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The Best of Both Worlds: Fundamental and Technical Analysis

April 17, 2017, 4:14 pm

The market reacted with uncertainty to a mixed bag of bank earnings last Thursday, initially showing some resilience before taking a more pronounced turn lower in the afternoon. While the earnings results mostly beat expectations thanks to strong investment banking, there were some signs of worsening consumer credit conditions – although from very low levels. Comments from management indicated that business conditions as well as the economy remain sound.

With the first-quarter earnings season officially underway, results will continue to run Wall Street for the next two weeks. This week will be dominated by more financial company reports, but it’s the following one that will be critical as tech and industrials release their numbers.

The S&P 500 appears to have come under a bit of pressure recently after falling through its 50-day moving average (the blue line), but I’m not overly concerned about the action. In fact, I suspect the index will drift in a range between 2,320 and 2,360 (the black lines) until the full-year earnings outlook becomes clearer. With interest rates still low and no indication that they’ll move higher in the near term, I think the earnings bar is set low enough that any downside in the broad market is limited.

S&P Chart

Also helping limit near-term downside are the financials and large-cap tech stocks. The Financial Select Sector SPDR ETF (XLF) is nearing a point of support, and the PowerShares QQQ ETF (QQQ) is holding above its 50-day moving average. As long as tech leadership remains intact, I suspect the overall market strength will be tough to fracture.

I believe one of the best ways to play the current market environment is by analyzing both the charts and fundamentals and buying only stocks with the most favorable near-term technicals. This is exactly what we do in my Breakout Stocks service, and the strategy has put us in good shape to lock in solid gains. If you’re interested in learning how to win in the stock market with a mix of technical and fundamental analysis, Breakout Stocks could be a good fit for you. Click here to claim a risk-free membership before it’s too late

How to Grade Management

April 10, 2017, 4:28 pm

We’ve talked a lot about the fundamentals and technicals I watch when looking for potential investment opportunities. One factor we haven’t touched on very often is management, and I do get questions about judging management’s effectiveness, so I’d like to share some thoughts on ways to do that with growth companies in particular.

First let me say that I do not have specific criteria when it comes to evaluating management. Almost all CEOs are highly educated, intelligent and have enjoyed a lot of success in life. Since I tend to select stocks that have a solid history of growth, the CEOs have also had some measure of success in their position. In addition, most of the companies are growing while still investing big for their futures, so I do not think management tends to be focused solely on how much they can pocket in the near term.

Strong quantitative data is often a good indicator of the quality of management. However, we know that business is dynamic and not static in nature. Therefore, a good executive must be able to adapt to change. Growth businesses tend to attract more competition over time, and in technology, product obsolescence is often an issue. Given this, I look for management’s plans for future growth in their investor presentations and public filings, and how realistic they are. Companies that are slow to adapt to changing market conditions will at some point see their stock prices take a hit.

I also judge management by how they allocate incremental capital – the cash they take in each year in cash flow. Since they consider themselves as steering growth companies, most CEOs do not want to pay dividends, which is perfectly fine. But what I don’t like to see is a company buy back shares when its stock trades at above-average PEs. To me, this is not investing in growth, but actually a tool used to hide dilution (from issuing stop options). Unfortunately, this practice has become so ingrained among most U.S. companies it is hard to be critical of specific management, as this is an institutional issue.

It’s also important to gauge management’s ethical behavior. For years, Wells Fargo (WFC) was one of the most admired companies, not just in banking but in the market as a whole. In fact, Warren Buffett used WFC as a benchmark when evaluating other potential investments. It took decades to discover that the company’s strong growth in fee income was often achieved by illegal practices. While the bank was able to survive the crisis in decent shape, that may not be the case with smaller companies that do not have a franchise as strong as Wells Fargo.

Due to increased regulations, brokerage firms are spending less on conferences and instead disclosing everything over the Internet, so most investors have much less access to senior management than they did 20 years ago. Still, evaluating where a CEO is taking a company is an important part of determining a stock’s potential.

You Are Cordially Invited to Join Me Saturday, May 6, 2017 for my Live Investing Workshop!

April 7, 2017, 11:31 am


As a valued subscriber, it’s with a great deal of excitement that I would like to personally invite you and a guest to my 2017 Special Live Workshop at the Gaylord National Harbor located in the Washington, D.C. metropolitan area.

This exclusive event is typically only open to Inner Circle members, but this year, I’ve decided to open it up to all of my members.

Why you might ask?

Simple. Because there is enough uncertainty about this market right now that I want to offer you the reassurance you need to ensure you don’t miss out on any lucrative opportunities in the weeks and months ahead.

At this year’s intimate gathering, I will take you through two informative sessions.

Session #1: Market Analysis and my Top 10 Stocks for the Next 12 Months. I’ll take an up-close examination of the current state of the stock market and why I expect it to continue to rally under the Trump administration. Then we’ll dive into my Top 10 Stocks for the Next 12 Months. These are longer-term value and growth stock picks that are poised to explode in the next 12 to 18 months.

Session #2: How to Profitably Trade Stocks & Options in THIS Market. This session will strictly focus on our short-term trading strategies. We’ll dive into the best way to trade stocks right now, as well as cover how to safely invest in options. You won’t want to miss this highly informative session!

I’ll also personally answer as many questions as I can get to during our time together. I truly enjoy this one-on-one opportunity to discuss what is truly on your minds.

So make sure you have your pen and paper handy! I can guarantee you that you’ll leave this live event with actionable advice that you can put into play right away.

Here are a few event details for you:

WHEN? May 6, 2017

WHERE? At the Gaylord National Harbor in National Harbor, MD

HOW MUCH? Just $99 (This registration fee covers you and a guest. That’s an instant $200 savings off the regular $299 event price). But you must reserve your spot by this Thursday, April 13th.

Hurry, seats are filling up fast! I intentionally keep attendance to an intimate group so that I can spend as much time as possible with each of you. So please RSVP right away.

Once we have your reservation, we’ll email you with all of the details you’ll need to book your hotel room. A special room rate has been reserved for you the night of May 5th, at the rate of $219 per night.

I’m so pleased to provide you with this in-person session that will line you up for a very successful and profitable year of investing.

I look forward to seeing you on May 6th for a great discussion!

Sincerely,

Signed:
Hilary Kramer

CLICK HERE to Reserve Your Seat Today!

How to Profit from Trend Trading

April 4, 2017, 5:08 pm

There are many strategies you can use to make money in the stock market. One of my favorites when it comes to shorter-term investing is trend trading. With each trade, we are riding an already established trend – “established” being the key word. We’re not trying to call a top or a bottom in a stock.

This market has defied expectations already, going higher for a longer period of time than many thought possible. For trading right now, I’m not interested in trying to predict when a change will take place. I’m interested in profiting from what we know is already happening, taking what the market gives us.

So the trend really is your friend – and when it ends, you profit from a different trend. To give you a better idea of what I mean, let’s take a look at Advanced Micro Devices (AMD), a stock we made a quick 10% last quarter in my Absolute Capital Return service.

Let’s start with the chart below, which shows a general uptrend that began last November with a pretty sharp pullback to start the year. I love to buy strong uptrends on pullbacks to dampen risk and open up more profit potential, but this one was sharp enough that we needed confirmation the uptrend would resume before getting in. We got that confirmation with a strong bounce, at which point we were looking for the right entry point, which came on February 16.

AMD

I waited until we saw the action slide 9.5% from the established $14.27 trading top and then start at least tentatively forming a new base for a fresh move up. The test of 9-day support (the green line) gave me enough confidence to push the button.

AMD fell slightly and briefly below the 9-day moving average, but the balanced volume bars (below the price action) argued that the bears weren’t in control – those red lines would have to be a lot bigger than the gray ones to break the long bull trend. After that, the profit meter was running fast enough to let us cash out within the week.

I expect to scoop up more trades like this over the next few weeks – especially as stocks start to move heading into and out of their earnings reports. This period right around the start of earnings season is often a busy (and profitable!) one here in Absolute Capital Return. If quick-hit technical trades like the one I talked about today sound interesting to you, then you couldn’t have picked a better time to join us. Click here to claim a risk-free membership before it’s too late.

Should You Get Defensive with Defense Stocks?

March 27, 2017, 3:39 pm

It’s no surprise this industry has been on the top of investors’ minds given how long it’s been in the headlines. Not only did President Trump promise to build up the military while on the campaign trail, he proposed a “historic” increase in defense spending of $54 billion, bringing the Pentagon budget to a whopping $603 billion, during his first speech to Congress. Despite all this, I do not see a lot of growth investing opportunities here.

Due to budgetary restrictions imposed by the Budget Control Act of 2011, as well as the need to spend more on Social Security and Medicare as the population ages, there’s not much room for long-term defense spending growth. Even President Trump’s much talked about 10% increase in defense spending in the September 2018 fiscal year would only put Department of Defense expenditures back to 2007 levels, when spending declined as the Iraq war wound down.

In addition, there’s no guarantee that the president will get the increase he’s asking for, with even some Republicans uncomfortable with the amount of non-defense spending cuts that would be required to fund the additional budget. Barring another major war, I do not expect to see consistent long-term spending gains drive revenue growth for defense contracts.

The pure-play defense stocks are dominated by a few large names: Lockheed Martin (LMT), General Dynamics (GD), Raytheon (RTN) and Northrop Grumman (NOC). Top-line growth for these companies has been minimal the past several years due to lackluster defense budgets. And yet, the stocks have actually done well, with share prices more than tripling over the past five years. These names have used the low interest rate environment to aggressively buy back stock, with earnings also benefitting from margin expansion. However, engineering growth this way is not sustainable, and with the shares now trading around 20X this year’s earnings estimates, I don’t see significant upside in them over the next 12 months.

In fact, LMT, RTN and NOC have lagged the market considerably after rallying the day after the election. While GD has beaten this trend with strong margin performance in the fourth quarter, I believe the recent underperformance of the group as a whole is a “tell” that the great five-year run the stocks have been on will not repeat itself. The industry is more likely to not see meaningful earnings increases from incremental defense spending, or it at least has already been discounted into the stock price.

Is Now the Time to Buy Oil Stocks?

March 20, 2017, 2:11 pm

Oil and gas was one of the best performing sectors in the previous decade. Everything went right for the industry in terms of oil prices, which traded briefly above $100 in 2008. There was incremental demand from China as that economy grew rapidly. New supply was limited as companies were cautious about exploration after the industry was burned with oil falling below $20 in 1998. In addition, increased speculation from trading desks also caused the price to spike at times. Today, we’re looking at a very different picture. Hydraulic fracking and horizontal drilling in North America has increased supply and greatly diminished OPEC’s pricing power. The Chinese economy has also cooled. New financial regulation has caused many trading desks to shut down.

As a result, oil prices fell sharply in late 2014 when OPEC could not reach agreements on production cuts. Today, the Energy Select Sector SPDR ETF (XLE) is up just 22% excluding dividends since the end of 2009, which stands in stark comparison to the S&P’s 111% rise. In addition to declining oil prices, many companies have been guilty of poor capital allocation decisions. For example, Exxon Mobil (XOM) overpaid for natural gas producer XTO Energy in June 2010, issuing $25 billion in stock and assuming $16 billion in debt right before natural gas prices plunged. XOM also borrowed money to buy its own stock at much higher prices than what it currently trades for.

Most investors think of XOM, Royal Dutch Shell and Chevron (CVX) as the big oil players. They’re certainly well-known, financially strong and diversified, but there’s much more to this industry than those three. There are also exploration and production (E&P) companies, which explore for, develop and sell unrefined product; refiners, which take crude oil and turn it into finished products like gasoline, heating oil and jet fuel; and integrated companies, which are a mix of two. E&P and refiner companies tend to be more volatile given their unpredictable earnings.

Some E&P names include EOG Resources (EOG), Occidental Petroleum (OXY), Anadarko Petroleum (APC) and Devon Energy (DVN). The profitability of these companies is set to improve this year as oil prices are still generally higher than they were a year ago. Still, like most stocks in this group, they carry PEs at 40 or higher based on this year’s earnings estimates, which is very high for companies that will not produce a lot of organic unit growth in the current market conditions. Therefore, I feel these stocks are already discounting oil prices well above current levels and are vulnerable to further downside if this price rise (which doesn’t look likely at this time) fails to materialize.

The refining companies are enjoying good profitability right now, as the lower price in oil combined with stable demand for finished products has provided decent profit margins (also known as crack spreads, which measure the difference on how much it costs to process crude to final product and how much the refiner can sell it for). However, crack spreads are subject to rapid change should inventories of finished product build or the price of crude surge. Occasionally, these companies can go through quarters with limited profitability or even losses. Due to this earnings volatility, along with extreme capital intensity and limited unit growth, refiners have generally sold for low PE ratios. Currently the major refiners, Valero Energy (VLO) and Tesoro (TSO) sell for PEs of 12X and 13X this year’s earnings estimates, respectively.

The integrated companies benefit from being in both businesses; while declining oil prices will hurt their E&P operations, it will help their refining operations. As a result, these stocks generally trade somewhere in between the valuations of refiners and the E&P names. Valuations will be higher than refiners, since earnings tend to be more stable, but lower than E&P companies, as earnings don’t have the same potential upside with higher oil prices. For example, XOM and CVX trade at 20X and 22X this year’s EPS estimates, respectively. As is the case with E&P stocks, at this level of valuation the shares seem to be discounting higher commodity prices going forward.

In addition to discounting an increase in energy prices that seems elusive, these companies need to spend more to replace reserves than they had previously, and unit growth will be limited by greater fuel efficiencies, alternative sources of energy and even mandated limits on demand if governments take more aggressive steps to limit consumption due to future climate change. I believe XLE will continue to underperform until its valuation is more reasonable or oil looks ready to move higher, and I feel the same way about oil service stocks like Schlumberger (SLB) and Halliburton (HAL).

How to Keep Emotional Investing In Check

March 13, 2017, 2:38 pm

With all of the noise that’s been circulating the market since before the election, it’s become harder and harder to invest with a level head. Emotions end up running wild, causing investors to make quick, unjustified decisions that leave their portfolio worse off than it was in the first place.

The simple fact is that it is impossible, even with the best analysis and insight, to eliminate all risks when it comes to investing. But careful selection and proper diversification allow us to manage that risk and still produce above-average returns over the intermediate and long term. The key is a well-rounded approach, and I don’t recommend allocating more than 5% of your total investable dollars to any one position in a portfolio. This helps the losers, which are an inevitable part of investing, sting less.

Say a company you are invested in reports disappointing earnings and quickly leaves you with a 20% loss. With just 5% allocated to that stock, your portfolio takes a very manageable 1% hit for the year that your remaining stocks should easily be able to make up. If the 19 other positions have an average return of 12% and the market gains 10% overall, you’ll still outperform with 10.4% profits despite the 20% loser.

Of course, it’s still disappointing to be left with some red ink, so when you’re holding on to a stock that shows a double-digit loss how do you make a sound judgment based on business sense and not emotion? I like to remember Warren Buffet’s excellent dictum: In the short term the market is a popularity machine, and in the long run it’s a weighing machine. So I go back and review the long-term earnings power of a company, which is how most stocks are valued. If I see no reason to doubt my original assumptions and conclude that the stock is down either for a reason not clearly defined or because the industry is out of favor, there is no reason to panic. As long as I’m properly diversified I can weather the weakness.

However, if I find that the stock is down for a clear reason (such as an earnings disappointment) my earnings outlook would have to change. Even the slightest downward revision of future expectations can have a meaningful negative impact on value, especially for higher PE growth stocks. So let’s say a stock is down 10% following a weaker-than-expected report. My new calculations would likely show that the stock is expensive despite its decline. In this case, it would be important to stick to the knitting and sell, even though it may be painful to take the loss. Remember, staying disciplined with a risk management strategy is imperative to building wealth over the long term.

It all boils down to three key steps to controlling your emotions and making smart decisions when it comes to your portfolio:

  1. Diversify. When a position is not life or death to your portfolio, you are able to evaluate any potential problems more calmly and rationally.
  2. Accept the fact that some price movements are simply short-term randomness. If there are no headlines or unusual trading volume to suggest that a several-day pullback is meaningful, take a deep breath and keep a close eye on your position. Selling may still be warranted, but never pull the trigger as a panicked knee-jerk reaction.
  3. Realize that over time stocks will reflect the present value of their future earnings. If a stock is down sharply, reevaluate its earnings situation. If the new analysis suggests the stock still has more to fall, have the discipline to sell whether or not it’s painful – trust me, taking on a larger loss will be even more painful. On the other hand, if the company’s earnings potential has not been compromised, don’t be afraid to weather the storm and hang on for a rebound over the long term.

Investing should be treated as your business, not your baby. If you let the qualitative and quantitative facts act as your guide, over time you will achieve exceptional results.

Is There a Risk to Averaging Down?

March 6, 2017, 3:11 pm

We’ve all had that one stock that reverses and plummets 10%, 15% or more the day after you bought it. There are several strategies to manage that red ink, but two well-known ones are simply cutting your losses or averaging down (buying more shares in the company at a lower price than you initially purchased, which brings the average price you’ve paid on all your shares down).

Let’s say you bought 10 shares of XYZ stock trading at $100 (a total of $1,000). However, following a broader market pullback the stock drops 30% to $70 a share. You purchase 10 more shares of XYZ (or $700 worth), which brings the average purchase price to $85 a share ($1,000 + $700)/20 shares = $85 a share). You’ve lowered the original cost by $15.

Now averaging down is a bit of a double-edged sword. By lowering your initial cost, you stand to make a lot more money if the stock reverses to the upside. But if it continues falling, your loss will be greater since you own more shares. So the big question becomes: is it worth it?

My answer is that it depends. For longer-term investments, if you have a strong conviction that the market is declining and the weakness is not company-specific, it’s certainly something think about. However, you may want to consider only adding by a half or fourth position so you’re not overweight in that stock.

For options trades, I really don’t encourage it. You have to respect the action in the stock/option when you are dealing with a trade that has a certain expiration date. This is much different than when you are looking at a long-term investment where short-term movements in the stock might create buying opportunities. When you are dealing with a near-term expiration, time is the enemy and it is best to simply cut your losses. In some cases you can extend the time period by rolling the option, but it depends on if there are still enough near-term catalysts that would warrant the added time.

However, short-term stock trades are more of a gray area. There are several reasons why I don’t normally add to stocks that are down. When I’m holding a position for just a few months, I’d rather cut my losses and put the available cash into new trade set-ups. I also take risk management very seriously. If a stock gets down around 10%, I need high conviction it can turn around to stay with it. And if the reasons we got into a trade to begin with change – technical or fundamental – I will usually sell.

That said, when a stock is down for reasons that don’t change my thesis and look to be temporary, and when I have exceptionally high confidence that it will move higher, I may add a second position to lower my cost basis and make that money back faster. I don’t do this very often, though.

One of the challenges with these second positions – and your own dollar-cost averaging activity – is that conviction is a moving target. I have to have the same level or higher conviction in the stock than when I first opened the trade. Because I place a great deal of emphasis on the charts for stock trades, a move to the downside can weaken the technical situation or prolong recovery. It may improve the long-term fundamental opportunity, but that’s not my goal here.

At the end of the day, it really depends on your risk tolerance and what you’re comfortable with. If averaging down is something you’d like to try, just be aware of the benefits as well as the risks before you do it.

Should You Bet on the Bank Stocks?

February 27, 2017, 2:26 pm

Following all the media excitement about the “Trump Trades” and the sectors to be in (or stay away from) right now, I’ve gotten a lot of questions from investors on the street about them. Financials were one of most asked about, so I thought I’d spend some time talking about them today.

When you hear news about hope for earnings growth in financials, it’s referring to cyclical growth, increased lending as the economy advances and improvement in interest margins as interest rates rise. While loan growth has been on the upswing, a lot of changes that have been in company earnings have reflected cost controls.

In addition, gains in long-term interest rates remain elusive, and I believe investors looking forward to a steeper yield curve that brings higher net interest margins could be disappointed. Net interest margin for banks is actually a lot more complicated than the notion that Federal Reserve tightening will lead to higher profits; much will depend on how a bank positions its balance sheet for borrowing and lending.

Financials are quintessential value stocks versus growth stocks, accounting for 25% or even more of the Russell Value Indexes. They fit comfortably in the value style of investing, as they have historically sold for price-to-earnings and price-to-book ratios meaningfully lower than market averages. The low valuation reflects the lack of internal growth in the industry, and more importantly, the above-average risk in investing in financials.

This risk stems from the extensive use of financial leverage. While the days of holding $30 of assets for only $1 of equity are over, financials still require leverage to be profitable. For example, JPMorgan Chase (JPM), which is possibly the best capitalized large-cap bank, has $2.49 trillion in assets and $207 billion in tangible equity for a leverage ratio of 12:1. So if the value of JPM’s assets declined by 8%, either by loan losses or a decline in the value of securities held, the company’s tangible equity would be wiped out. This is an extreme example that would only occur in a depression, but I want to demonstrate how volatile balance sheets can be for financials and why they sell at low valuation ratios.

It’s also important to keep in mind that when banks prepare their financial statements, they make wide use of estimates, such as the amount of expected loan losses and in some cases, the value of securities held. Any error or underestimation of potential liabilities could have a significant impact on the final statements. This factor also tends to depress valuation ratios.

In addition, the earnings power companies like JPM or Bank of America (BAC) are expected to achieve is dependent on economic factors instead of secular growth, and the economic conditions needed to produce this kind of performance may not even occur. With the average bank stock with a market cap over $1 billion trading at 14.1X 2018 EPS estimates, a lot of the improvement has already been priced into the group.

Of course, this doesn’t mean that you should stay away from this sector right now. Financials can make for great longer-term holdings, especially with the Fed likely to raise interest rates three times this year. I just recommend waiting to grab them on pullbacks first.

Another Round of Records

February 21, 2017, 3:20 pm

It was another round of records for the broad market last week, with the S&P 500 flirting with new highs after Valentine’s Day and ending the week up 1.3%. And the party kept going today, with all three major indices hitting new highs again. Some of the gains have come on earnings season, which has been a good one. And even though another 870 companies are scheduled to report this week, the broad strokes have already been painted in.

Growth is tracking at a healthy 5% across the market as a whole, which would mark the first consecutive quarter of earnings growth since Q1 2015. At the start of the year, estimates were for Q4 earnings to increase 3.1%. This continued improvement in a wide range of sectors is just more confirmation of our belief that stocks will continue to move higher, because at the end of the day strength is based on underlying fundamentals – especially earnings. With the 2017 outlook improving each week, the future looks increasingly bullish.

Then there’s the Trump administration, which has talked about a big announcement on the horizon regarding tax cuts. There’s not a market in history that hasn’t welcomed tax cuts with open arms. And on top of that, economic numbers released last week show a solid economy as well as a pickup in inflation. All of these factors were viewed as bullish and acted as catalysts to send stocks higher.

I bring this up because improving economic readings combined with higher inflation could be the perfect storm for more interest rate hikes from the Federal Reserve. Chair Janet Yellen’s appearance in Washington last week sparked a boost in the odds we’ll get three 25-basis-point hikes sometime this year from 33% to 41% according to Fed Fund futures, and Goldman Sachs (GS) raised its odds of a rate hike at the next FOMC meeting in mid-March from 15% to 20%. While I don’t think a move in March is likely (unless something drastically changes in the next month), there’s still plenty of time for more rate hikes this year, so they are something we should be prepared for.

For more than a year the market fixated heavily on the Fed’s next move, but ever since the election ended and attention shifted to what’s going on in D.C. the central bank has taken a backseat. This can be good for easing market panic, but the Fed remains central to the future of stocks as interest rates will continue to play a role in performance through 2017.