Archives for January 2017

Trump Error, Day 7 – Waiting on the Fed

Courtesy of Phil of Phil’s Stock World

Well, now what?

The World was shocked at the US’s sweeping Muslim ban with another round of anti-Trump protests at home and abroad and the Global Markets are tumbling and the Volatility Index (VIX) is rising as even Green-Card Holders were banned from returning to the US on a sudden executive order that stranded thousands of legal immigrants overseas this weekend.

I’d love to not talk about politics but politics is driving the markets at the moment so responsible analysts NEED to discuss politics or they are doing you a tremendous disservices.  I’m not going to get into the back and forth of the thing – that’s all over the papers but we also declared a trade war with Mexico and China is now saying:

“‘A war within the president’s term’, ‘war breaking out tonight’ are not just slogans, but the reality.” 

The commentary was first reported by South China Morning Post on Friday, and comes amid concerns about a trade war between the world’s two largest economies. “The Chinese government is quite concerned about the potential for direct confrontation with the Trump administration,” said Ian Bremmer of the Eurasia Group. “Chinese officials are preparing for the worst, and they expect to retaliate decisively in response to any U.S. policies they perceive as against their interests.”

So happy Monday to you on Day 7 of the Trump Error.  Over in Europe, Germany is now worried about too much inflation and is calling for the ECB to start tightening monetary policy but poor Italy is still having bank troubles (and Europe is down 1% this morning with Italy down 2%) and Greece and Puerto Rico are both heading into debt crises (again).

Peurto Rico got an extension but the IMF just said Greece’s debt, at 275% of their GDP is “explosive and highly unsustainable”.  Explosive and unsustainable is what they say about collapsing stars – not economies inside the solar system!  And if the IMF says this about Greece, then why are Japan and China still getting a pass – both of whom have over 250% debt to GDP (assuming you can even believe China’s GDP number).

Perhaps Lord Trump is doing China a favor by starting a war to distract their population – giving the Communist Party someone to blame for their coming economic crisis.  I don’t think he’s gotten around to pissing off Japan yet, maybe because they are still taking bids for casino rights over there – just like the 4 muslim countries Trump does business with were not included in his immigration ban (Azerbaijan, Egypt, Turkey and Saudi Arabia).

In fact, Trump was on the phone with Kind Salman of Saudi Arabia this weekend and reportedly spoke to him for an hour, maybe finding out why 11 of the 19 9/11 hijackers came from Saudi Arabia… maybe.  Actually the call seemed to be about how we can help fighting Saudi Arabia’s enemies,

“The Saudis welcomed Tillerson’s appointment,” Teneo’s Holdings’ Hawes said. “Tillerson is someone who has tremendous diplomatic experience in the region,” he said. “He is a known quantity. Right now, I think this is going as well as Saudi policymakers could have hoped.”

Anyway, back to China!  China is essentially closed this week for the Lunar New Year and that’s a good thing as they’ve been approaching a liquidity crisis all month and a week break will, hopefully, give the PBOC a chance to print up a bunch of money. As you can see from the chart, capital has been fleeing China since 2014 with estimates of $3-5 TRILLION leaving the country and bubbling into foreign stocks, bonds and especially real estate.

More and more of that capital is flowing through China’s unregulated “Shadow Banking” system, which now dwarfs the banks that are under state control.  That means that, in a crisis, there is no way for the Government to control what happens – scary! With borrowing costs rebounding in 2017, firms will likely run into trouble again as the real-estate cycle winds down – this time with even more debt in play.

In some respects, China is much worse off than Japan with 170% of their GDP in Non-Financial Corporate Debt alone but, of course, those corporations are mostly owned or controlled by the Government so running the presses is a short-term solution to that problem too.

My big concern with China (and the World) is that they are one of the largest drivers of the Global Real Estate Recovery and rising rates my depress home prices and then panicky Chinese property investors may decide to dump their holdings and suddenly we’re back in a crisis as home prices begin to drop rapidly, setting off more panic.

Needless to say, we’re a bit skeptical of the Real Estate sector in 2017, even though we do see a US-based housing recovery, with rates holding back some of the enthusiasm.  Nothing matters this week ahead of Wednesday’s 2pm Fed Statement and we don’t expect them to do anything so anything else would be a surprise:

Notice no Fed speak to move the markets and just Evans (dove) after the meeting on Friday morning, presumably to salvage the week with some encouraging words.  We’re still waiting for some encouragement from the earnings reports.  So far, there hasn’t really been much to justify the 10% “Trump Rally” and nothing Trump has done so far has justified buying stocks for 25 times earnings or higher.  We’ll see if this week’s reports can tip the scales (doubt it):

We’re still short (see last week’s posts) and this morning, in our Live Member Chat Room, we added shorts back on the Oil Futures (/CL) at $53.25 to go with our Dow (/YM) Futures shorts from our Live Trading Webinar last Wednesday.  We’ve already hit $52.75 for $500 per contract gains on the oil shorts – isn’t it a good thing you saved $3 today by not subscribing!

Be careful out there!

 

Smart Shoppers Like Sales: Ross and Costco

By Paul Price of Arrow Loop Research

In recent years retail’s sweet spot has been “off-price” merchandise. That means high-quality, yet deeply discounted goods. People want nice things but are insisting on bargain prices.

Ross Stores (ROST) and Costco (COST) are businesses that have prospered along with that trend. Both companies appear on track to post all-time record earnings in their current fiscal years. Shares of each have risen significantly since the end of The Great Recession.

These firms make money because educated consumers know what things are worth and appreciate getting them at marked-down levels.

Should you be buying, or holding these stocks now, with the expectation of further gains?

Those who buy stocks in the way consumers buy other items won’t be purchasing Ross or Costco at today’s quotes. Neither appears to offer much upside over the coming year. Both ROST and COST are pricey versus their historical valuation metrics.

The 2008-09 recession left ROST available to investors at a single-digit forward multiple. ROST sold at P/Es ranging from 10.5x to 14.0x during each of the next four calendar years (green-starred below). Its asking price escalated in recent years as momentum chasers continued to jump on board.

From 2010 through 2016 ROST sported an average multiple of 16.9x. Its typical yield was about 1.05%.

Prior to 2017, there were three previous periods of clear overvaluation (red-starred). Pullbacks started at P/Es ranging from 20.0x to 22.6x. Ross Store’s Jan. 13, 2017, multiple of 21.4x its FY 2017 projection (ends Feb. 3, 2018) falls right in the midst of that “toppy” zone.

ROST’s long-term holders saw eventual gains. Failure to sell at overpriced valuations forced them to sit through drawdowns of 25.1% (from $35.40 to $26.50), 24.6% ($41.00 to $30.90) and 23.3% ($56.70 to $43.50) over the following 6 – 9 months.

A regression towards a more typical P/E could send ROST back to the $53 – $60 range, even if the coming year plays out well. Unforeseen adversity could make things even worse.

Independent research house Morningstar sees it similarly. They carry ROST with a 2-star, out of 5, sell rating. Their fair value estimate sits at $59, about 12% below last week’s quote.

Costco is a terrific operator which prices product aggressively. COST makes virtually all its net profits from recurring membership fees. High customer loyalty allows management to raise those fees about 10% about once every two years.

The company’s good characteristics are well known and appreciated, though. Costco was so beloved by investors that, late in 2015, its share valuation ventured to north of 32x (red-starred below). That valuation represents a 38% premium to Costco’s 10-year average P/E of 23.2x.

Paying too much achieved the expected result. While profits trended higher over the ensuing thirteen months, COST shares traded last week around $7.70 per share lower.

Costco’s best entry points, during 2009, 2010, 2012 and 2015, came at below average multiples. Current yields at those moments (green-starred) were all higher than average as well.

As of Jan. 13, 2017, COST still fetched a pricey 27.5x its FY 2017 (ends Sep. 2, 2017) estimate of $5.89. Consensus views for FY 2018 now center on a rise to $6.54 per share. Applying a normalized P/E to Costco’s forward estimate would only support an 18-month target price of about $152.

Could COST really see multi-year growth without parallel share price movement? A peek at the chart shows that’s exactly what happened from the top in 2008 through the first half of 2011.

Once again, quantitatively-based Morningstar seconded my conclusion. They rate Costco with just 2-stars while calling fair value as $149, around 8% below the current quote.

Why be the chump who pays top dollar to get stocks which are fated to go on sale later?

There will likely be much better future opportunities to get into Costco shares. It appears appropriate for value-conscious holders of both ROST and COST to be taking profits.

Both are great examples of good companies, trading at bad prices.

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