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All Eyes On The September Jobs Report

All Eyes On The September Jobs Report

Today’s Big Picture

US market futures point to a modestly lower open Friday morning. After the disappointing manufacturing and services data this week, all eyes will be on today’s Nonfarm Payrolls report, which is expected to see 145,000 jobs added in September, up from 130,000 in August with the unemployment rate holding at 3.7% and wages gaining +0.2%. Keep in mind that the General Motors (GM) strike will add some confusion to the data as striking workers aren’t counted in payrolls.

We’ll also be looking for any updates on the previous downward revisions to payrolls. In August the BLS cut job gain estimates for 2018 and early 2019 by about 500,000, the largest such downward revision in the past decade. Overall we’ve seen downward revisions for around 17 months – a sure sign that labor market dynamics ...

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Everything You Need To Know About The Markets Today

Everything You Need To Know About The Markets Today

Markets in Asia struggled today to get any traction following yesterday’s lackluster markets in the US and the weakening data coming out of Europe. The European equity markets are mostly in the green (albeit only slightly) with the exception of the FTSE 100 which is slightly down as of mid-day trading.

The beleaguered Hong Kong stock exchange got a shot in the arm today as the initial public offering of AB InBev’s Asia Pacific business – Budweiser Brewing Company APAC Ltd (1876.HK) – raised $5 billion, the second largest IPO of the year behind Uber’s (UBER) $8.1 billion in May. The company had initially looked to raise closer to $10 billion two months ago but was forced to put the IPO on hold after investors balked at the price. That seems to be a growing trend these days.

Major events for the day will be… READ MORE HERE

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: As earnings season continues, the market catches a positive breather

Weekly Issue: As earnings season continues, the market catches a positive breather

Key points in this issue:

  • As expected, more negative earnings revisions roll in
  • Verizon says “We’re heading into the 5G era”
  • Nokia gets several boosts ahead of its earnings report
  • USA Technologies gets an “interim” CFO

 

As expected, more negative earnings revisions roll in

In full, last week was one in which the domestic stock market indices were largely unchanged and we saw that reflected in many of our Thematic Leaders. Late Friday, a deal was reached to potentially only temporarily reopen the federal government should Congress fail to reach a deal on immigration. Given the subsequent bluster that we’ve seen from President Trump, it’s likely this deal could go either way. Perhaps, we’ll hear more on this during his next address, scheduled ahead of this weekend’s Super Bowl.

Yesterday, the Fed began its latest monetary policy meeting. It’s not expected to boost interest rates, but Fed watchers will be looking to see if there is any change to its plan to unwind its balance sheet. As the Fed’s meeting winds down, the next phase of US-China trade talks will be underway.

Last week I talked about the downward revisions to earnings expectations for the S&P 500 and warned that we were likely to see more of the same. So far this week, a number of high-profile earnings reports from the likes of Caterpillar (CAT), Whirlpool (WHR), Crane Co. (CR), AK Steel (AKS), 3M (MMM) and Pfizer (PFE) have revealed December-quarter misses and guidance for the near-term below consensus expectations. More of that same downward earnings pressure for the S&P 500 indeed. And yes, those misses and revisions reflect issues we have been discussing the last several months that are still playing out. At least for now, there doesn’t appear to be any significant reversal of those factors, which likely means those negative revisions are poised to continue over the next few weeks.

 

Tematica Investing

With the market essentially treading water over the last several days, so too did the Thematic Leaders.  Apple’s (AAPL) highly anticipated earnings report last night edged out consensus EPS expectations with guidance that was essentially in line. To be clear, the only reason the company’s EPS beat expectations was because of its lower tax rate year over year and the impact of its share buyback program. If we look at its operating profit year over year — our preferred metric here at Tematica — we find profits were down 11% year over year.

With today’s issue already running on the long side, we’ll dig deeper into that Apple report in a stand-alone post on TematicaResearch.com later today or tomorrow, but suffice it to say the market greeted the news from Apple with some relief that it wasn’t worse. That will drive the market higher today, but let’s remember we have several hundred companies yet to report and those along with the Fed’s comments later today and US-China trade comments later this week will determine where the stock market will go in the near-term.

As we wait for that sense of direction, I’ll continue to roll up my sleeves to fill the Guilty Pleasure void we have on the Thematic Leaders since we kicked Altria to the curb last week. Stay tuned!

 

Verizon says “We’re heading into the 5G era”

Yesterday and early this morning, both Verizon (VZ) and AT&T (T) reported their respective December quarter results and shared their outlook. Tucked inside those comments, there was a multitude of 5G related mentions, which perked our thematic ears up as it relates to our Disruptive Innovators investing theme.

As Verizon succinctly said, “…we’re heading to the 5G era and the beginning of what many see as the fourth industrial revolution.” No wonder it mentioned 5G 42 times during its earnings call yesterday and shared the majority of its $17-$18 billion in capital spending over the coming year will be spent on 5G. Verizon did stop short of sharing exactly when it would roll out its commercial 5G network, but did close out the earnings conference call with “…We’re going to see much more of 5G commercial, both mobility, and home during 2019.”

While we wait for AT&T’s 5G-related comments on its upcoming earnings conference call, odds are we will hear it spout favorably about 5G as well. Historically other mobile carriers have piled on once one has blazed the trail on technology, services or price. I strongly suspect 5G will fall into that camp as well, which means in the coming months we will begin to hear much more on the disruptive nature of 5G.

 

Nokia gets several boosts ahead of its earnings report

Friday morning one of Disruptive Innovator Leader Nokia’s (NOK) mobile network infrastructure competitors, Ericsson (ERIC), reported its December-quarter results. ERIC shares are trading up following the report, which showed the company’s revenue grew by 10% year over year due primarily to growth at its core Networks business. That strength was largely due to 5G activity in the North American market as mobile operators such as AT&T (T), Verizon (VZ) and others prepare to launch their 5G commercial networks later this year. And for anyone wondering how important 5G is to Ericsson, it was mentioned 26 times in the company’s earnings press release.

In short, I see Ericsson’s earnings report as extremely positive and confirming for our Nokia and 5G investment thesis.

One other item to mention is the growing consideration for the continued banning of Huawei mobile infrastructure equipment by countries around the world. Currently, those products and services are excluded in the U.S., but the U.K. and other countries in Europe are voicing concerns over Huawei as they look to confirm their national telecommunications infrastructure is secure.

Last week, one of the world’s largest mobile carriers, Vodafone (VOD) announced it would halt buying Huawei gear. BT Group, the British telecom giant, has plans to rip out part of Huawei’s existing network. Last year, Australia banned the use of equipment from Huawei and ZTE, another Chinese supplier of mobile infrastructure and smartphones.

In Monday’s New York Times, there was an article that speaks to the coming deployment of 5G networks both in the U.S. and around the globe, comparing the changes they will bring. Quoting Chris Lane, a telecom analyst with Sanford C. Bernstein in Hong Kong it says:

“This will be almost more important than electricity… Everything will be connected, and the central nervous system of these smart cities will be your 5G network.”

That sentiment certainly underscores why 5G technology is housed inside our Disruptive Innovators investing theme. One of the growing concerns following the arrest of two Huawei employees for espionage in Poland is cybersecurity. As the New York Times article points out:

“American and British officials had already grown concerned about Huawei’s abilities after cybersecurity experts, combing through the company’s source code to look for back doors, determined that Huawei could remotely access and control some networks from the company’s Shenzhen headquarters.”

From our perspective, this raises many questions when it comes to Huawei. As companies look to bring 5G networks to market, they are not inclined to wait for answers when other suppliers of 5G equipment stand at the ready, including Nokia.

Nokia will report its quarterly results this Thursday (Jan. 31) and as I write this, consensus expectations call for EPS of $0.14 on revenue of $7.6 billion. Given Ericsson’s quarterly results, I expect an upbeat report. Should that not come to pass, I’m inclined to be patient and hold the shares for some time as commercial 5G networks launches make their way around the globe. If the shares were to fall below our blended buy-in price of $5.55, I’d be inclined to once again scale into them.

  • Our long-term price target for NOK shares remains $8.50.

 

USA Technologies gets an “interim” CFO

Earlier this week, Digital Lifestyle company USA Technologies (USAT) announced it has appointed interim Chief Financial Officer (CFO) Glen Goold. According to LinkedIn, among Goold’s experience, he was CFO at private company Sutron Corp. from Nov 2012 to Feb 2018, an Associate Vice President at Carlyle Group from July 2005 to February 2012, and a Tax Manager at Ernst & Young between 1997-2005. We would say he has the background to be a solid CFO and should be able to clean up the accounting mess that was uncovered at USAT several months ago.

That said, we are intrigued by the “interim” aspect of Mr. Goold’s title — and to be frank, his lack of public company CFO experience. We suspect the “interim” title could fuel speculation that the company is cleaning itself up to be sold, something we touched on last week. As I have said before, we focus on fundamentals, not takeout speculation, but if a deal were to emerge, particularly at a favorable share price, we aren’t ones to fight it.

  • Our price target on USA Technologies (USAT) shares remains $10.

 

 

 

Weekly Issue: Thematic M&A and Adding Back a Digital Infrastructure Position

Weekly Issue: Thematic M&A and Adding Back a Digital Infrastructure Position

Key points inside this issue

  • Despite the stock market’s year to date gains, concerns remain for December quarter earnings season
  • Thematic M&A was rampant in 2018
  • Our price targets on AMN Healthcare (AMN), Chipotle Mexican Grill (CMG) and Netflix (NFLX) remain $75, $550 and $500, respectively.
  • Putting shares of Guilty Pleasure thematic leader Altria (MO) on watch
  • We are issuing a Buy on and adding back shares of Digital Infrastructure company, USA Technologies (USAT), to the Tematica Select List with a price target of $10.

 

Despite the stock market’s year to date gains, concerns remain for December quarter earnings season

Over the last week, stocks continued to move higher placing all the major domestic stock market averages higher. Quite the turn from what we saw in much of the December quarter that evaporated all of 2018’s gains. Part of the rebound reflects the harsh beating that many stocks received as investors came to grips with the various factors that I’ve been discussing here over the last two months. The down and dirty summation of those factors is this: the global economy continues to slow and it is raising questions over not only GDP prospects for the coming year but also earnings.

Stoking those earnings growth concerns were negative pre-announcements from Apple (AAPL), Samsung, LG, Macy’s (M), Target (TGT) and Kohl’s (KSS) over the last two weeks. That combination points to slower smartphone demand, but I continue to see it picking up in the coming quarters as the Disruptive Innovation that is 5G ripples its way across our Digital Infrastructure and Digital Lifestyle investing themes.  This week we can add Delta Airlines (DAL), Dialog Semiconductor (DLGNF), Nordstrom (JWN), Electronics for Imaging (EFII), Sherwin Williams (SHW) and Ford Motor Company (F) to that list as well as earnings misses from Wells Fargo (WFC), BlackRock (BLK) and others. Not exactly a vote of confidence for the December quarter earnings season.

Adding fuel to the uncertainty, this morning rail company Genesee & Wyoming (GWR) reported traffic volumes for December fell 4.8% year over year. That piles on the limited data we are getting, which included the January reading for the Empire State Manufacturing Survey General Business Conditions Index that fell to 3.9 from 11.5 in December. That drop was led by a deceleration in new orders, inventories, and the number of employees. The survey’s six-month outlook also dropped, falling to 17.8 from 30.6 last month. These data points fit the view that there is a slowdown in manufacturing activity, which has piqued concerns about a broader slowdown in economic activity unfolding in 2019.

On top of that, yesterday Sen. Chuck Grassley said U.S. Trade Representative Robert Lighthizer saw little progress on “structural issues” in last week’s talks with China. These issues include intellectual property, stealing trade secrets, and putting pressure on corporations to share information with the Chinese government and industries. These issues are the very ones I was concerned about in terms of the trade negotiations. With China cutting its growth forecast some days ago to 6% from 6.5% and more data pointing to that economy cooling, there is likely room for the trade talks to include those issues, but my concern remains the ticking timeline until tariffs jump further. If that comes to pass, it would be another headwind to the global economy and corporate earnings for the coming quarters.

Given all of that, I remain concerned with the December quarter earnings season that will kick into gear next week and what it could do for the stock market’s recent rebound. We’ll continue to keep the long position in ProShares Short S&P 500 (SH) in play as we watch and listen to the thematic signals we see. One great thematic signal this week for our Guilty Pleasures investing theme is that Pizza Hut, owned by Yum Brands (YUM) is expanding beer delivery to 300 restaurants across seven states later this month. Amazing to think that only now Pizza Hut is realizing one of the great culinary pairings of Pizza and beer as it looks to offer customer one-stop shopping as well as capture that incremental revenue and profits. Odds are there will be some element of our Digital Lifestyle theme at play, given the push toward mobile orders we are seeing across the restaurant industry. Now to see what beer they offer… hopefully, it will be more than just the big brand beers like Budweiser.

Another signal that points to the bleeding over of our Digital Lifestyle, Disruptive Innovators and Aging of the Population themes is the partnering between Walgreens Boots Alliance (WBA) and Microsoft (MSFT). Over the next several years, the two will research and develop new methods of delivering healthcare services through digital devices, including virtually connecting people with Walgreens stores.

We at Tematica see thematic signals for our 10 investing themes practically everywhere… and that means we will continue using them to build and refine our investing mosaic in the days, weeks and months ahead. As we navigate the next few weeks, we may have a change or two on the Thematic Leaders and a few companies that make it onto the Contender List for when the stock market finds its footing.

 

Thematic M&A was rampant in 2018

Over the last two weeks, we here at Tematica have been reviewing the thematic database of more than 2,400 stocks that we’ve ranked based on their exposure to our 10 investment themes. That was no small project let me tell you, and it was a key initiative for 2018. In looking back over that body of work, I noticed more than a dozen companies that were in the database at the start of last year had been acquired during the second half of 2018. Here’s a short list of what I’m talking about:

As you can see, the acquisition activity was spread across a number of our themes and included both strategic and financial buyers. In each case, the buyer looked to fill a competitive hole be it a product, market or technology. That’s the classic finance take on it, but we know those buyers were looking to solidify their exposure to the thematic tailwinds that are powering their businesses or in some cases expose themselves to another one.

Are we likely to see more thematically based M&A in the coming months?

My view is yes, particularly as the global economy slows and companies look to deliver top and bottom line growth be it on an organic or acquired basis.

Adding back shares of Digital Infrastructure company USA Technologies

Today I am calling shares of mobile payments company, USA Technologies (USAT),  back onto the Tematica Select List following news earlier this week about the results of an internal investigation into its accounting practices. You may recall that last year, USAT shares were a high flyer for the Select List. However, upon learning that the USAT board would conduct an internal investigation into the accounting of certain of its present and past contractual arrangements and its financial reporting controls and would miss filing the company’s 10-K, we smartly jettisoned the shares near $10.25 last September.

We had been trimming the position at higher levels near $14 in the preceding months, but in light of those developments we “got out of Dodge”, so to speak, and did not stick around for the free fall to $3.44 by early December. While we continued to see growing adoption of mobile payments, especially at USAT’s core market of vending machines and unattended retail, we also saw the stock price pain associated with these investigations and potential financial restatements. “No thanks” was my thinking.

The company on Monday announced both the findings of its internal investigation and remedial actions to be implemented by the board. It also shared that it is working to file its 10-K as soon as possible and disclosed the departures of both its chief financial officer (CFO) and chief services officer (CSO). In tandem with those announcements, USAT also shared it is in negotiations for a new CFO.

In terms of the investigation and the planned responses, the company’s Audit Committee found that, for certain transactions, USAT had prematurely recognized revenue and, in some cases, the reported number of connections associated with the transactions under review. The committee went on to recommend the company enhance its internal controls and its compliance and legal functions; expand its public disclosures; and consider appropriate employment actions related to certain employees as well as splitting the roles of chairman and CEO.

These measures, along with the departure of the CFO and CSO, are not surprising, but they do put USAT on the path to restoring investor confidence in its reporting. While this investigation was happening the market for mobile payments continued to be on a tear as companies such as PepsiCo (PEP) inked a new five-year agreement with USAT.

Clearly, there is more work to be completed, and there is the risk that we are re-entering these shares on the early side. However, as we have seen in the past, as these clouds lift investors will focus on the tailwinds of the business, which in this case are centered on mobile payments and are improving. Therefore, we will resume ownership of USAT shares and look to scale on potential stock price weakness when the company formally restates its revenue and other key metrics. Better a bit early than too late is my thinking on this one.

Our previous price target on USAT shares was $16. However, we should prudently assume that several of the underlying financial metrics will be restated lower. Consequently, I’m taking a haircut relative to our prior target and putting out a new price target of $10. As the company releases its updated financials, I’ll look to fine-tune that price target as needed

  • We are issuing a Buy on and adding back shares of Digital Infrastructure company, USA Technologies (USAT), to the Tematica Select List with a price target of $10.

 

The Thematic Leaders

As the stock market moved higher week over week as of last night’s close, we saw several Thematic Leaders move higher. These included Aging of the Population leader AMN Healthcare (AMN), and Clean Living leader Chipotle Mexican Grill (CMG) as well as Thematic King Amazon (AMZN). The big winner, however, was Digital Lifestyle leader Netflix (NFLX), which yesterday announced it would boost prices for its monthly memberships by 13% to 18%. This marks the company’s biggest price increase and I suspect was well thought out by the management team, given the increasingly competitive playing field. That price increase should drive Wall Street’s revenue expectations higher and improve its ability to not only spend on proprietary content but also its ability to service its quarterly debt costs.

  • Our price targets on AMN Healthcare (AMN), Chipotle Mexican Grill (CMG) and Netflix (NFLX) remain $75, $550 and $500, respectively.

 

Putting Altria shares on watch

Even though we’re just a few weeks into 2019, shares of Guilty Pleasure leader Altria have been underperforming on both an absolute basis and a relative one compared to the S&P 500. Weighing the shares down are questions over its ability to recoup the $12.8 billion investment for a 35% stake, in e-vapor market leader Juul Labs (JUUL). While this is part of the company’s efforts to reposition itself, given prospects for continued declines in its core tobacco market, complicating things is the FDA’s move to stub out youth access to e-vapor and flavored cigarettes.

Odds are this will take several years to come about but it raises questions as to whether Altria is trading one shrinking market for another. Candidly, I would have preferred Altria take that $12.5 billion and spread it across several cannabis investments. I’ll continue to be patient for now with this thematic leader, however, I’ll be looking at several in the coming days that could offer a far better risk to return tradeoff.

 

Tematica Investing: Thematic Tailwinds for 2019 and Scaling into AXON

Tematica Investing: Thematic Tailwinds for 2019 and Scaling into AXON

 

Key Points Inside this Issue:

Last Friday’s favorable December Employment Report showed the domestic economy is not falling off a cliff and comments by Fed Chair Jay Powell reflected that the central bank will be patient with monetary policy as it watches how the economy performs. Those two things kicked the market off on its most recent three-day winning streak as of last night’s close. In many ways, Powell gave the market what it was looking for when he shared the Fed will remain data dependent when it looks at the economy and its next step with monetary policy.

Taking a few steps back, we’ve all experienced the market volatility over the last several weeks as it contends with a host of issues that we here at Tematica have laid out through much of the December quarter. These include:

  • U.S.-China trade issues
  • The slowing economy
  • A Fed that could boost rates twice in 2019 and continues to unwind its balance sheet
  • Brexit and political uncertainty in the Eurozone
  • And more recently the government shutdown.

These factors have led investors to question growth prospects for the global as well as the domestic economy and earnings in 2019.

Powell’s comments potentially take one of those issues off the table at least in the short-term. If the economy continues to deliver job creation as we saw in December, with some of the best year-over-year wage gains we’ve seen in years, before too long the Fed-related conversation could very well turn from two rate hikes to three.

Currently, that isn’t what the market is expecting.

The reason it isn’t is that outside of the December jobs report, data from ISM and IHS Markit continued to show a decelerating global and U.S. economy. With new orders and backlog levels falling, as well as pricing-related data, it likely means we won’t see a pronounced pickup in the January data. The JPMorgan Global Composite Output Index for December delivered its lowest reading since September 2016 due principally to the slowdown in the eurozone. Rates of expansion slowed in Germany (66-month low) and Spain (three-month low), while Italy stagnated. China, the UK, and Brazil all saw modest growth accelerations.

 

Despite the month over month declines in the December data for the US, it was the best performer on a relative basis even though the IHS Markit Composite PMI reading for the month hit a 15-month low. A more sobering view was shared by Chris Williamson, Chief Business Economist at IHS Markit who said:

“Manufacturers reported a weakened pace of expansion at the end of 2018, and grew less upbeat about prospects for 2019. Output and order books grew at the slowest rates for over a year and optimism about the outlook slumped to its gloomiest for over two years.”

That should give the Fed some room to hold off boosting rates, but it also confirms the economy is decelerating, which will likely have revenue and earnings guidance repercussions in the upcoming December-quarter earnings season.

There are several catalysts that could drive both the economy and the stock market higher in the coming months. These include a “good deal” resolution to the U.S.-China trade situation and forward movement in Washington on infrastructure spending. This week, the US and China have met on trade and it appears those conversations have paved the way for further discussions in the coming weeks. A modest positive that has helped drive the stock market higher this week, but thus far concrete details remain scant.

Such details are not likely to emerge for at least several weeks, which means the next major catalyst for the stock market will be the upcoming December quarter earnings season that begins in nine trading days.

 

Earnings expectations are being revised lower

Facing a number of risks and uncertainties over the last several weeks, investors have once again questioned growth prospects for both the economy and earnings growth for 2019. The following two charts – one of the Citibank Economic Surprise Index and one showing the aggregate profit margin for the S&P 500 companies – depict what investors are grappling with weaker than expected economic data at a time when corporate operating margins have hit the highest levels in over 20 years.

While expectations for growth in both the domestic economy and earnings for the S&P 500 have come in compared to forecasts from just a few months ago, the current view per The Wall Street Journal’s Economic Forecasting Survey calls for 2019 GDP near 2.3% (down from 3.0% in 2018) with the S&P 500 group of companies growing their collective EPS by 7.4% year over year in 2019.

 

Here’s the thing, in recent weeks, analysts lowered their earnings estimates for companies in the S&P 500 for the December quarter by roughly 4% to $40.93. The Q4 bottom-up EPS estimate (which is an aggregation of the median EPS estimates of all the companies in the index) dropped by 4.5% to $40.63. In the chart below, you can see this means quarter over quarter, December quarter earnings are expected to drop breaking the typical pattern of earnings growth into the last quarter of the year. What you can’t see is that marks the largest cut to quarterly S&P 500 EPS estimates in over a year.

 

 

Getting back to that 7.4% rate of earnings growth that is currently forecasted for 2019, I’d call out that it too has been revised down from 9% earlier in the December quarter. That new earnings forecast is a far cry from 21.7% in 2018, which was in part fueled by a stronger economy as well as the benefits of tax reform that was passed in late 2017. As we all know, there that was a one-time bump to corporate bottom lines that will not be repeated this year or in subsequent ones. The conundrum that investors are facing is with the market barometer that is the S&P 500 currently trading at 15.9x consensus 2018 EPS of $161.54, the factors listed above have investors asking what the right market multiple based on 2019’s consensus EPS of $173.45 should be?

And while most investors don’t “buy the market,” its valuation and earnings growth are a yardstick by which investors judge individual stocks.

 

Thematic tailwinds will continue to drive profits and stock prices

One of the key principles to valuing stocks is that companies delivering stronger EPS growth warrant a premium valuation. Of course, in today’s stock buyback rampant world, that means ferreting out those companies that are growing their net income. My preference has been to zero in on what is going on with a company’s operating profit and operating margins given that their vector and velocity are the prime drivers of earnings. That was especially needed last year given the widespread bottom-line benefits of tax reform.

At the heart of it, the question is what is driving the business?

As I’ve shared before, sector classifications don’t speak to that as they are a grouping of companies by certain characteristics rather than the catalysts that are driving their businesses. As we’ve seen before, some companies, such as Amazon (AMZN) or Apple (AAPL) capitalize on those catalysts, while others fail to do so in a timely manner if at all. Sears (SHLD), JC Penney (JCP) are easy call outs, but so are Toys R Us, Bon-Ton Stores, Sports Authority, Blue Apron (APRN), and Snap (SNAP) to name just over a handful.

Very different, and we can see the difference in comparing revenue and profit growth as well as stock prices. The ones that are performing are responding to the changing landscapes across the economic, demographic, psychographic, technological, regulatory and other playing fields they face. In short, they are riding the thematic tailwinds that we here at Tematica have identified. As a reminder those themes are:

 

As we move into 2019, I continue to see the tailwinds associated with those themes continuing to blow hard. Despite all the vain attempts to fight it temporarily, there is no slowing down the aging process. Consumers continue to flock to better for you alternatives, and as you’ll see below that has led Thematic Leader Chipotle Mexican Grill (CMG) to bring a new offering to market.

As we saw this past holiday shopping season, consumers are flocking more and more to digital shopping while hours spent streaming content continue to thwart broadcast TV and the box office. This year 5G networks and devices will become a reality as AT&T (T), Verizon (VZ) and others launch those commercial networks. The legalization of cannabis continues, and consumers continue to consume chocolate, alcohol and other Guilty Pleasures.

Whether you are Marriott International (MAR), Facebook (FB), British Airways or the Bridgeport School System, cyber threats continue to grow and as we saw last night during the presidential address and Democratic response, border security be it through a wall, technology or other means is a pain point that needs to be addressed. While the last two monthly Employment Reports have shown some of the best wage gains in years, Middle-class Squeeze consumers continue to face a combination of higher debt and interest rates as well as rising healthcare costs and the need to save for their golden years that will weigh on the ability to spend.

Like any set of winds, there will be times when some blow harder than others. For example, as we peer into the coming year the launch of 5G networks and gigabit ethernet will likely see the Digital Infrastructure tailwind accelerate in the first half of the year as network and data center operators utilize the services of companies like Thematic Leader Dycom Industries (DY) to build the physical networks. Some tailwinds, such as those associated with Aging of the Population, Clean Living and Middle-class Squeeze are likely to be more persistent over the coming year. Other tailwinds will gust hard at times almost seemingly out of nowhere reminding that they have been there all along. Given the nature of high profile cyber attacks and other threats, that’s likely to once again be the case with Safety & Security.

The bottom line is this – the impact to be had of the tailwinds associated with our 10 investment themes will continue to be felt in 2019. They will continue to influence consumer and business behavior, altering the playing field and forcing companies to either respond or not. The ones that are capitalizing on that changing playing field and are delivering pronounced profit growth are the ones investors should be focusing on.

 

TEMATICA INVESTING 

Scaling into AAXN, and updates on NFLX, CMG, and DFRG

As I discussed above, the December quarter was one of the most challenging periods for the stock market in some time. Even though we are just over a handful of days into 2019, we’re seeing the thematic tailwinds blow again on the Thematic Leaders with 9 of the 11 positions ahead of the S&P 500. Yes, we’re looking pretty good so far but it’s too early in the year to start patting our backs, especially with the upcoming earnings season. Odds are Apple’s (AAPL) negative preannouncement last week won’t be the only sign of misery to be had, and that’s why I’m keeping the ProShares Short S&P 500 ETF (SH) active for the time being. As I shared with you last week, while Apple and others are contending with a maturing smartphone market, I continue to like the long-term Digital Lifestyle aspects as it moves into streaming content and subscription-related businesses.

Of those 9 companies that are ahead of the S&P 500, as you can see in the table above, there are several that are significantly outperforming the market in the brief time that is 2019. These include Netflix (NFLX) shares, Axon Enterprises (AAXN), and Chipotle Mexican Grill (CMG)  as well as Del Frisco’s (DFRG).

After falling just over 28% in the December quarter as investors gave up on the FANG stocks, as of last night’s market close Netflix shares are up 20% so far for the new year. Spurring them along have been favorable comments and a few upgrades from the likes of Piper Jaffray, Barclays, Sun Trust, and several other investment banks. From my perspective, even though Netflix will face a more competitive landscape as AT&T (T), Disney (DIS), Hulu, Amazon (AMZN), Google (GOOGL), Facebook (FB), and Apple (AAPL), it has a substantial lead in the original content race over the likes of Facebook, Apple, Google and Amazon.

Candidly, only AT&T given its acquisition of Time Warner, and Disney, especially once it formally acquires with the movie, TV and other content from 21stCentury Fox (FOXA), will be streaming content contenders in the near term. And Disney is starting from scratch while AT&T lags meaningfully behind Netflix in terms of not only overall subscribers but domestic ones as well. For now, the digital streaming horse to play remains Netflix, especially as it brings more content to its service for both the US and international markets, which should drive its global subscriber base higher.

 

New bowls at Chipotle signal the Big Fix continues

Since its beginnings, Chipotle has been at the forefront of our Clean Living investing theme, but last week it took another step to attract those who are aiming to eat healthier when it introduced a line of Lifestyle Bowls. These included Keto, Paleo, Whole30, and Double Protein versions are only available through the company’s mobile app and the Chipotle website. Clearly, the new management team that arrived last year understands the powerful tailwind associated with our Digital Lifestyle investing theme. More on those new bowls can be found here, and we expect to hear more on the management team’s Big Fix initiatives when the company presents at the ICR Conference on Jan. 15.

 

Adding to Axon Enterprises as EPS expectations move higher

When we added shares of Axon Enterprises to the Thematic Leaders for the Safety & Security slot, we noted the company’s long reach into US police departments and other venues that should drive adoption of its newer Taser units but more importantly its body cameras and digital storage businesses. In the company’s November earnings report we saw that positive impact as its Axon Cloud revenue rose 47% year over year to $24 million, roughly $24 million or 23% of revenue vs. 18% in the year-ago quarter. Even better, the gross margin associated with that business has been running in the mid 70% range over the last few quarters, well above the corporate gross margin average of 36%-37%. Over the last 90 days, we’ve seen Wall Street boost its EPS forecasts for the company to $0.77 for 2018, up from $0.52, and to $0.92 for 2019 up from $0.73.

Even though we AAXN shares are on a roll thus far in 2019, the position is still in the red since joining the Thematic Leaders. Against the favorable tailwind of our Safety & Security investing theme and rising EPS expectations, we will scale into AAXN shares at current levels, which will drop our cost basis to around $61 from just under $73. Our $90 price target remains intact.

  • We are scaling into shares of Safety & Security Thematic Leader Axon Enterprises (AXON) at current levels, which will dramatically improve our cost basis. Our $90 price target remains intact.

 

Del Frisco’s shares jump on takeout speculation

Over the last few weeks, there has a sizable rebound in the shares of high-end restaurant name Del Frisco’s Restaurant Group. Ahead of the year-end 2018 holidays, the company’s board of directors was the recipient of activist investor action from Engaged Capital. During the holiday weeks, the company shared it has hired investment firm Piper Jaffray to “review and consider a full range of options focused on maximizing shareholder value, including a possible sale of the Company or any of its dining concepts.”

In other words, Del Frisco’s is putting itself in play. Often this can result in a company being taken out either by strategic investors, private equity or a combination of the two. There is also the chance a company going through this process is not acquired due primarily to a mismatch between the potential buyer(s) and the board on price as well as underlying financing.

From my perspective, 2018 was a challenging year for Del Frisco’s as it repositioned its branded portfolio. This included the sale of Sullivan’s Steakhouse and the acquisition of Barteca Restaurant Group, the parent of both Bartaco and Barcelona restaurants.

Transitions such as these can be challenging, and in some cases, the benefits of the transformation may take longer to emerge than planned. That said, given the data we’ve discussed previously on the recession-resistant nature of high-end dining, such as at Del Frisco’s core Double Eagle Steakhouse and Grille, we do think the company would be a feather in the cap for another restaurant group. As we noted when we added DFRG shares to the Thematic Leaders, there are very few standalone public steakhouse companies left — the vast majority of them have been scooped up by names such as Landry’s or Darden Restaurants (DRI).

From a fundamental perspective, the reasons why we are bullish on Del Frisco’s are the same ones that make it a takeout candidate. While we wait and see what emerges on the bid front, I’ll be looking over other positions to fill DFRG’s slot on the Thematic Leaders should a viable bid emerge.  Given the company’s restaurant portfolio, the continued spending on high-end dining and its recession-resistant nature, odds are rather high of that happening.

  • Our price target on Del Frisco’s Restaurant Group (DFRG) remains $14.

 

 

Weekly Issue: Investor anxiety continues

Weekly Issue: Investor anxiety continues

Key points inside this issue

  • As the investors grapple with anxiety over trade as well as the speed of economic and earnings growth, we’ll continue to hold ProShares Short S&P 500 (SH) shares.
  • Our price target on the shares of Guilty Pleasure Thematic Leader Del Frisco’s Restaurant Group (DFRG) remains $14.
  • Our price target on Middle-Class Squeeze Thematic Leader Costco Wholesale (COST) shares remains $250.
  • Our price target on Amazon (AMZN) shares remains $2,250

 

The stock market experienced another painful set of days in last week as it digested the latest set of economic data, and what it all means for the speed of the domestic and global economy. Investors also grappled with determining where the U.S. is with regard to the China trade war as well as the prospects for a deal by the end of March that would prevent the next round of tariffs on China from escalating.

There remain a number of unresolved issues between the U.S. and China, some of which have been long-standing in nature, which suggests a fix in the next 100+ days is somewhat questionable. This combination induced a fresh round of anxiety in the market, leading it to ultimately finish the week lower as the major indices sagged further quarter to date. In turn, that pushed all the major market indices into the red as of Friday’s close, most notably the small-cap heavy Russell 2000, which finished Friday down 5.7% year to date. For those keeping score, that equates to the Russell 2000 falling just under 15% quarter to date.

Last week we added downside protection to our holdings in the form of ProShares Short S&P 500 (SH) shares, and we’ll continue to hold them until signs of more stable footing for the overall market emerge. As we do this, I’ll continue to evaluate not only the thematic signals that are in and around us day-in, day-out, but also examine the potential opportunities on a risk to reward basis the market pain is creating.

 

Shares of Del Frisco’s get some activist attention

Late last week, our shares of Guilty Pleasure Thematic Leader Del Frisco’s Restaurant Group (DFRG) bucked the overall move lower in the domestic stock market following the revelation that activist hedge fund Engaged Capital has acquired a nearly 10% in the company with a plan to push the company to sell itself according to The Wall Street Journal. Given the sharp drop in DFRG shares thus far in 2018, down 52%, it’s not surprising to see this happen, and when we added the shares to our holdings, we shared the view that at some point it could be a takeout candidate as the restaurant industry continues to consolidate. In particular, Del Frisco’s presence in the higher end dining category and its efforts over the last few months to become a more focused company help explain the interest by Engaged.

In response, Del Frisco’s issued the following statement:

“Del Frisco’s is committed to maximizing long-term value for all shareholders. While we do not agree with certain characterizations of events or of our business and operations contained in the letter that we received from Engaged Capital, the Company values constructive input toward the goal of enhancing shareholder value. “

Compared to other Board responses this one is rather tame and suggests Del Frisco’s will indeed have a dialog with Engaged. Given the year to date performance in DFRG shares, odds are there are several on the Board that are frustrated either with the rate of change in the business or how that change is being viewed in the marketplace.

In terms of who might be interested in Del Frisco’s, we’ve seen a number of going private transactions in recent years led by private equity investors that re-tool a company’s strategy and execution or combine it with other entities. We’ve also seen several restaurant M&A transactions as well. Let’s remember too how on Del Frisco’s September quarter earnings conference call, the management team went out of its way to explain how the business performed during the last recession. That better than industry performance may add to the desirability of Del Frisco’s inside a platform, multi-branded restaurant company.

As much as we may agree with the logic behind Del Frisco’s being taken out, we’d remind subscribers that buying a company on takeout speculation can be dicey. In the case of Del Frisco’s, we continue to see a solid fundamental story. We are seeing deflation in food prices that bode well for Del Frisco’s margins and bottom line EPS. Over the last quarter we’ve seen prices in the protein complex – beef, pork, and chicken – move lower across the board. According to the United Nation’s Food and Agriculture Organisation’s (FAO) food price index, world food prices declined during the month of November to their lowest level in more than two years. We’re also seeing favorable restaurant spending per recent monthly Retail Sales reports, which should only improve amid year-end holiday dinners eaten by corporate diners and individuals.

We’ll continue to hold DFRG for the fundamentals, but we won’t fight any smart, strategic transaction that may emerge.

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

 

What to watch in the week ahead

As we move into the second week of the last month of the quarter, I’ll continue to examine the oncoming data to determine the vector and velocity of the domestic as well as global economy. Following Friday’s November Employment Report that saw weaker than expected job creation for the month, but year over year wage gains of 3.1% the Atlanta Fed continued to reduce its GDP forecast for the current quarter. That forecast now sits at 2.4%, down from 3.0% at the end of October.

With the sharp drove in oil prices has consumers feeling a little holiday cheer at the gas pump, odds are next week’s November inflation reports will be tame. The fact that world food prices per the Food and Agriculture Organization’s (FAO) food price index hit the lowest level since May 2016 also bodes well for a benign set of inflation data this week. Later in the week, we’ll get the November Retail Sales report, which should be very confirming for our holiday facing positions – Amazon (AMZN), United Parcel Service (UPS), McCormick & Co. (MKC) and Costco Wholesale (COST) – that given the kickoff of “seasons eatings” with Thanksgiving and the start of the holiday shopping season that clearly shifted to digital shopping.

That report will once again provide context for this shift as well as more than likely confirm yet again that Costco Wholesale (COST) continues to take consumer wallet share. Speaking of Costco, the company will report its quarterly results this  Thursday. Quarter to date, the company’s monthly same store sales reports are firm evidence it is winning consumer wallet share, and we expect it did so again in November, especially with its growing fresh foods business that keeps luring club members back. Aside from its top and bottom line results, I’ll be focused once again on its pace of new warehouse openings, a harbinger of the crucial membership fee income to be had in coming quarters.

  • Our price target on Middle-Class Squeeze Thematic Leader Costco Wholesale (COST) shares remains $250.

We’ll end the economic data stream this week with the November Industrial Production report. Given the sharp fall in heavy truck orders in November, I’ll be digging into this report with a particular eye for what it says about the domestic manufacturing economy.

As discussed above, this week Costco will report its results and joining it in that activity will be several other retailers such as Ascena Retail (ASNA), DWS (DWS), American Eagle (AEO) and Vera Bradley (VRA). Inside their comments and guidance, which will include the holiday shopping season, I’ll be assessing the degree to which they are embracing our Digital Lifestyle investing theme. We’ll also see Adobe Systems (ADBE) report its quarterly result and I’ll be digesting what it has to say about cloud adoption, pricing and prospects for 2019. As we know, that is a core driver of Amazon Web Services, one of the key profit and cash flow drivers at Amazon (AMZN).

  • Our price target on Amazon (AMZN) shares remains $2,250

 

Weekly Issue: Looking Around the Bend of the Current Rebound Rally

Weekly Issue: Looking Around the Bend of the Current Rebound Rally

 

Stock futures are surging this morning in a move that has all the major domestic stock market indices pointing up between 1.5% for the S&P 500 to 2.2% for the Nasdaq Composite Index. This surge follows the G20 Summit meeting of President Trump and Chinese President Xi Jinping news that the US and China will hold off on additional tariffs on each other’s goods at the start of 2019 with trade talks to continue. What this means is for a period of time as the two countries look to hammer out a trade deal during the March quarter, the US will leave existing tariffs of 10% on more than $200 million worth of Chinese products in place rather than increase them to 25%.  If after 90 days the two countries are unable to reach an agreement, the tariff rate will be raised to 25% percent.

In my view, what we are seeing this morning is in our view similar to what we saw last week when Fed Chair Powell served up some dovish comments regarding the speed of interest rate hikes over the coming year – a sigh of relief in the stock market as expected drags on the economy may not be the headwinds previously expected. On the trade front, it’s that tariffs won’t escalate at the end of 2018 and at least for now it means one less negative revision to 2019 EPS expectations. In recent weeks, we’ve started to see the market price in the slowing economy and potential tariff hikes as 2019 EPS expectations for the S&P 500 slipped over the last two months from 10%+ EPS growth in 2019 to “just” 8.7% year over year. That’s down considerably from the now expected EPS growth of 21.6% this year vs. 2017, but we have to remember the benefit of tax reform will fade as it anniversaries. I expect this to ignite a question of what the appropriate market multiple should be for the 2019 rate of EPS growth as investors look past trade and the Fed in the coming weeks. More on that as it develops.

For now, I’ll take the positive performance these two events will have on the Thematic Leaders and the Select List; however, it should not be lost on us that issues remain. These include the slowing global economy that is allowing the Fed more breathing room in the pace of interest rate hikes as well as pending Brexit issues and the ongoing Italy-EU drama. New findings from Lending Tree (TREE) point to consumer debt hitting $4 trillion by the end of 2018, $1 trillion higher than less five years ago and at interest rates that are higher than five years ago. Talk about a confirming data point for our Middle-class Squeeze investing theme. And while oil prices have collapsed, offering a respite at the gas pump, we are seeing more signs of wage inflation that along with other input and freight costs will put a crimp in margins in the coming quarters. In other words, headwinds to the economy and corporate earnings persist.

On the US-China trade front, the new timeline equates to three months to negotiate a number of issues that have proved difficult in the past. These include forced technology transfer by U.S. companies doing business in China; intellectual-property protection that the U.S. wants China to strengthen; nontariff barriers that impede U.S. access to Chinese markets; and cyberespionage.

So, while the market gaps up today in its second sigh of relief in as many weeks, I’ll continue to be prudent with the portfolio and deploying capital in the near-term.  At the end of the day, what we need to see on the trade front is results – that better deal President Trump keeps talking about – rather than promises and platitudes. Until then, the existing tariffs will remain, and we run the risk of their eventual escalation if promises and platitudes do not progress into results.

 

The Stock Market Last Week

Last week we closed the books on November, and as we did that the stock market received a life preserver from Federal Reserve Chair Powell, which rescued them from turning in a largely across-the-board negative performance for the month. Powell’s comments eased the market’s concern over the pace of rate hikes in 2019 and the subsequent Fed November FOMC meeting minutes served to reaffirm that. As we shared Thursday, we see recent economic data, which has painted a picture of a slowing domestic as well as global economy, giving the Fed ample room to slow its pace of rate hikes. 

While expectations still call for a rate increase later this month, for 2019 the consensus is now looking for one to two hikes compared to the prior expectation of up to four. As we watch the velocity of the economy, we’ll also continue to watch the inflation front carefully given recent declines in the PCE Price Index on a year-over-year basis vs. wage growth and other areas that are ripe for inflation.

Despite Powell’s late-month “rescue,” quarter to date, the stock market is still well in the red no matter which major market index one chooses to look at. And as much as we like the action of the past week, the decline this quarter has erased much of the 2018 year-to-date gains. 

 

Holiday Shopping 2018 embraces the Digital Lifestyle

Also last week, we had the conclusion of the official kickoff to the 2018 holiday shopping season that spanned Thanksgiving to Cyber Monday, and in some cases “extended Tuesday.” The short version is consumers did open their wallets over those several days, but as expected, there was a pronounced shift to online and mobile shopping this year, while bricks-and-mortar traffic continued to suffer. 

According to ShopperTrak, shopper visits were down 1% for the two-day period compared to last year, with a 1.7% decline in traffic on Black Friday and versus 2017. Another firm, RetailNext, found traffic to U.S. stores fell between 5% and 9% during Thanksgiving and Black Friday compared with the same days last year. For the Thanksgiving to Sunday 2018 period, RetailNext’s traffic tally fell 6.6% year over year. 

Where were shoppers? Sitting at home or elsewhere as they shopped on their computers, tablets and increasingly their mobile devices. According to the National Retail Federation, 41.4 million people shopped only online from Thanksgiving Day to Cyber Monday. That’s 6.4 million more than the 34.7 million who shopped exclusively in stores. Thanksgiving 2018 was also the first day in 2018 to see $1 billion in sales from smartphones, according to Adobe, with shoppers spending 8% more online on Thursday compared with a year ago. Per Adobe, Black Friday online sales hit $6.22 billion, an increase of 23.7% from 2017, of which roughly 33% were made on smartphones, up from 29% in 2017.

The most popular day to shop online was Cyber Monday, cited by 67.4 million shoppers, followed by Black Friday with 65.2 million shoppers. On Cyber Monday alone, mobile transactions surged more than 55%, helping make the day the single largest online shopping day of all time in the United States at $7.9 billion, up 19% year over year. It also smashed the smartphone shopping record set on Thanksgiving as sales coming from smartphones hit $2 billion.

As Lenore Hawkins, Tematica’s Chief Macro Strategist, and I discussed on last week’s Cocktail Investing podcast, the holiday shopping happenings were very confirming for our Digital Lifestyle investing theme. It was also served to deliver positive data points for several positions on the Select List and the Thematic Leader that is Amazon (AMZN). These include United Parcel Service (UPS), which I have long viewed as a “second derivative” play on the shift to digital shopping, but also Costco Wholesale (COST) and Alphabet/Google (GOOGL). Let’s remember that while we love McCormick & Co. (MKC) for “season’s eatings” the same can be said for Costco given its food offering, both fresh and packaged, as well as its beer and wine selection. For Google, as more consumers shop online it means utilizing its search features that also drive its core advertising business.

As we inch toward the Christmas holiday, I expect more data points to emerge as well as more deals from brick & mortar retailers in a bid to capture what consumer spending they can. The risk I see for those is profitless sales given rising labor and freight costs but also the investments in digital commerce they have made to fend off Amazon. Sales are great, but it has to translate into profits, which are the mother’s milk of EPS, and that as we know is one of the core drivers to stock prices.

 

Marriott hack reminds of cyber spending needs

Also last week, we learned of one of the larger cyber attacks in recent history as Marriott (MAR) shared that up to 500 million guests saw their personal information ranging from passport numbers, travel details and payment card data hacked at its Starwood business. As I wrote in the Thematic Signal in which I discussed this attack, it is the latest reminder in the need for companies to continually beef up their cybersecurity, and this is a profound tailwind for our Safety & Security investing theme as well as the  ETFMG Prime Cyber Security ETF (HACK) shares that are on the Select List.

 

The Week Ahead

Today, we enter the final month of 2018, and given the performance of the stock market so far in the December quarter it could very well be a photo finish to determine how the market finishes for the year. Helping determine that will not only be the outcome of the weekend’s G-20 summit, but the start of November economic data that begins with today’s ISM Manufacturing Index and the IHS Markit PMI data, and ends the week with the monthly Employment Report. Inside those two reports, we here at Tematica be assessing the speed of the economy in terms of order growth and job creation, as well as inflation in the form of wage growth. These data points and the others to be had in the coming weeks will help firm up current quarter consensus GDP expectations of 2.6%, per The Wall Street Journal’s Economic Forecasting Survey that is based on more than 60 economists, vs. 3.5% in the September quarter.

Ahead of Wednesday’s testimony by Federal Reserve Chair Powell on “The Economic Outlook” before Congress’s Joint Economic Committee, we’ll have several Fed heads making the rounds and giving speeches. Odds are they will reinforce the comments made by Powell and the November Fed FOMC meeting minutes that we talked about above. During Powell’s testimony, we can expect investors to parse his words in order to have a clear sense as to what the Fed’s view is on the speed of the economy, inflation and the need to adjust monetary policy, in terms of both the speed of future rate hikes and unwinding its balance sheet. Based on what we learn, Powell’s comments could either lead the market higher or douse this week’s sharp move higher in the stock market with cold water.

On the earnings front this week, we have no Thematic Leaders or Select List companies reporting but I’ll be monitoring results from Toll Brothers (TOL), American Eagle (AEO), Lululemon Athletica (LULU), Broadcom (AVGO) and Kroger (KR), among others. Toll Brothers should help us understand the demand for higher-end homes, something to watch relating to our Living the Life investing theme, while American Eagle and lululemon’s comments will no doubt offer some insight to the holiday shopping season. With Broadcom, we’ll be looking at its demand outlook to get a better handle on smartphone demand as well as the timing of 5G infrastructure deployments that are part of our Disruptive Innovators investing theme. Finally, with Kroger, it’s all about our Clean Living investing theme and to what degree Kroger is capturing that tailwind.

 

Weekly Issue: A Number of Our Thematic Leaders Well Positioned for the Holidays

Weekly Issue: A Number of Our Thematic Leaders Well Positioned for the Holidays

 

Normally we here at Tematica tend to shut down during the short week that contains Thanksgiving, but given all that is going on in the stock market of late, we thought it prudent to share some thoughts as well as what to watch both this week and next. From all of us here at Tematica, we wish you, your family, friends and love a very happy Thanksgiving!

Now let’s get started…

Key points in this issue

  • Despite the recent market pain, I continue to see a number of holdings being extremely well positioned for the holiday season including Amazon, Costco Wholesale (COST), United Parcel Service (UPS), McCormick & Co. (MKC) and both businesses at International Flavors & Fragrances (IFF).
  • I’ll continue to heed our Thematic Signals and look for opportunities for when the stock market lands on solid footing.
  • Later this week, Disney’s (DIS) latest family-friendly move, Ralph Breaks the Internet, hits theaters and we’ll be checking the box office tallies come Monday.
  •  Taking a look at shares of Energous Corp. (WATT), a Disruptive Innovator contender

 

The stock market so far this week…

There is no way to sugar coat or tap dance around it – this week has been a difficult slug ahead of the Thanksgiving holiday as the pressures we’ve talked about over the last two months continue to plague the market as the impact has widened out. Oil prices have continued to plummet, pressuring energy stocks; housing data continues to disappoint, hitting homebuilding stocks; and we’ve received more new of iPhone production cuts as well as potential privacy regulation that has rippled through much of the tech sector. Retail woes were added to the pile following disappointing results from Target (TGT) and L Brands (LB) that pressured those shares and sent ripples across other retail shares.

The net effect of the last few weeks has wiped out the stock market’s 2018 gains with both the Dow Jones Industrial Average and the S&P 500 down roughly 1.0% as of last night’s market close. While the Nasdaq Composite Index is now flat for the year, the small-cap heavy Russell 2000 is firmly in the red, down 4.3% for all of 2018 as of last night.

The overall market moves in recent days have weighed on several constituents of the Thematic Leaders and the Select List, most notably Apple (AAPL), Amazon and Alphabet/Google (GOOGL). Despite that erasure, we are still nicely profitable those positions as well as AMN Healthcare (AMN), Costco Wholesale (COST), Disney (DIS), Alphabet (GOOGL), ETFMG Prime Cyber Security ETF (HACK), and several others. More defensive names, such as McCormick & Co. (MKC), and International Flavors & Fragrances (IFF) have outperformed on a relative basis of late, which we attribute to their respective business models and thematic tailwinds.

As I describe below, the coming days are filled with events that could continue the pain or lead to a reprieve. As that outcome becomes more clear, we’ll either stay on the sidelines collecting thematic signals for our existing positions or take advantage of the recent market pain to scoop up shares in thematically well-positioned companies at prices we haven’t seen in months.

 

What to watch the rest of this week

As we get ready for the Thanksgiving holiday, we know before too long the official kick-off to the holiday shopping race will being. Some retailers will be open late Thursday, while others will open their doors early Black Friday morning and keep them open all weekend long. As we get the tallies for the shopping weekend, the fun culminates with Cyber Monday, a day that is near and dear to our hearts given our Digital Lifestyle investing theme.

Given the market mood of late, as well as the disappointing results from Target and L Brands earlier this week, we can count on Wall Street picking through the shopping weekends results to determine how realistic recently issued holiday shopping forecasts. The National Retail Federation’s consumer survey is calling for a 4.1% increase year over year this holiday season, which they define as November and December. The NRF’s own forecast is looking for a more upbeat 4.3%-4.8% increase vs. 2017.

Consulting firm PwC has a more aggressive view — based on its own survey, consumers expect to spend $1,250 this holiday season on gifts, travel and entertainment, a 5% increase year over year. One of the differences in the wider array of what’s included in the survey versus the NRF. In that vein, Deloitte’s inclusion of January in its findings explains why its 2018 holiday shopping forecast tops out among the highest at a 5.0%-5.6% improvement year over year. That Deloitte forecast includes a 17%-22% increase in digital commerce this holiday shopping season compared to 2017, reaching $128-$134 billion in the process. That’s a sharp increase but some estimates call for Amazon (AMZN) to increase its sales during the period by at least 27%.

I continue to see a number of holdings being extremely well positioned for the holiday season including Amazon, Costco Wholesale (COST), United Parcel Service (UPS), McCormick & Co. (MKC) and both businesses at International Flavors & Fragrances (IFF).

Also this week, Disney’s (DIS) latest family-friendly move, Ralph Breaks the Internet, hits theaters and we’ll be checking the box office tallies come Monday.

 

What to watch next week

As mentioned above, next week will bring us the full tally of holiday shopping results and begin with Cyber Monday, which means more holiday shopping data will be had on Tuesday. As we march toward the end of November, we’ll have several of the usual end of the month pieces of economic data, including Personal Income & Spending as well as New Home Sales and Pending Home Sales for October. We’ll also get the second print for the September quarter GDP, and many will be looking to measure the degree of revision relative to the initial 3.5% print.

As they do that, they will likely be taking note of the forward vector for GDP expectations, which per The Wall Street Journal’s Economic Forecast Survey sees current quarter GDP at 2.6% with 2.5% in the first half of 2019 and 2.15% for the back half of 2019. Taking a somewhat longer view, that means the economy peaked in the June quarter with GDP at 4.2%, due in part to the lag effect associated with the 2018 tax reform, and has slowed since due to the slowing global economy, trade war,  strong dollar, and higher interest rates compared to several quarters ago. As tax reform anniversaries, that added boost to the corporate bottom lines will disappear and in the coming weeks, we expect investors will be asking more questions about the likelihood of the S&P 500 delivering 10% EPS growth in 2018 vs. 2017.

With that in mind, perhaps the two most critical things for investors next week will be the minutes to the Fed’s November meeting and the G20 Summit that will be held Nov. 30-Dec. 1. Inside the Fed minutes, we and other investors will be looking for comments on inflation and the speed of rate future rate hikes, which the market currently expects to be four in 2019. And yes, the December Fed policy meeting continues to look like a shoe-in for a rate hike. Per White House economic adviser Larry Kudlow, US-China trade is likely to come to a head at the summit. If the speech given by Vice President Pence at the Asia-Pacific Economic Cooperation summit – the United States “will not change course until China changes its ways” – we could see the current trade war continue. We’ll continue to expect the worst, and hope for the best on this front.

On the earnings front next week, there will be a number of reports worth noting including those from GameStop (GME), Salesforce (CRM), JM Smucker (SJM) and a number of retailers ranging from Dick’s Sporting Goods (DKS) and Tiffany & Co. (TIF) to PVH (PVH) and Abercrombie & Fitch (ANF). Those retailer results will likely include some comments on the holiday shopping weekend, and we can expect investors to match up comparables and forecasts to determine who will be wallet share winners this holiday season. Toward the end of next week, we’ll also hear from Palo Alto Networks (PAWN) and Splunk (SPLK), which should offer a solid update on the pace of cybersecurity spending.

 

Taking a look at shares of Energous Corp. (WATT)

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. This coming change fits very well inside our Disruptive Innovators investing theme.

Off to digging I went and turned up Energous Corp. (WATT) and its WattUp solution, which 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.”

If we connect the dots, it would seem that Energous very well could be that critical supplier that enables Apple’s wireless charging pads. Here’s the thing: We have yet to hear when Apple will begin shipping those devices, which also means we have no idea when a teardown of one will reveal Dialog-Energous solutions inside. Given that there was no mention of Apple’s wireless charging efforts at either its 2018 iPhone or iPad events, odds are this product has slipped into 2019. That would jibe with the timing laid out by Energous.

Based on three Wall Street analysts covering WATT shares, steep losses are expected to continue into 2019, which in my view suggests a ramp with any meaningful volume in the second half of the year. That’s a long way to go, and given the pounding taken by the Nasdaq of late, we’ll put WATT shares onto the Contender’s so we can keep them in our sights for several months from now.

 

 

Weekly Issue: The Changing Mood of the Market

Weekly Issue: The Changing Mood of the Market

Over the last several days, volatility in the stock market has been rampant with wide swings taking place. Part and parcel of this has been a mood change in the stock market as high-flying stocks, including a number of technology ones, have come under pressure as investors re-think their growth prospects. That continued yesterday as shares of iPhone maker Apple (AAPL) became the latest one to dip into bear market territory with last night’s close following renewed concerns over the company’s device shipments in the near-term. This, in turn, has led to a few downgrades by Wall Street analysts, that at least in my view, are being somewhat short-sighted as the company continues to morph its business into one that is more reliant on high margin services rather than just the iPhone.

The same can be said with Amazon (AMZN), which has seen its shares tumble despite there being no slowdown in the shift to digital commerce as evidenced by the October Retail Sales Report. That report showed Nonstore retail sales for the month climbing just shy of 3x as fast as overall retail sales year over year. That was certainly confirmed in the latest earnings reports this week from Macy’s (M) and Walmart (WMT).  All indications, as well as expectations, have this aspect of our Digital Lifestyle investing theme accelerating into the all-important holiday shopping season. And yes, this keeps me bullish on our shares of United Parcel Service (UPS)

Now here’s the tough part to swallow – while we and our thematic way of investing are likely to be right in the medium to long-term, the mood in the stock market tends to prevail in the short-term. And with several of the concerns I’ve talked about here as well as in Tematica Investing and on our podcast, Cocktail Investing, rearing their heads odds are the stock market will continue to be a volatile one in the very near-term. This will likely see the current expectation resetting continue, especially for the sector-based investor view of “technology” stocks. Talk about a multi-headed sector that is simply a mish-mash of things – I’ll stick to our thematic lens approach, thank you very much. That said, with “tech” being in the doghouse, I’m using the time to evaluate a number of companies for the currently open Disruptive Innovators slot in our Thematic Leaders. Some of the current contenders include cloud-focused companies Dropbox (DBX), Instructure (INST) and Okata (OKT) among others.

This week

What’s been driving the latest round of roller coaster like thrills in the stock market can be found in the intersection of the latest earnings reports, economic data, and political developments. From sector investing perspective, we continue to get mixed results as evidenced by this week’s earnings reports as JC Penney (JCP) lagged expectations while Walmart (WMT) and Macy’s (M) beat them. From a thematic one, however, we see the dichotomy in those results as strong confirmation in our Digital Lifestyle investing theme as both Macy’s and Walmart delivered strong digital shopping performance in those quarterly reports, while JC Penney continues to struggle with its brick & mortar business.

Our Living the Life investing theme was also the recipient of positive confirmation this week as high-end outerwear company Canada Goose (GOOS) simply smashed top and bottom line expectations. Similarly, profits at luxury car company Aston Martin (AML.L) soared as its sales volume doubled year over year in the September quarter.

 

Sticking with Del Frisco’s

And while the Living the Lifestyle Thematic Leader that is Del Frisco’s (DFRG) reported a sloppy quarter following the disposal of its Sullivan’s business, the company shared a vibrant outlook, including the plan to grow its revenue and EBITDA to at least $700 million and $100 million by, respectively, by 2020 from the September quarter run rates of $420 million and $74 million, respectively. The intent on average will be to roll out two to three Double Eagles, two to three Barcelona Wine Bars and six bartacos restaurants each year, which is a measured move over the coming years and one that could be scaled back quickly should the domestic economy begin to falter several quarters out.

Near-term, Del Frisco’s should benefit from a pick-up in activity quarter to date following the arrival in the third quarter of its new chief marketing officer. On the earnings conference call, management shared Double Eagle’s private dining is up almost 20% in the first few weeks of the quarter and bookings for the rest of the quarter are up more than 20% compared to last year at this time.

The company also confirmed one of the key aspects of our investment thesis, which centers on margin improvement due in part to beef deflation. As discussed on the earnings call, the company’s total cost of sales as a percentage of revenue for the quarter decreased by 60 basis points to 27.3% from 27.9% in the year-ago period due to margin improvements at Double Eagle, Barcelona, and bartaco. This improvement and the year-over-year jump in bookings certainly point to the expected holiday inflection point panning out, which is also the most seasonally profitable time of year for Double Eagle and Grille. Cost-reduction efforts put in place earlier this year at these two brands should lead to visible margin improvement versus year-ago levels as the holiday volumes take effect.

  • For now, we’ll keep our long-term price target of $14 for Del Frisco’s (DFRG) shares intact, revisiting as needed should the company’s rollouts begin to slip.

 

Several headwinds remain in place

Despite these positive signals and happenings, we have to remember there are several headwinds blowing on the overall stock market. These include Italy standing firm with its latest budget, which puts it at odds with the European Union; Brexit limping forward; inflationary readings in both the October Producer Price Index and Consumer Price Index that will more than likely keep the Fed’s rate hike path intact, a looming concern for consumer debt and high levels of corporate debt; and the pending trade talks between the US and China at a time when more data shows a cooling in the global economy.

On a positive note, the NFIB Small Business Index’s October reading continued the near-two year string of record highs with more small businesses than not citing a bullish attitude toward the economy and expanding their businesses. A note of caution here as most businesses tend to exude such sentiment at or near the economic peak – few see the looming the downside. The NFIB’s report once again called out the lack of skilled workers with 53% of those surveyed reporting few or no qualified applicants.

This signals potential wage pressures ahead, however, the sharp fall in oil prices, which follows the notion of the slowing global economy and rising inventory levels, is poised to give some relief to both businesses and consumers as we head into the holiday shopping season. Yes, average gas prices have fallen to $2.68 per gallon from $2.89 a month ago, but they are still up vs. $2.56 per gallon this time last year. When it comes to gas prices, most consumers think sequentially, which means they are recognizing the drop in recent weeks, which in their minds offers some relief.

Noticed, I said some relief – consumers still face high debt levels with larger servicing costs vs. the year-ago levels. And let’s be honest, a consumer with a 12-gallon gas tank in his or her car that fills up twice a week is saving all of $4.80 per week compared to this time last month. In today’s world, that’s about enough to buy one pizza with some toppings a month. In other words, it will take more pronounced declines in gas prices to make a meaningful difference for those investors that resonate with our Middle-Class Squeeze investing theme.

 

What to watch next week

In looking at the calendar for next week, we have the Thanksgiving holiday, which long-time subscribers know is one of my favorites. While the stock market is only closed for that holiday, we do have shortened trading hours next Friday – better known as Black Friday – and that will kick off the race for holiday shopping. That means we can expect the litany of headlines over initial holiday shopping sales over the post-holiday weekend as we ease into Cyber Monday. And yes, I will be paying close attention to those results given our positions in Amazon and UPS.

Before we get to share our thankfulness with family and friends, we will have a few economic reports to chew through including October Housing Starts, Durable Orders and Existing Home Sales. This week even Fed Chair Powell recognized the softening housing market as a headwind to the economy, and in my view that sets the stage for yet another lackluster housing report next week. Inside the Durable Orders report, we’ll be watching the all-important core capital goods line, a proxy for business investment. The stronger that number, the better the prospects for the current quarter, which tends to benefit from “use it or lose it” capital spending budgets.

On the earnings front next week, we will continue to hear from retailers, such as Best Buy (BBY), Kohl’s (KSS), Ross Stores (ROST) and TJX Companies (TJX). With regard to our own Costco Wholesale (COST) shares, we’ll be paying close attention to results from competitor BJ Wholesale (BJ). Outside of those retailers, I’ll be listening to what Nuance Communications (NUAN) has to say about the adoption of voice interfaces and digital assistants next week.