping each other.”

We did get through Sandy, the election and everything else, and four years later, the S&P 500 is nearly 50% higher than it was then.

I’m bringing this up today because even with the market near all-time highs there are many folks who think the sky is falling. They’re concerned the market won’t make it through the inevitable interest rate hike, or that the next president will send stocks crashing.

In the end, there will always be concerns and reasons to not invest. But there are also always opportunities, and most important of all, the stock market is still the best wealth-building mechanism ever invented. Sure there may be some bumps in the road, but perhaps the biggest tragedy of all is not the dollars lost in the tough times but the profits never earned in the good times. Having a balanced portfolio helps smooth all of that out, and fortunately, more indicators are pointing to good times right now. I look forward to the market finishing 2016 on a strong note.

Looking Forward to Earnings

October 3, 2016, 2:22 pm

Earnings give investors one of the most reliable reads on how businesses are faring and overall economic conditions, and the upcoming third-quarter season is especially critical. The estimate for S&P 500 earnings were positive just a few weeks ago, but today analysts are forecasting a 2.3% year-over-year decline.

There are a couple of important points to keep in mind. First is the outsized impact of the energy sector, with earnings expected to fall 66% from last year. This would be the second straight year of declining year-over-year quarterly EPS results for the beaten-down industry. Energy stocks have been a huge burden on the overall earnings number, and in fact we would have actually seen positive S&P earnings growth in four of the last five quarters if the sector was excluded.

The second point is what typically happens relative to these estimates. Looking at historical statistics, earnings typically come in about 2.8% better than anticipated, which would put third-quarter results at a positive 0.5%. So despite the revised estimates, I continue to anticipate better-than-expected results and believe earnings have a shot at breaking the five-quarter streak of declines. I don’t expect robust growth, but a good enough number that will spark optimism for the future of corporate earnings. Revenue, which has been negative since the end of 2014, should also be positive — yet another very bullish signal for the broad market.

That outcome would lead to a rally in equities as investors turn their attention toward the future and officially put the past behind them. Of course, there will always be the naysayers, who will likely point to the fact that stocks are near all-time highs after five consecutive quarters of negative earnings. But it’s important to note that the S&P 500 is up less than 5% in that time, which isn’t a very big move. The lack of earnings has held the indices back from breaking out, but a turnaround in the earnings outlook could finally be the catalyst to get money off the sidelines and back into the market.

Naturally, any relapse would shake the market after it’s already waited years for companies to deliver, but remember: The recovery, like the earnings recession that preceded it, will be unevenly distributed. Some sectors of the economy have been performing well over the last few years and will continue to grow for the foreseeable future. Others, like the energy sector, have been a profound drag on the market as a whole. We’ve seen several quarters now where slightly higher petroleum prices would have generated positive year-over-year growth instantaneously because everything out of the oil patch was doing just fine.

Right now the rest of the economy seems to be doing relatively well. Just about every theme that directly touches the consumer is in fairly good shape, from utilities to the rate-thirsty banks. It’s not a lot of growth, but there’s enough of a pulse to preserve valuations and take the pressure off management to cut jobs in order to make the margins work. As long as that scenario holds, people will keep working and spending – again, it’s not a boom, but it’s enough to maintain a bullish status quo.

However the numbers stack up, I’ll be watching them closely once Alcoa (AA) gets things started next week. Earnings season is often a hectic but invigorating time on the Street, and if you’re observant, it’s a chance to lock in some really rare opportunities.

Making Money When the Fed Moves

September 30, 2016, 3:18 pm

The Federal Reserve has factored into Wall Street psychology for generations, but the last decade has seen the once-nuanced relationship narrow down to a basic all-or-nothing catalyst: when it looks like the Fed wants to raise rates (or “tighten”), traders get scared and sell stocks without much consideration for how they would be impacted by higher rates ahead. If the status quo remains, the reaction is generally one of near-universal relief.

With a market this nervous about an action that will undoubtedly occur, it’s important to keep your head and not join in the panic. Rising interest rates are far from universally bad: arguably up to one out of every four stocks can actually benefit from a Fed move, and when rates finally rise to normal levles, the big banks and brokerage firms stand to reap a 45%-50% profit windfall. While other stocks would feel the drag, the financial sector is so heavily weighted in most portfolios that the S&P 500 as a whole could register a net growth boost.

Contrary to what many believe (or would have you believe), the start of a tightening cycle isn’t always a death sentence for a bull market. It only feels that way because the only Fed move in a decade – last December’s largely symbolic 0.25% increase – triggered a 13% secondary correction. With those psychological wounds still fresh, it’s no wonder so many traders associate the Fed with problems.

However, it only took the S&P 500 three months to recover all lost ground, so the pain was short-lived. Three months after that breakeven point, the big benchmark had run up another 5.3% from its pre-Fed peak and we could see even more upside ahead.

That’s actually pretty close to the average tightening cycle going back 30 years to the mid-1980s. Most of the time it’s taken Wall Street about three to six months to recover from the initial shock, but in general the market strengthens significantly beyond that transition period.

In short, the tightening cycle is typically far from a disaster, so investors who head for the sidelines waste a whole lot of time.

And if the Fed can’t find a clear path to raising rates again, it brings to mind the “one and done” cycle of March 1997. While the global currency crash kept rates on hold for another two years, 1997-1999 was a fantastic period for U.S. stocks. In the first year after the one-time hike, the S&P 500 soared a healthy 40% and ultimately doubled that score throughout the 30-month period.

Here’s the bottom line: We don’t have to be afraid of the Fed once the market remembers that we’ve survived much steeper rate hikes in the past and the financials have thrived. The Fed has also told us over and over again that the path to higher rates will be a slow one. The key will remain solid fundamentals for longer-term investments – companies growing earnings and trading at reasonable valuations – and charts, price movements and the technicals on shorter-term trades.

3 Tips to Trading Past the Election

September 26, 2016, 4:12 pm

I keep hearing investors confess that they’re profoundly worried about the presidential election going the wrong way for the economy and the nation. Whichever side of the aisle you’re voting, a deeply divided electorate and the two least-loved candidates in recent memory mean that there’s not likely to be a lot of joy anywhere when the ballots are counted. While the electoral map looked like a Clinton cakewalk a few months ago,  odds have recently evened out to something close to a coin flip. But regardless of who wins, there are opportunities in the market since this election is still far from the end of the world.

Step One: Get Beyond the Binary

Suspense is the market’s biggest enemy right now. Left alone with an open outcome and no way to handicap it, Wall Street will obsess over the worst scenarios and leave stocks to flounder. “Analysis paralysis” is a real phenomenon. It costs investors a lot of missed opportunities and a lot of wasted time.

An investor’s real challenge is to build a portfolio that makes money no matter which side of the political coin comes out on top. That’s actually not as hard as it sounds because from an economic perspective, Clinton and Trump have plenty in common. Both candidates are friendly to business, and both are relatively centrist in terms of their stated economic policies.

Yes, margins may narrow or expand a few points in specific cases to account for regulation, tax reform or broad federal budget incentives, but dynamic, fast-moving companies aren’t going to implode and seriously challenged businesses aren’t going to suddenly come back to life. At the end of the day, a truly solid company will remain solid nonetheless.

Step Two: Embrace Uncertainty

This nation has survived a lot of political upheavals and the long-term trend on Wall Street has always pointed up. Until I see proof that the pattern of innovation is truly dead, the trend favors continued investment in the future, even if that future is uncertain.

The only thing to be wary of is the market’s tendency to pour emotional energy into a tight race and send stock prices in harrowing circles. It’s called the “election uncertainty hypothesis.” Since at least 1992, when detailed data become available, the less sure Wall Street is about who’s going to win an election, the higher the volatility index (VIX) climbs.

But if this is as bad as the uncertainty effect gets, it’s actually not so bad. The VIX is still on the low side of normal. Everything else in the economy seems to be humming along: the Fed is eager to raise interest rates, but the calendar doesn’t look good for that until December at the earliest. In the meantime, unemployment is low, wages are rising and interest rates remain supportive enough to let consumers take on as much debt as they can afford. Factor out the election and the bears would struggle to find something to complain about.

Step Three: Hedge, Don’t Hide

There are always ways to make money in any market and after nearly 30 years in the market, I’ve uncovered just about all of them. All that experience has shown me that one of the worst decisions you can make is to stop investing altogether. Hiding the money under the bed until the political storm breaks is not going to get you much closer to being able to achieve any of your goals. You’ll keep your money safe from loss, but it just won’t grow faster than the Fed’s inflation target.

As an alternative, you could shift more of your assets into defensive and then ultimately contrarian areas of the market: some of my services have made money on gold around the Brexit, for example, or outright short calls against specific stocks or sectors.

Investors can’t hide. But we can hedge our bets. With a coin toss on the horizon, it’s probably worth having a little cash or hard assets in the portfolio to smooth the rough patches. Otherwise, it’s business as usual.

Sector Spotlight: Information Technology (IT)

September 19, 2016, 2:05 pm

Information Technology (IT) companies have been among the best performers this year, with the Technology Select Sector SPDR ETF (XLK) up around 10% so far. What’s interesting here is that the strength isn’t just from the high flyers. Out of last year’s FANG (Facebook, Amazon, Netflix and Alphabet/Google) group, only Facebook (FB) has solidly beaten XLK, climbing about 20%.

Instead, that outperformance is coming from the “old tech” companies as they begin to reinvent themselves aided by favorable valuations, investors searching for yield and a recovery in the PC market after its slump in 2015. International Business Machines (IBM, +12%), HP (HPQ, +22%), Hewlett Packard Enterprise (HPE, +49%), Cisco Systems (CSCO, +14%) and Verizon (VZ, +11%) are among the large, old-tech companies that have come roaring back to life this year.

Given this rotation, overall IT spending is not advancing at a rapid rate. Consulting firm Gartner believes total global IT spending will be flat in 2016 in dollar terms, and up just 1.5% when adjusted for currency changes. In addition, IT spending growth is expected to average 2.7% between 2017 and 2020. I think this reflects the fact that most spending still gravitates to many of these old tech firms.

Now that’s not to say there aren’t any opportunities in the tech space. You just have to find the right pocket, and I see cloud computing as one of them. According to Statista, spending on public cloud infrastructure, which was $25 billion last year, is expected to surge to $126 billion by 2020. Software-as-a-Service (SaaS) and Platform-as-a-Service (PaaS) spending within this segment will increase from $8 billion to a whopping $32 billion, driven by the lower cost than the traditional client/server IT model.

Some of the old tech companies will be a part of this boom, with Morgan Stanley (MS) estimating that 30% of Microsoft’s (MSFT) revenues will come from the cloud by 2018, a big departure from the days when all Windows and Office programs were contained on a hard disk in a PC.

Big Data also has solid growth ahead of it. International Data Corp. found that spending on Big Data and business analytics software will increase 50% from the end of last year to 2019 as companies continue to mine data in an effort to have valuable information for marketing purposes. The major components of the spending on Big Data are expected to come from services and software.

The trend is clear—more and more companies are going to rely on cloud computing and Big Data to manage their massive networks in the coming years. Given the long-term potential of the sector, I think now is the perfect time to consider getting your foot in the door.

Ford Looks Toward the Future

September 14, 2016, 2:33 pm

For a lot of Fortune 500 companies, the biggest challenge is identifying growth opportunities that will make a meaningful difference without being too ambitious for realistic implementation. Ford (F) and its rivals in the auto industry have struggled with that challenge, as well as the disruptive threats of ride sharing, autonomous vehicles and electric propulsion. Our means of getting from Point A to Point B are on the cusp of changing drastically—so now is the time to ask who the winners and losers will be as the auto industry shifts into the next gear.

Some car makers like Tesla (TSLA) and General Motors (GM) are leaping headfirst with massive investments in the next transportation revolutions, so these stocks revolve around all-or-nothing bets in the long-term. Likewise, Alphabet (GOOGL), Apple (AAPL) and Uber have all thrown their hats in the ring and may or may not become the next generation of vehicle manufacturers.

Ford, however, is taking a more incremental approach to making money on the way to the next big thing. As you can see from the company’s recent acquisition of shuttle-van startup Chariot, management’s ambitions are more about taking over fixed bus routes than investing in Uber’s competitors.

We know that Ford will have autonomous vehicles on the road by the 2021 model year. Watching the company’s lead into this week’s Auto Summit makes me think they’ll street test those driverless cars on fixed routes in specialized traffic lanes where obstacles are relatively infrequent. This is where bus lanes come in—a natural low-risk learning environment for autonomous vehicles—and it’s why the Chariot acquisition is so interesting.

Chariot drivers currently don’t stop until a passenger signals for a pick up or drop-off. They just keep the bus on course and watch the road for trouble. It’s the kind of job an autopilot system could start learning as soon as the regulatory paperwork is ready, and from there the human driver can begin phasing out. Realistic disruption starts here.

There are 665,000 bus drivers in this country, nearly three times as many as the taxi drivers Uber hopes to either consolidate or replace. It’s a big opportunity and far from an all-or-nothing gambit that assumes a sudden global shift from driver-owned cars to a driverless world. That’s what I like about Ford’s strategy. It’s measurable and proceeds in stages instead of banking on revolutionary change. And it happens without investing a vast amount of capital in untested business models (GM paying $500 million for Lyft was a big gamble on cutting-edge “ride sharing” systems).

We could even see fireworks among companies like Avis (CAR) or Hertz (HTZ), where there are too many redundant legacy brands and not a whole lot of competitive fire. Right now, Ford is a leader in this field through its deep relationships with rental and livery fleet operators. If the bus experiment works out well, it’s not hard to imagine the company buying out a rental chain. It’s another point of easy access that could result in massive disruption and a big win for Ford.

For now, Ford is taking baby steps. Investors shouldn’t make any large assumptions, but I already like Ford’s measured approach to tackling the tech of tomorrow. It’s one of the safest ways to keep itself relevant in the high-risk industry it operates in.