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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 Potential Impact Tariffs Will Have on 2nd Half Earnings

WEEKLY ISSUE: The Potential Impact Tariffs Will Have on 2nd Half Earnings

 

Given the way the Fourth of July holiday falls this year, we strongly suspect the back of the week will be quieter than usual. For those reasons, we’re coming at you earlier than usual this week. And while we have your attention, Tematica will be dark next week as we recharge our batteries ahead of the 2Q 2018 earnings onslaught that kicks off on July 16.

With the housekeeping stuff out of the way, let’s get to this week’s issue…

Closing the bookS on 1Q 2018

Last Friday, we closed the books on the second quarter, and while it’s true all four major US stock market indices delivered positive returns, the last three months were far more volatile than most expected back in January. Year to date, the Dow Jones Industrial Average remains modestly in the red and the S&P 500 modestly in the green. By comparison, despite being overshadowed in the second quarter by the small-cap heavy Russell 2000, the Nasdaq Composite Index finished the first half of the year with a 9% gain.

From a Tematica Investing Select List perspective, there we a number of outperformers to be had including Alphabet (GOOGL), Amazon (AMZN), Apple (AAPL), Costco Wholesale (COST), ETFMG Prime Cyber Security ETF (HACK), McCormick & Co. (MKC), USA Technologies (USAT). To paraphrase one of team Tematica’s favorite movies, Star Wards, our themes are strong with those companies. As much as we like the accolades to be had with performing positions, there are ones such as Dycom Industries (DY), Nokia (NOK), AXT Inc. (AXTI) and Applied Materials (AMAT) that had a challenging few months but they too should be seeing the benefits of thematic tailwinds in the coming months.

During the quarter, we did some fine tuning with the Select List, adding shares of GSV Capital (GSVC), Habit Restaurant (HABT) and Farmland Partners (FPI). We also shed our positions in Starbucks (SBUX), LSI Industries (LYTS), Corning (GLW) and International Flavors & Fragrances (IFF) during the second quarter. In making those moves, we’ve enhanced the Select List’s position for the back half of 2018 as the focus for investors centers on the impact of trade and tariffs on revenue and earnings. Let’s discuss…

 

First Harley Davidson, then BMW and General Motors

Last week we were reminded that trade wars and escalating tariffs increasingly are on the minds of investors. Something that at first was thought would be short-lived has grown into something far more pronounced and widespread, with tariffs potentially being exchanged among the U.S., China, the European Union, Mexico and Canada. As we discussed Harley-Davidson (HOG) shared that its motorcycle business will be whacked by President Trump’s decision to impose a new 25% tariff on steel imports from the EU and a 10% tariff on imported aluminum.

We soon heard from BMW (BMWG) that U.S. tariffs on imported cars could lead it to reduce investment and cut jobs in the United States due to the large number of cars it exports from its South Carolina plant. Soon thereafter, General Motors (GM) warned that if President Trump pushed ahead with another wave of tariffs, the move could backfire, leading to “less investment, fewer jobs and lower wages” for its employees. Then yesterday, citing a state-by-state analysis, the new campaign argues that Trump is risking a global trade war that will hit the wallets of U.S. consumers,  the U.S. Chamber of Commerce shared it would launch a campaign to oppose Trump’s trade tariff policies.

With up to $50 billion in additional tariffs being placed on Chinese goods after July 6, continued tariff retaliation by China and others could lead to a major reset of earnings expectations in the back half of 2018. And ahead of that potential phase-in date, Canada’s foreign minister announced plans to impose about $12.6 billion worth of retaliatory tariffs on U.S. goods beginning yesterday. Not all companies may swallow the tariffs the way Harley Davidson is choosing to, which likely means consumers and business will be paying higher prices in the coming months. That will show up in the inflation metrics, and most likely lead to the Fed being more aggressive on interest rate hikes than previously thought.

As part of our Middle-Class Squeeze investing theme, a growing number of consumers are already seeing their buying power erode, and if the gaming out of what could come it means more folks will be shopping with Amazon (AMZN) and Costco Wholesale (COST) and consumer McCormick & Co. (MKC) products.

 

Falling investor sentiment sets the stage for 2Q 2018 earnings

All of this, is weighing on the market mood and investor sentiment as we get ready for the 2Q 2018 earnings season. Remember that earlier this year, investors were expecting earnings to rise as the benefits of tax reform were thought to jumpstart the economy and if Harley Davidson is the canary in the coal mine, we are likely going to see those expectations reset lower. We could see management teams offer “everything and the kitchen sink” explanations should they rejigger their outlooks to factor in potential tariff implications, and their words are likely to be met with a “shoot first, ask questions later” mentality by investors.

Helping fan the flames of that investor mindset, the Citibank Economic Surprise Index (CESI) has dropped into negative territory. We’ve discussed this indicator before as has Tematica’s Chief Macro Strategist Lenore Hawkins, but as a quick reminder CESI tracks the rate that U.S. economic indicators come in better or worse than estimates over a rolling three-month period. When indicators are better than expected, the CESI is in positive territory and when indicators disappoint, it is negative.

As Lenore pointed out in last week’s Weekly Wrap:

While the CESI has just dropped into negative territory, let’s add some context and perspective — the index has had an impressive run of 188 trading days of positive readings, the longest such streak by 37 days in the 15-year history of the index. Now some of that reflects the enthusiasm surrounding tax reform and its economic prospects from the start of the year, but economic reality is now hitting those earlier expectations. Odds are the reality as seen through the trade and tariff glasses will continue to weigh on the CESI in the coming weeks, adding to investor anxiety.

I’d point out the level of anxiety hit Fear last week on the CNNMoney Fear & Greed Index, down from Neutral a month ago. But there is reason to think it will not rebound quite so quickly…

 

Here’s the question investors are pondering

The growing question in investors’ minds is likely to center on the potential impact in the second half of 2018 from these tariffs if they are enacted for something longer than a short period. While GDP expectations for the current quarter have climbed, the concern we have is the cost side of the equation for both companies and consumers, thanks in part to Harley-Davidson’s recent comments.

We have yet to see any meaningful change to the 2018 consensus earnings forecast for the S&P 500 this year, which currently sits around $160.85 per share, up roughly 12% year over year. But we will soon be entering second-quarter earnings season and could very well see results and comments lead to expectation changes that run the risk of weighing on the market. Given the upsizing of corporate buyback programs over the last few months due in part to tax reform, any potential pullback could be muted as companies scoop up shares and pave the way for further EPS growth as they shrink their share count. That means we’ll be increasingly focused on the internals of earnings reports as well as new order and backlog metrics.

There are roughly a handful of companies reporting this week, and next week sees a modest pick-up in reports, with roughly 25 companies issuing their latest quarterly results. It’s the week after, that sees the number of earnings reports mushroom to more than 220. We’ll enjoy the slower pace over the next two weeks as we get ready for that onslaught, but we will be paying close attention to comments on potential tariff impacts in the second half of 2018 and what that means for earnings expectations for both the market as well as companies on the Select List.

 

 

WEEKLY ISSUE: Trade and Tariffs, the Words of the Week

WEEKLY ISSUE: Trade and Tariffs, the Words of the Week

 

KEY POINTS FROM THIS WEEK’S ISSUE:

  • We are issuing a Sell on the shares of MGM Resorts (MGM) and removing them from the Tematica Investing Select List.
  • While the markets are reacting mainly in a “shoot first and ask questions later” nature, given the widening nature of the recent tariffs there are several safe havens that patient investors must consider.
  • We are recasting several of our Investment Themes to better reflect the changing winds.

 

Investor Reaction to All the Tariff Talk

Over the last two days, the domestic stock market has sold off some 16.7 points for the S&P 500, roughly 0.6%. That’s far less than the talking heads would suggest as they focus on the Dow Jones Industrial Average that has fallen more than 390 points since Friday’s close, roughly 1.6%. Those moves pushed the Dow into negative territory for 2018 and dragged the returns for the other major market indices lower. Those retreats in the major market indices are due to escalating tariff announcements, which are raising uncertainty in the markets and prompting investors to shoot first and ask questions later. We’ve seen this before, but we grant you the causing agent behind it this time is rather different.

What makes the current environment more challenging is not only the escalating and widening nature of the tariffs on more countries than just China, but also the impact they will have on supply chain part of the equation. So, the “pain” will be felt not just on the end product, but rather where a company sources its parts and components. That means the implications are wider spread than “just” steel and aluminum. One example is NXP Semiconductor (NXPI), whose chips are used in a variety of smartphone and other applications – the shares are down some 3.7% over the last two days.

With trade and tariffs being the words of the day, if not the week, we have seen investors bid up small-cap stocks, especially ones that are domestically focused. While the other major domestic stock market indices have fallen over the last few days, as we noted above, the small-cap, domestic-heavy Russell 2000 is actually up since last Friday’s close, rising roughly 8.5 points or 0.5% as of last night’s market close. Tracing that index back, as trade and tariff talk has grown over the last several weeks, it’s quietly become the best performing market index.

 

A Run-Down of the Select List Amid These Changing Trade Winds

On the Tematica Investing Select List, we have more than a few companies whose business models are heavily focused on the domestic market and should see some benefit from the added tailwinds the international trade and tariff talk is providing. These include:

  • Costco Wholesale (COST)
  • Dycom Industries (DY)
  • Habit Restaurants (HABT)
  • Farmland Partners (FPI)
  • LSI Industries (LYTS)
  • Paccar (PCAR)
  • United Parcel Services (UPS)

We’ve also seen our shares of McCormick & Co. (MKC) rise as the tariff back-and-forth has picked up. We attribute this to the inelastic nature of the McCormick’s products — people need to eat no matter what — and the company’s rising dividend policy, which helps make it a safe-haven port in a storm.

Based on the latest global economic data, it once again appears that the US is becoming the best market in the market. Based on the findings of the May NFIB Small Business Optimism Index, that looks to continue. Per the NFIB, that index increased in May to the second highest level in the NFIB survey’s 45-year history. Inside the report, the percentage of business owners reporting capital outlays rose to 62%, with 47% spending on new equipment, 24% acquiring vehicles, and 16% improving expanded facilities. Moreover, 30% plan capital outlays in the next few months, which also bodes well for our Rockwell Automation (ROK) shares.

Last night’s May reading for the American Trucking Association’s Truck Tonnage Index also supports this view. That May reading increased slightly from the previous month, but on a year over year basis, it was up 7.8%. A more robust figure for North American freight volumes was had with the May data for the Cass Freight Index, which reported an 11.9% year over year increase in shipments for the month. Given the report’s comment that “demand is exceeding capacity in most modes of transportation,” I’ll continue to keep shares of heavy and medium duty truck manufacturer Paccar (PCAR) on the select list.

The ones to watch

With all of that said, we do have several positions that we are closely monitoring amid the escalating trade and tariff landscape, including

  • Apple (AAPL),
  • Applied Materials (AMAT)
  • AXT Inc. (AXTI)
  • MGM Resorts (MGM)
  • Nokia (NOK)
  • Universal Display (OLED)

With Apple we have the growing services business and the eventual 5G upgrade cycle as well as the company’s capital return program that will help buoy the shares in the near-term. Reports that it will be spared from the tariffs are also helping. With Applied, China is looking to grow its in-country semi-cap capacity, which means semi- cap companies could see their businesses as a bargaining chip in the short-term. Longer- term, if China wants to grow that capacity it means an eventual pick up in business is likely in the cards. Other drivers such as 5G, Internet of Things, AR, VR, and more will spur incremental demand for chips as well. It’s pretty much a timing issue in our minds, and Applied’s increased dividend and buyback program will help shield the shares from the worst of it.

Both AXT and Nokia serve US-based companies, but also foreign ones, including ones in China given the global nature of smartphone component building blocks as well as mobile infrastructure equipment. Over the last few weeks, the case for 5G continues to strengthen, but if these tariffs go into effect and last, they could lead to a short-term disruption in their business models. Last week, Nokia announced a multi-year business services deal with Wipro (WIT) and alongside Nokia, Verizon (VZ) announced several 5G milestones with Verizon remaining committed to launching residential 5G in four markets during the back half of 2018. That follows the prior week’s news of a successful 5G test for Nokia with T-Mobile USA (TMUS) that paves the way for the commercial deployment of that network.

In those cases, I’ll continue to monitor the trade and tariff developments, and take action when are where necessary.

 

Pulling the plug on MGM shares

With MGM, however, I’m concerned about the potential impact to be had not only in Macau but also on China tourism to the US, which could hamper activity on the Las Vegas strip. While we’re down modestly in this Guilty Pleasure company, as the saying goes, better safe than sorry and that has us cutting MGM shares from the Select List.

  • We are issuing a Sell on the shares of MGM Resorts (MGM) and removing them from the Tematica Investing Select List

 

Sticking with the thematic program

On a somewhat positive note, as the market pulls back we will likely see well-positioned companies at better prices. Yes, we’ll have to navigate the tariffs and understand if and how a company may be impacted, but to us, it’s all part of identifying the right companies, with the right drivers at the right prices for the medium to long-term. That’s served us well thus far, and we’ll continue to follow the guiding light, our North Star, that is our thematic lens. It’s that lens that has led to returns like the following in the active Tematica Investing Select List.

  • Alphabet (GOOGL): 60%
  • Amazon (AMZN): 133%
  • Costco Wholesale (COST) : 30%
  • ETFMG Prime Cyber Security ETF (HACK): 34%
  • USA Technologies (USAT): 62%

Over the last several weeks, we’ve added several new positions – Farmland Partners (FPI), Dycom Industries (DY), Habit Restaurant (HABT) and AXT Inc. (AXTI) to the active select list as well as Universal Display (OLED) shares. As of last night’s, market close the first three are up nicely, but our OLED shares are once again under pressure amid rumor and speculation over the mix of upcoming iPhone models that will use organic light emitting diode displays. When I added the shares back to the Select List, it hinged not on the 2018 models but the ones for 2019. Let’s be patient and prepare to use incremental weakness to our long-term advantage.

 

Recasting Several of our investment themes

Inside Tematica, not only are we constantly examining data points as they relate to our investment themes we are also reviewing the investing themes that we have in place to make sure they are still relevant and relatable. As part of that exercise and when appropriate, we’ll also rename a theme.

Over the next several weeks, I’ll be sharing these repositions and renamings with you, and then providing a cheat sheet that will sum up all the changes. As I run through these I’ll also be calling out the best-positioned company as well as supplying some examples of the ones benefitting from the theme’s tailwinds and ones marching headlong into the headwinds.

First up, will be a recasting of our Rise & Fall of the Middle-Class theme.  As the current name suggests, there are two aspects of this theme — the “Rise” and the “Fall” part. It can be confusing to some, so we’re splitting it into two themes.  The “Rise” portion will be “The New Global Middle Class” and will reflect the rapidly expanding middle class markets particularly in Asia and South America. On the other hand, the “Fall” portion will be recast as “The Middle Class Squeeze” to reflect the shrinking middle class in the United States and the realities that poses to our consumer-driven economy.

We’ll have a detailed report to you in the coming days on the recasting of these two themes, how it impacts the current Select List as well as other companies we see as well-positioned given the tailwinds of each theme.

 

 

The Expanding Pain Point Fueling Safety and Security Investment Theme

The Expanding Pain Point Fueling Safety and Security Investment Theme

Over the last few weeks, we’ve been reminded of the dark side of our increasingly Connected Society, given cyber attacks and hacks at Equifax (EFX) and more recently Amazon’s (AMZN) Whole Foods and Sonic Corp. (SONC). Those are but a handful of examples in what is an expanding pain point that is fueling our Safety & Security investing theme and the ETFMG Prime Cyber Security ETF (HACK)* shares on the Tematica Investing Select List.

Unsurprisingly to us, there is yet another new report that not only paints a gloomier picture but also forecasts a continued ramp in cyber attacks. We see this as confirming our $35 price target on HACK shares over the coming quarters. New research by Gemalto showed that almost 2 billion data records around the world were lost or stolen by cyber attacks in the first half of 2017. Worse yet, the number of breaches is slated to rise further. Per the latest Gemalto breach level index report, there were 918 breaches during the first six months of 2017, and of those breaches, 500 had an unknown number of compromised records. Meanwhile, the top 22 breaches involved more than one million compromised records.

With new regulations such as the U.K. data protection bill, the European Union’s General Data Protection Regulation and Australia’s Privacy Amendment (Notifiable Data Breaches) Act set to come into force in the coming months and quarters, odds are we will see another step up in the number of reported security breaches. No wonder in its latest annual results, consulting firm Deloitte described cybersecurity as a “high growth area” for the firm.

A somewhat different view on this was had with FedEx’s (FDX) recent earnings report, in which it copped to the fact that cyberattack Petya cost the company around $300 million dollars. This should serve as a reminder the impact of a cyber attack can cost a company day to day, but it also has implications for its stock price when it misses earnings expectations.

We see all of the above as a reminder of the incremental spending to be had to fend and secure companies from prospective cyberattacks, a good thing for the companies contained inside the HACK ETF.

  • Our price target on Safety & Security investing position in the ETFMG Prime Cyber Security ETF (HACK) remains $35.

 

* One quick housekeeping item, there was a recent name change for HACK shares to ETFMG Prime Cyber Security ETF from PureFunds. The underlying strategy of the ETF and its focus on cybersecurity stocks remains intact.

May Data From ADP and Challenger Offer Confirmation for Several Tematica Select List Positions

May Data From ADP and Challenger Offer Confirmation for Several Tematica Select List Positions

This morning we received the Challenger Job Cuts Report as well as ADP’s view on May job creation for the private sector. While ADP’s take that 253,000 jobs were created during the month, a nice boost from April and more in line with 1Q 2017 levels, we were reminded that all is not peachy keen with Challenger’s May findings. That report showed just under 52,000 jobs were cut during the month, a large step up from 36,600 in April, with the bulk of the increase due unsurprisingly to retail and auto companies.

As Challenger noted in the report, nearly 40% of the May layoffs were due to Ford (F), but the balance was wide across the retail landscape with big cuts at Macy’s (M), The Limited, Sears (SHLD), JC Penney (JCP) and Lowe’s (LOW) as well as others like Hhgregg and Wet Seal that have announced bankruptcy. In total, retailers continued to announce the most job cuts this year with just under 56,000 for the first five months of 2017. With yesterday’s news that Michael Kors (KORS) will shut 100 full-price retail locations over the next two years, we continue to see more pain ahead at the mall and fewer retail jobs to be had.

Sticking with the Challenger report, one of the items that jumped out to us was the call out that,

“Grocery stores are no longer immune from online shopping. Meal delivery services and Amazon are competing with traditional grocers, and Amazon announced it is opening its first ever brick-and mortar store in Seattle. Amazon Go, which mixes online technology and the in-store experience, is something to keep an eye on since it may potentially change the grocery store shopping experience considerably, “

 

In our view, this means the creative destruction that has plagued print media and retail brought on by Amazon (AMZN) is set to disrupt yet another industry, and it’s one of the reasons we’ve opted out of both grocery and retail stocks. The likely question on subscriber minds is what does this mean for our Amplify Snack Brands (BETR) position? In our view, we see little threat to Amplify’s business; if anything we see it’s mix of shipments skewing more toward online over time. Not a bad thing from a cost perspective. We’d also note that United Natural Foods (UNFI) is a partner with Amazon as well.

  • Our price target on Amazon (AMZN) remains $1,100 and offers more than 10% upside from current levels.
  • Amplify Snack Brands (BETR) has an $11 price target and is a Buy at current levels.
  • Our target on United Natual Foods (UNFI) is $65, and the recent pullback over the last six weeks enhances the long-term upside to be had.

We’d also note comments from Chipotle Mexican Grill (CMG) that its recent cybersecurity attack hit most Chipotle restaurants allowing hackers to steal credit card information from customers. In a recent blog post, Chipotle copped to the fact the malware that it was hit with infected cash registers, capturing information stored on the magnetic strip on credit cards. Chipotle said that “track data” sometimes includes the cardholder’s name, card number, expiration date and internal verification code. We see this as another reminder of the down side of what we call both our increasingly connected society and the shift toward cashless consumption. It also serves as a reminder of the long-tail demand associated with cyber security, and a nice confirmation point for the position PureFunds ISE Cyber Security ETF (HACK) shares on the Tematica Select List.

  • Our price target on PureFunds ISE Cyber Security ETF (HACK) shares remains $35.