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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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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.

 

 

Apple’s negative pre-announcement serves as a reminder to the number of risks that have accumulated

Apple’s negative pre-announcement serves as a reminder to the number of risks that have accumulated

 

We are “breaking in” to share my thoughts with you on the implications of Apple’s (AAPL) downside December quarter earnings news last night. Quickly this is exactly of what I was concerned about in early December, but rather than take a victory lap, let’s discuss what it means and what we’re going to do. 

Last night we received a negative December quarter earnings preannouncement from Apple (AAPL), which is weighing on both AAPL shares as well as the overall market. It serves as a reminder to the number of risks that have accumulated during the December quarter – the slowing global economy, including here at home; the US-China trade war; Brexit and other geopolitical uncertainty in the eurozone; the strong dollar; shrinking liquidity and a Fed that looks to remain on its rate hike path while also unwinding its balance sheet. Lenore Hawkins and I talked about these at length on the Dec. 21 podcast, which you can listen to here.

In short, a growing list of worries that are fueling uncertainty in the market and in corporate boardrooms. When the outlook is less than clear, companies tend to issue conservative guidance which may conflict with Wall Street consensus expectations. In the past when that has happened, it’s led to a re-think in growth prospects for both the economy, corporate profits and earnings, the mother’s milk for stock prices.

These factors and what they are likely to mean when companies begin issuing their December quarter results and 2019 outlooks in the coming weeks, were one of the primary reasons we added the ProShares Short S&P 500 (SH) shares to our holdings in just under a month ago. While the market fell considerably during December, our SH shares rose 5% offering some respite from the market pain. As expectations get reset, and odds are they will, we will continue to focus on the thematic tailwinds and thematic signals that have been and will remain our North Star for the Thematic Leaders and the larger Select List.

 

What did Apple have to say?

In a letter to shareholders last night, Apple CEO Tim Cook shared that revenue for the quarter would come in near $84 billion for the quarter vs. the consensus estimate of $91.5 billion and $88.3 billion, primarily due to weaker than expected iPhone sales. In the letter, which can be read here, while Apple cited several known headwinds for the quarter that it baked into its forecast such as iPhone launch timing, the dollar, supply constraints, and growing global economic weakness, it fingered stronger than expected declines in the emerging markets and China in particular.

Per the letter, most of the “revenue shortfall to our guidance, and over 100 percent of our year-over-year worldwide revenue decline occurred in Greater China across iPhone, Mac, and iPad.”

Cook went on to acknowledge the slowing China economy, which we saw evidence of in yesterday’s December Markit data for China. Per that report,

“The Caixin China General Manufacturing PMI dipped to 49.7 in December, the first time since May 2017 that the reading has been below 50, the mark that separates expansion from contraction. The sub-index for new orders slid below the breakeven point of 50 for the first time since June 2016, reflecting decreasing demand in the manufacturing sector.”

In our view here at Tematica, that fall in orders likely means China’s economy will be starting off 2019 in contraction mode. This will weigh on corporate management teams as they formulate their formal guidance to be issued during the soon to be upon us December quarter earnings season.

Also, in his letter, Cook called out the “rising trade tensions with the United States”  and the impact on iPhone demand in particular.

In typical Apple fashion, it discussed the long-term opportunities, including those in China, and other positives, citing that Services, Mac, iPad, Wearables/Home/Accessories) combined to grow almost 19% year-over-year during the quarter with records being set in a number of other countries. While this along with the $130 billion in cash that Apple has on its balance sheet exiting the December quarter, bode well for the long-term as well as its burgeoning efforts in healthcare and streaming entertainment, Apple shares came under pressure last night and today.

 

Odds are there will more negative earnings report to come

In light of the widespread holding of Apple shares across investor portfolios, both institutional and individual, as well as its percentage in the major market indices, we’re in for some renewed market pressure. There is also the reality that Apple’s decision to call out the impact of U.S.-China trade will create a major ripple effect that will lead to investors’ renewed focus on the potential trade-related downside to many companies and on the negative effect of China’s slowing economy.

In recent months we’ve heard other companies ranging from General Motors (GM) to FedEx (FDX) express concerns over the trade impact, but Apple’s clearly calling out its impact will have reverberations on companies that serve markets tied to both the smartphone and China-related demand. Overnight we saw key smartphone suppliers ranging from Skyworks Solutions (SWKS) and Qorvo (QRVO) come under pressure, and the same can be said for luxury goods companies as well. We’d note that Skyworks and Qorvo are key customers for Select List resident AXT Inc (AXTI, which means if we follow the Apple revenue cut through the supply chain, it will land on AXT and its substrate business.

All of the issues discussed above more than likely mean Apple will not be the only company to issues conservative guidance. Buckle up, it’s going to be a volatile few weeks ahead.

 

Positives to watch for in the coming weeks and months

While the near-term earnings season will likely mean additional pain, there are drivers that could lift shares higher from current levels in the coming months. These include a trade deal with China that has boasts a headline win for the US, but more importantly contains positive progress on key issues such as R&D technology theft, cybercrimes and the like – in other words, some of the meaty issues. There is also the Federal Reserve and expected monetary policy path that currently calls for two rate hikes this year. If the Fed is data dependent, then it likely knows of the negative wealth effect to be had following the drop in the stock market over the last few months.

Per Moody’s economist Mark Zandi, if stocks remained where there were as of last night’s close, it would equate to a $6 trillion drop in household wealth over the last 12-15 months. Per Zani, that would trim roughly 0.5% to 2019 GDP – again if the stock market stayed at last night’s close for the coming weeks and months. As we’re seeing today, and given my comments about the upcoming earnings season, odds are that 2019 GDP cut will be somewhat larger. That would likely be an impetus for the Fed to “slow its roll” on interest rates or at least offer dovish comments when discussing the economy.

Complicating matters is the current government shutdown, which has both the Census Bureau and Bureau of Economic Analysis closed. Even though there will be some data to be had, such as tomorrow’s December 2018 Employment Report from the Labor Department, it means the usual steady flow of economic data will not be had until the government re-opens. No data makes it rather difficult to judge the speed of the economy from all of us, including the Fed.

Given all of the above, we’ll continue to keep our more defensive positions companies like McCormick & Co. (MKC), Costco Wholesale (COST), and the ProShares Short S&P 500 shares intact. We’ll continue to watch input costs and what they mean for corporate profits at the margin – case in point is Del Frisco’s (DFRG), which is benefitting from not only falling protein costs but has been approached by an activist investor that could put the company in play. With Apple, Dycom Industries (DY), and AXT, we will see 5G networks lit this year here in the US, which will soon be followed by other such networks across the globe in the coming years. Samsung, Lenovo/Motorola and others have announced 5G smartphones will be shipping by mid-2019, and we expect Apple to once again ride that tipping point in 2020. That along with its growing Services business and other efforts to increase the stickiness of iPhone (medical, health, streaming, payments services), keeps us long-term bulls on AAPL shares.

When not if but when, the stock market finds its footing, which likely won’t be until after the December quarter earnings season at the soonest, we will look to strategically scale into a number of positions for the Thematic Leaders and the Select List.

 

Weekly Issue December 17 2018

Weekly Issue December 17 2018

Key points inside this issue:

  • The Duke University/CFO Global Business Outlook survey surprises the market
  • Costco stumbles, but it is far from down and out
  • Thematic confirmation had in the November Retail Sales Report
  • Digging into Friday’s other economic reports
  • What to watch this week
  • Holiday Housekeeping

The Duke University/CFO Global Business Outlook survey surprises the market

What looked to be shaping up as a positive week for the stock market turned on its head Friday following renewed concerns over the pace of the global economy. As we’ve talked about recently, the vector and velocity of the latest economic reports suggest a slowing economy and that is fueling questions over the top and bottom-line growth prospects for 2019.

Tossing some logs on the that fire late last week was the new survey findings from the Duke University/CFO Global Business Outlook survey that showed almost half (48.6%) of US chief financial officers believe the United States will be in recession by the end of next year while 82% of CFOs surveyed believe that a recession will begin by the end of 2020. That’s quite different than the Wall Street consensus, which per The Wall Street Journal’s Economic Forecasting Survey sees the speed of the economy slowing from 3.5% in the September 2018 quarter to 2.5% in the current one to 2.4% in the first half of 2019 followed by 2.2% in the back half of the year.

This revelation has added to the list of concerns that I’ve been discussing of late and adds to the growing worries over EPS growth prospects in 2019.

 

Costco stumbles, but it is far from out

Last Thursday night, Costco Wholesale (COST), our Middle-Class Squeeze Thematic Leader, reported an EPS beat by $0.05 per share for the quarter, but revenue came in a tad short at up 10.3% year over year, or $34.3 billion vs. the expected $34.66 billion. Same-store sales for the quarter rose 8.8% (+7.5% ex-gasoline and currency), which is well above anything we’ve seen for the September-November period per Friday’s November Retail Sales report save for digital shopping (Non-store retailers) and gas station sales – more on that shortly.

Despite the positive EPS, COST shares fell 8.6% on Friday.

The issue with Costco was the margin profile as reported operating income was essentially flat year over year. When combined with the top line increase vs. the year-ago quarter it means the company’s operating margin hit 2.7% vs. 3.0% in the year-ago quarter, and 3.2% this past August quarter. Part of the issue was the jump up in pre-opening expenses for new warehouse locations which rose by 6% quarter over quarter. The real culprit was the step up in merchandising costs, which climbed 10.8% year over year for the November quarter vs. 5.4% year over year in the September quarter. Clearly, Costco is seeing the impact of not only higher prices but also the impact of tariffs associated with the U.S.-China trade war.

Despite that, the core basics at the company – foot traffic, renewal rates, and membership growth – continue to fire on all cylinders. That to me makes Costco one of the best-positioned retailers, and the fact that its e-commerce business continues to blossom is positive as well. In all of 2019, Costco looks to open 20-23 net new warehouses, which equates to an increase of 2.5%-3.0% year over year. This will likely drive pre-opening expenses higher in the coming months, but given the favorable metrics associated with each new location over the medium to longer-term, we’ll take it, especially if the economy slows more than expected. Odds are that will drive more consumers to Costco than not.

  • Our long-term price target on Costco Wholesale (COST) shares remains $250.

 

Thematic confirmation in the November Retail Sales Report

Looking over Friday’s November Retail Sales Report, core Retail Sales rose 4.0% year over year with strong performance as expected for Non-store Retailers (+10.8% year over year), Gasoline Stations (+8.2%) and Food Service & Drinking Places (+5.6%). To me, those first and third categories ring positive for our Digital Lifestyle and Living the Life investing themes. That means I see those as positive signs for our thematic and holiday shopping positioned companies, which includes the aforementioned Costco, but also Amazon (AMZN), United Parcel Service (UPS), McCormick & Co. (MKC), International Flavors & Fragrances (IFF) and Del Frisco’s Restaurant Group (DFRG).

Back to the November Retail Sales report, while the sequential overall retail comparisons came in either as expected or slightly better depending on the forecast one is looking at, what’s likely to catch the market’s attention is the sequential drop in year over year retail sales growth that was had in November. Again, year over year November retail sales growth rose 4.0%, which was down compared to the October year over year increase of 4.5%.

Given the growing amount of data that points to a slowing domestic economy, one that is driven meaningfully by the consumer, odds are market watchers will not love what they saw in those year over year comparisons. Add to it that a recent Gallup poll found that Americans plan to spend less on holiday gifts today than they expected back in October and less than they expected to spend in 2017. The $91 decline in expected spending since October is “one of the steeper mid-season declines, exceeded only by a $185 drop that occurred in 2008, as the Wall Street financial crisis was unfolding, and a $102 drop in 2009 during the 2007-2009 recession.”

Clearly, those latest data points weighed on the overall stock market last week, but those weren’t the only ones.

 

Digging into Friday’s other economic reports

The November Retail Sales report wasn’t the only set of key data that weighed on the market last Friday. The November Industrial Production Report showed a flat manufacturing economy following the modest dip in October. On the December Flash PMI reports, the U.S. hit a 19-month low for the month with softer new order growth, while “Lower oil-related costs contributed to the slowest rate of input price inflation since the start of the year.” Turning to the eurozone, its Composite Output PMI hit 51.3, down from 52.7 in November, and reached a four-year low. The Flash Manufacturing PMI data for Japan was better, as it rose to 52.4 for December up from 52.2 in November, but that is hardly what we would call a robust figure given the expansion/contraction line at the 50.0 level. While new orders activity improved in Japan, new export orders fell, signaling a change of direction, which supports the notion of a slowing global economy.

This data along with the back and forth on U.S.-China trade, Brexit developments, Italy budget concerns, protests in France, and the potential government shutdown have all raised investor uncertainty levels. We see this in the current “Extreme Fear” (9) reading on the CNN Business Fear & Greed Index, which is little changed over the last few weeks. We’ve seen this play out in the stock market as the number of stocks hitting new highs pales in comparison to hitting 52-week lows. As one likely suspects, we saw this play out in small cap stocks, which per the Russell 2000 last week, were once again the hardest hit of the major stock categories. Quarter to date, small cap stocks are down just under 17% quarter to date.

We saw a number of these concerns brewing as we exited September and entered the September- quarter earnings season. We have been careful in making additions to the Select List given what I’ve viewed as an environment that has been more skewed to risk than reward. Odds are that will continue to be the case between now and the end of the year, which means we will continue to be overly selective when it comes to deploying capital. For that reason, last week we added the ProShares Short S&P 500 ETF (SH) shares to our holdings to add some downside protection.

 

What to Watch This Week

Following last week’s rash of economic data, don’t ask me how or why but the Atlanta Fed saw fit to boost its GDP Now forecast for the current quarter to 3.0% from 2.4% last week. As subscribers know, I prefer the far more solid track record at the NY Fed and its Nowcast report, which now calls for the current quarter to be +2.4%, down from +2.44% last week. That’s in line with The Wall Street Journal’s Economic Forecasting Survey, but again that Duke poll is likely to be in the forefront of investor minds this week as more data is had. This includes several pieces of housing data — the November Housing Starts & Building Permits as well as November Existing Home Sales and the October NAHB Housing Market Index — as well as the November Durable Orders Report and November Personal Income & Spending data.

As I mentioned above, the number of economic numbers suggesting the global economy continues to slow are growing, which likely gives the Fed far more room to issue dovish comments after next week’s all but done December rate hike. In recent weeks as the Fed has once again signaled it will more than likely remain data dependent in 2019, we’ve seen a change in the futures market, which is now pricing in less than 20 basis points of rate hikes next year versus over 55 basis points just a few months ago. But we have to consider the reason behind this slower pace of rate hikes, which is the suggestion by recent data that the economy is far from overheating, which also adds to the core question we suspect investors and the market are asking: how fast/strong will EPS growth be in 2019?

As we prepare for Fed Chair Powell’s remarks, it’s not lost on me that we could very well see a “buy the rumor, sell the news” event following the FOMC meeting next week.

Heading down the final stretch of 2018, I’ll be looking at well-positioned companies relative to our investment themes that have been hard hit by the quarter to date move in the market. As of Friday’s market close, the S&P 500 was down X% quarter to date, while the tech-heavy Nasdaq Composite Index and the small-cap heavy Russell 2000 were down 14% and nearly 17%, respectively, on that basis. One of the criteria that I’ll be focusing on as I weed through this growing list of contenders is favorable EPS growth year over year relative to the S&P 500. And, yes, when I say that I do mean to “real” EPS growth due to rising profit margins and expanding dollar profits instead of those lifted largely by buyback activities.

With that in mind, I’ll be paying close attention to a number of key earnings reports coming at us next week. These include Nike (NKE), Carmax (KMX), ConAgra (CAG), General Mills (GIS), Micron (MU), FedEx (FDX) and Darden Restaurants (DRI). Inside these reports and company commentaries, I’ll be looking for data points that to confirm our investment themes, the question of inflation vs. deflation and where it may be, and a last-minute update from FedEx on digital commerce for this holiday shopping season that we are all in the thick of. Also, among those reports is Del Frisco’s competitor – The Capital Grill, which is owned by Darden. I’ll be paying extra close attention to that report and what it means for our DFRG shares.

 

Holiday Housekeeping!

And that brings us to our Housekeeping note, which is this – given the way the Christmas and New Year’s holidays fall this year, barring any unforeseen issues that will require our attention and immediate action, we here at Tematica will be in “get ready for 2019” mode. That means we’ll be using the quiet holiday time to review the Thematic Leaders as well as positions on the Select List to ensure we are well prepared for the coming months ahead.

As such, we’re likely to be back the week of January 7th, although I can’t rule out the urge to share some thoughts with you sooner. For example, if the Fed says something that rolls the stock market’s eyes later this week, I’ll be sure to weigh in and share my thoughts. The same goes for the Darden earnings report I mentioned above and what it may mean for our DFRG shares.

We will have a new podcast episode or two before then, and we will be sharing a number of Thematic Signals over the coming weeks – if only those confirming signs for our investment themes would take a break. I’m only kidding, but of course, I love how recognizable and relatable the themes are in and around our daily lives.

To you and your loved ones, Merry Christmas, Happy Holidays, and Happy New Year! See you 2019!!

 

 

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.

Looking past this week’s market relief rally

Looking past this week’s market relief rally

As expected, the last few days in the market have been a proverbial see-saw, which culminated in the sharp market rally following the mid-term elections. The outcome, which saw the Democrats gain ground in Washington, was largely expected. We’ll see in the coming weeks and months the degree of gridlock to be had in Washington and what it means for the economy, but we have to remember several other concerning items remain ahead of us. To jog memories, these include the next round of budget talks between Italy and EU, which should occur next week; continued rate hikes by the Fed as it looks to stave off inflation and get more tools back for the next eventual recession; and upcoming trade talks between the US-China.

While we like the mid-week, market rebound and what it did for the Thematic Leaders as well as positions on the Select List, the upcoming events outlined above suggest near-term caution is still warranted. Shares of McCormick & Co. (MKC) International Flavors & Fragrances (IFF) as well as Altria (MO), AMN Healthcare (AMN) and Costco Wholesale (COST) have been on a tear of late. Earlier this week, Costco reported its October same-store sales results, which once again confirmed this Middle-class Squeeze company is taking wallet share.

Yesterday, mobile infrastructure company Ericsson (ERIC) held its annual Capital Markets event at which it spoke in a bullish tone over 5G rollouts, so much so that it raised its 2020 targets. I see that along with other similar comments in the last few weeks as very positive for our positions in Digital Infrastructure leader Dycom (DY) and Disruptive Innovator Nokia Corp. (NOK) as well as AXT Inc. (AXTI) shares.

 

Axon’s – September quarter earnings and an upgrade

Over the last few weeks, share of Safety & Security Thematic Leader Axon Enterprises (AAXN) have come under considerable pressure, but on Tuesday night the company reported September quarter earnings of $0.20 per share, crushing the consensus view of $0.13 per share as both revenue and earnings before interest, taxes, depreciation, and amortization (EBITDA) soared. Axon then reiterated its full-year guidance which hinged on the continued adoption of its Axon camera and cloud-storage business. Year over year, the number of cloud seats booked by customers rose to 325,200 exiting September up from 187,400 twelve months earlier. The combination of the 25% pullback in the shares quarter to date and that upbeat outlook led JPMorgan Chase to upgrade the shares to Overweight from Neutral.

Yes, we are down with the shares, but as the market settles out I’ll look to add to the position and improve our cost basis along the way. I continue to expect Axon will eventually acquire rival Digital Ally (DGLY) and its $31 million market cap, removing the current legal overhang on the shares. Our price target remains $90.

 

Disney earnings on deck tonight

After tonight’s market close, Disney (DIS) will report its quarterly results, and while we are not expecting any surprises for the September quarter, it’s the comments surrounding the company’s streaming strategy and integration of the Fox assets that will be in focus. Expectations for the September quarter are EPS of $1.34 on revenue of $13.73 billion. Our position on Disney has been and continues to be that based on the success of its streaming services, investors will need to revisit how they value DIS shares as it goes direct to the consumer with a cash-flow friendly subscription business model. Our price target for DIS shares remains $125.

 

Del Frisco’s earnings to follow next week

Monday morning, Del Frisco’s Restaurant Group (DFRG) also postponed its quarterly earnings report from until Tuesday, Nov. 13, citing “additional time required to finalize the accounting and tax treatment of our acquisition of Barteca Restaurant Group, disposition of Sullivan’s Steakhouse, a secondary offering of common stock and debt syndication.”

Coincidence? Perhaps, but it raises questions over the bench strength of these companies as they reshape their business. If you’ve ever been in a negotiation, you know things can slip, but following GNC’s postponement, we are at heightened alert levels with Del Frisco’s. We knew this was going to be a sloppy earnings report and we clearly have confirmation; our only question is why didn’t the management team wait to announce its earnings date until it had dotted its Is and crossed its Ts on all of these items?

To some extent, I am expecting a somewhat messy report in light of the sale of its Sullivan’s business and its common stock offering early in the quarter that raised more than $90 million. In parsing the company’s report, I will be focusing on revenue growth for the ongoing business as well as its profit generation considering that earnings-per-share comparisons could be challenging if not complicated versus the year-ago quarter. Nonetheless, the reported quarterly results will be gauged at least initially against the consensus view, which heading into the weekend sat at a loss per share of $0.25 on revenue of $120 million. For the December quarter, one of the company’s seasonally strongest, Del Frisco’s is expected to guide to EPS near $0.23 on revenue of $144 million.

So far this earnings season we’ve heard how restaurant companies including Bloomin’ Brands Inc. (BLMN), Ruth’s Hospitality Group (RUTH), Del Taco Restaurants Inc. (TACO), Chipotle Mexican Grill Inc. (CMG) and more recently Wingstop Inc. (WING) are seeing their margins benefitting from food deflation. Along with a pickup in average check size owing to prior price increases, these companies have delivered margin improvement and expanding EPS. I expect the same from Del Frisco’s. When coupled with an expected uptick in holiday spending and consumer sentiment running at high levels, we remain bullish on DFRG shares heading into Monday’s earnings report. Our price target on DFRG shares remains $14.

 

What to Watch Next Week

On the economic front, we’ll get more inflation data in the form of the October CPI report next week, which follows tomorrow’s October PPI one. In both we hear at Tematica will be scrutinizing the year over year comparisons and given the growing number of companies issuing price increases we expect to see those reflected in these October as well as November inflation reports. If the figures come in hotter than expected, expect that to reignite Fed rate hike concerns. Also, next week, we have the October reports for Retail Sales and Industrial Production as well as the first look at November with the Empire Manufacturing and Philly Fed indices.

With the October Retail Sales report, we’ll be once again parsing it to compare against the October same-store sales reported yesterday by Costco Wholesale (COST), which were up 8.6% year over year (+6.6% core). Odds are we will once again have formal confirmation that Costco is taking consumer wallet share.

Compared to the more than 1,200 earnings reports we had this week, the 345 or so next week will be a proverbial walk in the park. there will be several key reports to watch including Home Depot (HD), Macy’s (M), JC Penney (JCP), Williams Sonoma (WSM), and WalMart (WMT). We’ll be matching their forecasts for the current quarter up against the 2018 holiday shopping forecasts from the National Retail Federation, Adobe (ADBE) and others that call for overall holiday shopping to rise 4.0%-5.5% with online shopping climbing more than 15% year over year. I continue to see that as very positive for our shares in Amazon (AMZN), Costco and United Parcel Service (UPS) as well as McCormick & Co. (MKC).

Perhaps the biggest wild card next week will be the Italian budget and as we near the end of this week, things are already getting heated on that front. Today, the Italian government said it is sticking with its plan to rapidly increase public spending despite the budget dispute with the European Union, and it has no intention of revising its plan by next week. As background, Italy is the third largest economy in the EU, and if a joint resolution is not reached we expect this to reignite talk of “Italeave,” which will stoke once again questions over the durability of the EU. Given its size compared to Greece, the Italian situation is one we will be watching closely in the coming days.

Weekly Issue: We aren’t out of the woods just yet

Weekly Issue: We aren’t out of the woods just yet

Key Points from this Issue:

  • We are downgrading Universal Display (OLED) shares from the Thematic Leaders to the Select List and cutting our price target to $125 from $150. In the coming days, we will name a new Thematic Leader for our Disruptive Innovators investing theme.
  • Given the widespread pain the market endured in October, Thematic Leaders Chipotle Mexican Grill (CMG), Del Frisco’s (DFRG), Axon Enterprises (AXXN), Alibaba (BABA) and Netflix (NFLX) were hit hard; however, the hardest hit was Amazon (AMZN).

 

This week we closed the books on the month of October, and what a month it was for the stock market. In today’s short-term focused society, some will focus on the rebound over the last few days in the major domestic stock market indices, but even those cannot hide the fact that October was one of the most challenging months for stocks in recent memory. In short, the month of October wiped out most the market’s year to date gains as investors digested both September quarter earnings and updated guidance that spurred a re-think in top and bottom line expectations.

All told, the Dow Jones Industrial Average fell 5.1% for the month, making it the best performer of the major market indices. By comparison, the S&P 500 fell 6.9% in October led by declines in eight of its ten subgroups. The technology-heavy Nasdaq Composite Index dropped 9.2% and the small-cap focused Russell 2000 plummeted 10.9%. That marked the Nasdaq’s steepest monthly drop since it posted a 10.8% fall in November 2008. The month’s move pulled the Russell 2000 into negative territory year to date while for the same time period both the Dow and S&P 500 closed last night up around 1.5%.

We are just over halfway through the September quarter earnings season, which means there are ample companies left to report and issue updated guidance. Candidly, those reports could push or pull the market either higher or continue the October pain. There are still ample risks in the market to be had as the current earnings season winds down. These include the mid-term elections; Italy’s next round of budget talks with Brussels; upcoming Trump-China trade talks, which have led to another round of tariff preparations; and Fed rate hikes vs. the slowing speed of the global economy.

Despite the very recent rebound in the stock market, CNN’s Fear & Greed Index remains at Extreme Fear (7) as I write this – little changed from last week. What this likely means is we are seeing a nervous rebound in the market, and it will likely some positive reinforcement to make the late October rebound stick. As we navigate that pathway to the end of the year, we will also be entering the 2018 holiday shopping season, which per the National Retail Federation’s annual consumer spending survey should rise more than 4% year over year.

This combination of upcoming events and sentiment likely means we aren’t out of the woods just yet even though we are seeing a reprieve from the majority of October. As is shared below, next week has even more companies reporting than this week as well as the midterm elections. The strategy of sitting on the sidelines until the calmer waters emerge as stock prices come to us is what we’ll be doing. At the right time, we’ll be adding to existing positions on the Thematic Leaders and Thematic Select List as well as introducing new ones.

Speaking of the Thematic Leaders and the Select List, as the mood shifts from Halloween to the year-end shopping season,  we have several companies including Amazon (AMZN), United Parcel Service (UPS), Costco Wholesale (COST), Del Frisco’s Restaurant Group (DFRG), McCormick & Co. (MKC) and Apple (AAPL) among others that should benefit from that uptick in holiday spending as well as our Digital Lifestyle, Living the Life and Middle-class Squeeze investing themes in the next few months.

 

UPDATES TO The Thematic Leaders and Select List

Given the widespread pain the market endured in October, we were not immune to it with the Thematic Leaders or companies on the Tematica Select List. Given the volatility, investor’s nerves it was a time of shoot first, ask questions later with the market – as expected – trading day to day based on the most recent news. I expect this to continue at least for the next few weeks.

The hardest hit was Amazon, which despite simply destroying September quarter expectations served up what can only be called a conservative forecast for the current quarter. For those that didn’t tune in to the company’s related earnings conference call, Amazon management flat out admitted that it was being conservative because it is too hard to call the second half of the quarter, which is when it does the bulk of its business during the frenetic holiday shopping season. I have long said that Amazon shares are one to hold not trade, and with the move to expand its private label product, move into the online pharmacy space as well as continued growth at Amazon Web Services, we will do just that. That conservative guidance also hit United Parcel Service (UPS) shares, but we see that as a rising tide this holiday season as digital shopping continues to take consumer wallet share this holiday shopping season.

Both Chipotle Mexican Grill (CMG), Del Frisco’s (DFRG), Axon Enterprises (AXXN), Alibaba (BABA) and Netflix (NFLX) have also been hit hard, and I’m waiting for the market to stabilize before scaling into these Thematic Leader positions. As we’ve moved through the current earnings season, comments from Bloomin’ Brands (BLMN), Del Taco (TACO), Wingstop (WING), Habit Restaurant (HABT) and others, including Chipotle, have all pointed to the benefit of food deflation. Chipotle’s Big Fix continues with progress had in the September quarter and more to be had in the coming ones. Del Frisco’s will soon report its quarterly results and it too should benefit from a consumer with high sentiment and lower food costs.

With Axon, the shares remain trapped in the legal volley with Digital Ally (DGLY), but as I pointed out when we added it to the Leaders, Axon continues to expand its safety business with law enforcement and at some point, I suspect it will simply acquire Digital Ally given its $30 million market cap. Turning to Alibaba (BABA) and Netflix (NFLX), both have been hit hard by the downdraft in technology stocks, with Alibaba also serving as a proxy for the current US-China trade war. In my opinion, there is no slowing down the shift to digital streaming that is driving Netflix’s business and its proprietary content strategy is paying off, especially outside the US where it is garnering subscriber growth at price points that are above last year’s levels. This is one we will add to as things settle down.

The same is true with Alibaba – there is no slowing down the shift to the Digital Lifestyle inside of China, and as Alibaba’s other business turn from operating losses to operating profits, I expect a repeat of what we saw with Amazon shares. For now, however, the shares are likely to trade sideways until we see signs of positive developments on trade talks. Again, let’s hang tight and make our move when the time is right.

 

Downgrading Universal Display shares to the Select List

Last night Thematic Leader Universal Display (OLED) reported rather disappointing September quarter results that fell well short of expectations and guided the current quarter below expectations given that the expected rebound in organic light emitting diode materials sales wasn’t ramping as expected despite a number of new smartphones using organic light emitting diode displays. On the earnings call, the company pointed out the strides being had with the technology in other markets, such as TV and automotive that we’ve been discussing these last few months but at least for the near-term the volume application has been smartphones. In short, with that ramp failing to live up to expectations for the seasonally strongest part of the year for smartphones, it speaks volumes about what is in store for OLED shares.

By the numbers, Universal now expected 2018 revenue in the range of $240-$250, which implies $63-$73 million for the December quarter vs. $77.5 million for the September quarter and $88.3 million in the year-ago one. To frame it another way, that new revenue forecast of $240-$250 million compares to the company’s prior one of $315- $325 million and translates into a meaningful fall off vs. 2017 revenues of $335.6 million. A clear sign that the expected upkeep is not happening as fast as was expected by the Universal management team. Also, too, the first half of the calendar year tends to be a quiet one for new smartphone models hitting shelves. And yes, there will be tech and consumer product industry events like CES, CEBIT, and others in 2019 that will showcase new smartphone models, but candidly we see these new models with organic light emitting diode displays as becoming a show-me story given their premium price points. Even with Apple (AAPL) and its September quarter earnings last night, its iPhone volumes were flat year over year at 46.9 million units falling short of the 48.0 million consensus forecast.

In my view, all of this means the best case scenario in the near-term is OLED shares will be dead money. Odds are once Wall Street computes the new revenue numbers and margin impact, EPS numbers for the next few quarters will be taken down and will hang on the shares like an anchor. Given our cost basis in the shares near $101, and where the shares are likely to open up tomorrow – after market trading indicates $95-$100, down from last night’s closing price of $129.65 – we have modest downside ahead. Not bad, but again, near-term the shares are likely range bound.

Given our long-term investing style and the prospects in markets outside of the smartphone, we’re inclined to remain long-term investors. That said, given the near-term headwinds, we are demoting Universal Display shares from the Thematic Leaders to the Select List. Based on revised expectations, we are cutting our price target from $150 to $125, fully recognizing the shares are likely to rangebound for the next 1-2 quarters.

  • We are downgrading Universal Display (OLED) shares from the Thematic Leaders to the Select List and cutting our price target to $125 from $150. In the coming days, we will name a new Thematic Leader for our Disruptive Innovators investing theme.

 

Clean Living signals abound

As we hang tight, I will continue to pour through the latest thematic signals that we see day in, day out throughout the year, but I’ll also be collecting ones from the sea of earnings reports around us.

If I had just read that it would prompt me to wonder what some of the recent signals have been. As you know we post them on the Tematica Research website but during the earnings season, they can get a tad overwhelming, which is why on this week’s Cocktail Investing podcast, Lenore Hawkins (Tematica’s Chief Macro Strategist) and I ran through a number of them. I encourage you to give it a listen.

Some of the signals that stood out of late center on our Clean Living investing theme. Not only did Coca-Cola (KO) chalk up its September quarter performance to its water and non-sugary beverage businesses, but this week PepsiCo (PEP) acquired plant-based nutrition bar maker Health Warrior as it continues to move into good for you products. Mondelez International (MDLZ), the company behind my personal fav Oreos as well as other cookies and snacks is launching SnackFutures, a forward-thinking innovation hub that will focus on well-being snacks and ingredients. Yep, it too is embracing our Clean Living investing theme.

Stepping outside of the food aspect of Clean Living, there has been much talk in recent months about the banning of plastic straws. Now MasterCard (MA) is looking to go one further with as it looks to develop an alternative for those plastic debit and credit cards. Some 6 billion are pushed into consumer’s hands each year. The issue is that thin, durable card is also packed with a fair amount of technology that enables transactions to occur and do so securely. A looming intersection of our Clean Living, Digital Infrastructure and Safety & Security themes to watch.

 

Turning to next week

During the week, the Atlanta Fed published its initial GDP forecast of 2.6% for the current quarter, which is essentially in line with the same forecast provided by the NY Fed’s Nowcast, and a sharp step down from the initial GDP print of 3.5% for the September quarter. Following the October Employment Report due later this week, where wage growth is likely to be more on investor minds that job gains as they contemplate the velocity of the Fed’s interest rate hikes, next week brings several additional pieces of October data. These include the October ISM Services reading and the October PPI figure. Inside the former, we’ll be assessing jobs data as well as pricing data, comparing it vs. the prior months for hints pointing to a pickup in inflation. That will set the stage for the October PPI and given the growing number of companies that have announced price increases odds are we will some hotter pricing data and that could refocus the investor spotlight back on the Fed.

Next week also brings the September JOLTS report as well as the September Consumer Credit report. Inside those data points, we expect more data on the continued mismatch between employer needs and available worker skills that is expected to spur more competitive wages.  As we examine the latest credit data, we will keep in mind that smaller banks reporting higher credit card delinquency rates while Discover Financial (DFS) and Capital One (COF) have shared they have started dialing back credit spending limits. That could put an extra layer of hurt on Middle-class Squeeze consumers this holiday season.

Also, next week, the Fed has its next FOMC meeting, and while it’s not expected to boost rates at that meeting, we can expect much investor attention to be focused on subsequent Fed head comments as well as the eventual publication of the meeting’s minutes in the coming weeks ahead of the December meeting.

On the earnings front, following this week’s more than 1,000 earnings reports next week bring another 1,100 plus reports. What this means is more than half of the S&P 500 group of companies will have issued September quarter results and shared their revised guidance. As these reports are had, we can expect consensus expectations for those companies to be refined for the balance of the year. Thus far, roughly 63% of the companies that have issued EPS guidance for the current quarter have issued negative guidance, but we have yet to see any meaningful negative revisions overall EPS expectations for the S&P 500.

Outside the economic data and corporate earnings flow next week, we also have US midterm elections. While we wait for the outcome, we would note if the Republicans maintain control of the House and Senate, it likely means a path of less resistance for President Trump’s agenda for the coming two years. Should the Democrats gain ground, which has historically been the case following a Republican presidential win, it could very well mean an even more contentious 24 months are to be had in Washington with more gridlock than not. Should that be the case, expectations for much of anything getting done in Washington in the medium-term are likely to fall.

Yes, next week will be another busy one that could challenge the recent market rebound. We’ll continue to ferret out signals for our thematic lens as we remain investors focused on the long-term opportunities to be had with thematic investing.

 

 

 

 

Weekly Issue: Among the Volatility, We See Several Thematic Confirming Data Points

Weekly Issue: Among the Volatility, We See Several Thematic Confirming Data Points

Key points inside this issue:

  • As expected, news of the day is the driver behind the stock market swings
  • Data points inside the September Retail Sales Report keep us thematically bullish on the shares of Amazon (AMZN), United Parcel Service (UPS) and Costco Wholesale. Our price targets remain $$2,250, $130 and $250, respectively.
  • We use the recent pullback to scale further into our Del Frisco’s Restaurant Group (DFRG) shares at better prices, our price target remains $14.
  • Netflix crushes subscriber growth in the September quarter; Our price target on Netflix (NFLX) shares remains $500.
  • September quarter earnings from Ericsson (ERIC) and Taiwan Semiconductor (TSM) paint a favorable picture from upcoming reports from Nokia (NOK) and AXT Inc. Our price targets on Nokia and AXT shares remain $8.50 and $11, respectively.
  • Walmart embraces our Digital Innovators investment theme
  • Programming note: Much commentary in this week’s issue centers on the September Retail Sales Report. On this week’s Cocktail Investing podcast, we do a deep dive on that report from a thematic perspective. 

 

As expected, news of the day is the driver behind the stock market swings

If there is one thing we can say about the domestic stock market over the last week, it remains volatile. While there are other words that one might use to describe the down, up, down move over the last week, but volatile is probably the most fitting. Last week I shared the market would likely trade based on the data of the day — economic, earnings or political — and that seems to have been the case. While we’ve received several solid earnings reports, including one from Thematic Leader Netflix (NFLX), several banks and even a few airlines, the headline economic data came up soft for September Retail Sales and Housing.

And then there was yesterday’s FOMC minutes from the Fed’s September monetary policy meeting, which showed that even though the Fed expects to remain on its tightening path, subject to the data to be had, several members of the committee see “a period where the Fed even will need to go beyond normalization of rates and into a more restrictive stance.”

Odds are we can expect further tweets from President Trump on this given his prior comments that the Fed is one of his greatest risks. I also expect this to reignite concerns for the current expansion, particularly since the Fed has historically done a good job hiking interest rates into a recession. From a thematic perspective, continued rate hikes by the Fed is likely to put some added pressure on Middle-Class Squeeze consumers. Before you freak out, let’s check the data. The economy is still growing, adding jobs, benefiting from lower taxes and regulation. It’s not about to fall off a cliff in the near term, but yes, the longer the current expansion goes, the greater the risk of something more than just a slower economy. More reasons to keep watching the monthly data.

Here’s the good news, inside that data and elsewhere we continue to receive confirming signals for our 10 investing themes as well as favorable data points for the Thematic Leaders and other positions on the Tematica Investing Select List.

 

Several positives in the September Retail Sales report for AMZN, UPS & COST

Cocktail Investing Podcast September Retail Sales Report

With the consumer directly or indirectly accounting for nearly two-thirds of the domestic economy and the average consumer spending 31% of his or her paycheck on retails goods, this monthly report is one worth monitoring closely.

Let’s take a closer look at this week’s September 2018 Retail Sales report. First, let’s talk about the headline miss that was making the rounds yesterday. Yes, the month over month comparison Total Retail & Food Services excluding motor vehicles & parts fell 0.1%, but Retail rose 0.4% on the same basis. The thing is, most tend to focus on those sequential comparisons, but as investors, we examine year over year comparisons when it comes to measuring revenue, profit and EPS growth. On that basis, Total Retail & Food Services rose 5.7% year over year while Retail climbed 4.4% compared to September 2017. That sounds pretty solid if you ask me. Now, let’s dig into the meat of the report and what it means for several of our thematic holdings.

Right off the bat, we can’t ignore the 11.4% year over year increase in gas station sales during September, which capped off a 17.2% increase for the September 2018 quarter. With such an increase owing to the rise in oil and gas prices, we would expect to see weakness in several of the retail sales categories as the cost of filling up the car saps spending at the margin and confirms our Middle-Class Squeeze investing theme. And we saw just that. Department stores once again fell in September vs. year ago levels as did Sporting goods, hobby, musical instrument, & bookstores. Given recent construction as well as housing starts data, the Building material & garden eq. & supplies dealer category posted slower year over year growth, which was hardly surprising.

Other than gas station sales, the other big gainer was Nonstore retailers – Census Bureau speak for e-tailers and digital commerce that are part of Digital Lifestyle investing theme,  which saw an 11.4% increase in September retail sales vs. year ago levels. That strong level clearly confirms our investment thesis that digital shopping continues to take consumer wallet share, which bodes well for our Amazon (AMZN), United Parcel Service (UPS), and to a lesser extent our Costco Wholesale (COST). With consumers feeling the pressure of our Middle-Class Squeeze investing theme, I continue to see them embracing the Digital Lifestyle to ferret out deals and bargains to stretch their after-tax spending dollars, especially as we head into the holiday shopping season.

Sticking with Costco, the company recently reported its U.S. same-store-sales grew 7.7% for September excluding fuel and currency. Further evidence that Costco also continues to gain consumer wallet share compared to retail and food sales establishments as well as the General Merchandise Store category.

  • Data points inside the September Retail Sales Report keep us thematically bullish on the shares of Amazon (AMZN), United Parcel Service (UPS) and Costco Wholesale. Our price targets remain $2,250, $130 and $250, respectively.

 

Scaling deeper into Del Frisco’s shares

Now let’s dig into the report as it relates to Del Frisco Restaurant Group, our Thematic Leader for the Living the Life investing theme. Per the Census Bureau, retail sales at food services & drinking places rose 7.1% year over year in September, which brought its year-over-year comparison for the September quarter to 8.8%. Clearly, consumers are spending more at restaurants, than eating at home. Paired with beef price deflation that has been confirmed by Darden Restaurants (DRI), this bodes well for profit growth at Del Frisco.

Against those data points, I’m using the blended 12.5% drop in DFRG shares since we added them to our holdings to improve our costs basis.

  • We are using the recent pullback to scale further into our Del Frisco’s Restaurant Group (DFRG) shares at better prices, our price target remains $14.

 

Netflix crushes subscriber growth in the September quarter

Tuesday night Netflix (NFLX) delivered a crushing blow to skeptics as it served up an EPS and net subscriber adds beat that blew away expectations and guided December quarter net subscriber adds above Wall Street’s forecast. This led NFLX shares to pop rather nicely, which was followed by a number of Wall Street firms reiterating their Buy ratings and price targets.

Were there some investors that were somewhat unhappy with the continued investment spend on content? Yes, and I suppose there always will be, but as we are seeing its that content that is driving subscriber growth and in order to drive net new adds outside the US, Netflix will continue to invest in content. As we saw in the company’s September quarter results, year to date international net subscriber adds is 276% ahead of those in the US. Not surprising, given the service’s launch in international markets over the last several quarters and corresponding content ramp for those markets.

Where the content spending becomes an issue is when its subscriber growth flatlines, which will likely to happen at some point, but for now, the company has more runway to go. I say that because the content spend so far in 2018 is lining its pipeline for 2019 and beyond. With its international paid customer base totaling 73.5 million users, viewed against the global non-US population, it has a way to go before it approaches the 45% penetration rate it has among US households.  This very much keeps Netflix as the Thematic Leader for our Digital Lifestyle investing theme.

One other thing, as part of this earnings report Netflix said it plans to move away from reporting how many subscribers had signed up for free trials during the quarter and focus on paid subscriber growth. I have to say I am in favor of this. It’s the paying subscribers that matter and will be the key to the stock until the day comes when Netflix embraces advertising revenue. I’m not saying it will, but that would be when “free” matters. For now, it’s all about subscriber growth, retention, and any new price increases.

That said, I am closely watching all the new streaming services that are coming to market. Two of the risks I see are a recreation of the cable TV experience and the creep higher in streaming bill totals that wipe out any cord-cutting savings. Longer-term I do see consolidation among this disparate services playing out repeating what we saw in the internet space following the dot.com bubble burst.

  • Our price target on Netflix (NFLX) shares remains $500.

 

What earnings from Ericsson and Taiwan Semiconductor mean for Nokia and AXT

This morning mobile infrastructure company Ericsson (ERIC) and Taiwan Semiconductor (TSM) did what they said was positive for our shares of Nokia (NOK) and AXT Inc. (AXTI).

In its earnings comments, Ericsson shared that mobile operators around the globe are preparing for 5G network launches as evidenced by the high level of field trials that are expected to last at such levels over the next 12-18 months. Ericsson also noted that North America continues to lead the way in terms of network launches, which confirms the rough timetable laid out by AT&T (T), Verizon (VZ) and even T-Mobile USA (TMUS) with China undergoing large 5G field trials as well. In sum, Ericsson described the 5G momentum as strong, which helped drive the company’s first quarter of organic growth since 3Q 2014. That’s an inflection point folks, especially since the rollout of these mobile technologies span years, not quarters.

Turning to Taiwan Semiconductor, the company delivered a top and bottom line beat relative to expectations. Its reported revenue rose just shy of 12% quarter over quarter (3.3% year over year) led by a 24% increase in Communication chip demand followed by a 6% increase in Industrial/Standard chips. In our view, this confirms the strong ramp associated with Apple’s (AAPL) new iPhone models as well as the number of other new smartphone models and connected devices slated to hit shelves in the back half of 2018. From a guidance perspective, TSM is forecasting December quarter revenue of $9.35-$9.45 billion is well below the consensus expectation of $9.8 billion, but before we rush to judgement, we need to understand how the company is accounting for currency vs. slowing demand. Given the seasonal March quarter slowdown for smartphone demand vs. the December quarter and the lead time for chips for those and other devices, we’d rather not rush to judgement until we have more pieces of data to round out the picture.

In sum, the above comments set up what should be positive September quarter earnings from Nokia and AXT in the coming days. Nokia will issue its quarterly results on Oct. 25, while AXT will do the same on Oct. 31. There will be other companies whose results as well as their revised guidance and reasons for those changes will be important signs posts for these two as well as our other holdings. As those data points hit, we’ll be sure to absorb that information and position ourselves accordingly.

  • September quarter earnings from Ericsson (ERIC) and Taiwan Semiconductor (TSM) paint a favorable picture from upcoming reports from Nokia (NOK) and AXT Inc. Our price targets on Nokia and AXT shares remain $8.50 and $11, respectively.

 

Walmart embraces our Digital Innovators investment theme

Yesterday Walmart (WMT) held its annual Investor Conference and while much was discussed, one of the things that jumped out to me was how the company is transforming  itself to operate in the “dynamic, omni-channel retail world of the future.” What the company is doing to reposition itself is embracing a number of aspects of our Disruptive Innovators investing theme, including artificial intelligence, robotics, inventory scanners, automated unloading in the store receiving dock, and digital price tags.

As it does this, Walmart is also making a number of nip and tuck acquisitions to improve its footing with consumers that span our Middle-Class Squeeze and in some instances our Living the Life investing theme as well our Digital Lifestyle one.  Recent acquisitions include lingerie company Bare Essentials and plus-sized clothing startup Eloquii. Other acquisitions over the last few quarters have been e-commerce platform Shoebuy, outdoor apparel retailer Moosejaw, women’s wear site Modcloth, direct-to-consumer premium menswear brand Bonobos, and last-mile delivery startup Parcel in September.

If you’re thinking that these moves sound very similar to ones that Amazon (AMZN) has made over the years, I would quickly agree. The question percolating in my brain is how does this technology spending stack up against expectations and did management boost its IT spending forecast for the coming year? As that answer becomes clear, I’ll have some decisions to make about WMT shares and if we should be buyers as we move into the holiday shopping season.