Menu
Weekly issue: Downside Protection Critical Amid These Uncertain Conditions

Weekly issue: Downside Protection Critical Amid These Uncertain Conditions

Key points inside this issue

  • Ahead of the Fed’s latest dot blot, 2019 GDP expectations move lower.
  • With uncertainties again on the rise, we reiterate our Buy rating on the ProShares Short S&P 500 ETF (SH) ahead of the upcoming March quarter earnings season.

 

Weakening GDP Expectations for the Remainder of 2019

Looking back over the last few weekly issues, it would be fair to say they were a little wordy. What can I say, between the economic data and earnings season, plus thematic data points, there was a lot to share over the last few weeks. Today, however, I’m going to cut to the point with my comments, largely because all investor eyes and ears are waiting to see and hear what Fed Chair Jerome Powell has to say about the speed of the US economy as they look for signs over what is coming next out of the Fed.

We’ve talked quite a bit about the slowing speed of the global economy, and even though there have been some individual bright spots across the aggregated hard and soft economic data from both government and third-party sources, the slowing speed is hard to ignore. Based on the published data, domestic GDP hit 3.1% last year, and as we’ve shared recently we’ve started to see the expectations for 2019 move lower in recent weeks. Per the March CNBC Fed Survey of 43 economists and Fed watcher findings, GDP for 2019 is now expected to clock in around 2.3% — not quite cut in half compared to 2018, but dramatically lower and significantly lower than folks were looking for in the back half of 2018.

When the Fed issues its post FOMC meeting statement today, the focus will more than likely not be on the interest rate decision – almost no one expects a hike. Instead, rapt attention will be paid to the Fed’s updated economic dot plot, which will reveal how it sees the US economy shaping up. Let’s remember that one unofficial aspect of the Fed’s job is to be a cheerleader for the economy, so it becomes a question of “if they are cutting their GDP forecast” how deep of a cut could we really see?

Culprits of the slowing economy and these cuts include aspects of our Middle-Class Squeeze investing theme as consumers in the US grapple with debt levels that have risen precipitously over the last several years. The consumer spending tailwind associated with our Living the Life investing theme appears to be slowing some given the rising debt levels of Chinese consumers. Governments have also run up debt in recent years as the current business cycle has grown longer in the tooth. And of course, there is the impact of currency as well as political and trade uncertainties, including the pushout of US-China trade talks to June.

 

Downside Protection is Key Under These Circumstances

In a little over 10 days, we will be exiting March, entering the second quarter and beginning the earnings season dance all over again. My concern is that given the above and the several unknowns therein, we are poised to see another earnings season during which aggregate expectations will be adjusted lower. Case in point, with the  US-China trade agreement timetable slipping and slipping, it becomes rather difficult for a company to factor any resolution into its guidance, especially when the terms of the agreement are unknown.

Despite all of the above, the domestic stock market has continued to chug higher, once again approaching overbought levels, even though 2019 EPS cuts for the S&P 500 have made the market even more expensive than it was as we exited 2018.

The potential poster child for this is FedEx (FDX), which saw its shares take a fall last night after the company cut its annual profit forecast for the second time in three months due to slowing global growth, rising costs from a 2016 acquisition in Europe and questions over its ability to withstand U.S.-China trade tensions and uncertainty over the U.K.’s exit from the European Union.

Not to go all Groundhog Day on you, but this looks increasingly like the situation we saw in December when I added the ProShares Short S&P 500 ETF (SH) to the Select List. If we didn’t have those shares to offer some downside protection for what lies ahead, I would be adding them today. If you don’t have any of those shares in your holdings, my advice would be to add some. Much like insurance, you may not know exactly when you’ll need it, but you’ll be happy to have it when something goes bad.

  • With uncertainties again on the rise, we reiterate our Buy rating on the ProShares Short S&P 500 ETF (SH) ahead of the upcoming March quarter earnings season.

 

 

Doubling Down on Digital Infrastructure Thematic Leader

Doubling Down on Digital Infrastructure Thematic Leader

Key point inside this issue

  • We are doubling down on Dycom (DY) shares on the Thematic Leader board and adjusting our price target to $80 from $100, which still offers significant upside from our new cost basis as the 5G and gigabit fiber buildout continues over the coming quarters.

We are coming at you earlier than usual this week in part to share my thoughts on all of the economic data we received late last week.

 

Last week’s data confirms the US economy is slowing

With two-thirds of the current quarter behind now in the books, the continued move higher in the markets has all the major indices up double-digits year to date, ranging from around 11.5-12.0%% for the Dow Jones Industrial Average and the S&P 500 to nearly 18% for the small-cap heavy Russell 2000. In recent weeks we have discussed my growing concerns that the market’s melt-up hinges primarily on U.S.-China trade deal prospects as earnings expectations for this year have been moving lower, dividend cuts have been growing and the global economy continues to slow. The U.S. continues to look like the best economic house on the block even though it, too, is slowing.

On Friday, a round of IHS Markit February PMI reports showed that three of the four global economic horsemen — Japan, China, and the eurozone — were in contraction territory for the month. New orders in Japan and China improved but fell in the eurozone, which likely means those economies will continue to slug it out in the near-term especially since export orders across all three regions fell month over month. December-quarter GDP was revealed to be 2.6% sequentially, which equates to a 3.1% improvement year over year but is down compared to the 3.5% GDP reading of the September quarter and 4.2% in the June one.  Slower growth to be sure, but still growing in the December quarter.

Before we break out the bubbly, though, the IHS Markit February U.S. Manufacturing PMI fell to its lowest reading in 18 months as rates of output and new order growth softened as did inflationary pressures. This data suggest the U.S. manufacturing sector is growing at its slowest rate in several quarters, as did the February ISM Manufacturing Index reading, which slipped month over month and missed expectations. Declines were seen almost across the board for that ISM index save for new export orders, which grew modestly month over month. The new order component of the February ISM Manufacturing Index dropped to 55.5 from 58.2 in January, but candidly this line item has been all over the place the last few months. The January figure rebounded nicely from 51.3 in December, which was down sharply from 61.8 in November. This zig-zag pattern likely reflects growing uncertainty in the manufacturing economy given the pace of the global economy and uncertainty on the trade front. Generally speaking though, falling orders translate into a slower production and this means carefully watching both the ISM and IHS Markit data over the coming months.

In sum, the manufacturing economy across the four key economies continued to slow in February. On a wider, more global scale, J.P. Morgan’s Global Manufacturing PMI fell to 50.6 in February, its lowest level since June 2016. Per J.P. Morgan’s findings, “the rate of expansion in new orders stayed close to the stagnation mark,” which suggests we are not likely to see a pronounced rebound in the near-term. We see this as allowing the Fed to keep its dovish view, and as we discuss below odds are it will be joined by the European Central Bank this week.

Other data out Friday included the December readings for Personal Income & Spending and the January take on Personal Income. The key takeaway was personal income fell for the first time in more than three years during January, easily coming in below the gains expected by economists. Those pieces of data not only help explain the recent December Retail Sales miss but alongside reports of consumer credit card debt topping $1 trillion and record delinquencies for auto and student loans, point to more tepid consumer spending ahead. As I’ve shared before, that is a headwind for the overall US economy but also a tailwind for those companies, like Middle-class Squeeze Thematic Leader Costco Wholesale (COST), that help consumers stretch the disposable income they do have.

We have talked quite a bit in recent Tematica Investing issues about revisions to S&P 500 2019 EPS estimates, which at last count stood at +4.7% year over year, down significantly from over +11% at the start of the December quarter. Given the rash of reports last week – more than 750 in total –  we will likely see that expected rate of growth tweaked a bit lower.

Putting it all together, we have a slowing U.S. and global economy, EPS cuts that are making the stock market incrementally more expensive as it has moved higher in recent weeks, and a growing number of dividend cuts. Clearly, the stock market has been melting up over the last several weeks on increasing hopes over a favorable trade deal with China, but last week we saw President Trump abruptly end the summit with North Korea’s Kim Jong Un with no joint agreement after Kim insisted all U.S. sanctions be lifted on his country. This action spooked the market, leading some to revisit the potential for a favorable trade deal between the U.S. and China.

Measuring the success of any trade agreement will hinge on the details. Should it fail to live up to expectations, which is a distinct possibility, we could very well see a “buy the rumor, sell the news” situation arise in the stock market. As I watch for these developments to unfold, given the mismatch in the stock market between earnings and dividends vs. the market’s move thus far in 2019 I will also be watching insider selling in general but also for those companies on the Thematic Leader Board as well as the Tematica Select List. While insiders can be sellers for a variety of reasons, should we see a pronounced and somewhat across the board pick up in such activity, it could be another warning sign.

 

What to Watch This Week

This week we will see a noticeable drop in the velocity of earnings reports, but we will still get a number of data points that investors and economists will use to triangulate the speed of the current quarter’s GDP relative to the 2.6% print for the December quarter. The consensus GDP forecast for the current quarter is for a slower economy at +2.0%, but we have started to see some economists trim their forecasts as more economic data rolls in. Because that data has fallen shy of expectations, it has led the Citibank Economic Surprise Index (CESI) to once again move into negative territory and the Atlanta Fed’s GDPNow current quarter forecast now sat at 0.3% as of Friday.

On the economic docket this week, we have December Construction Spending, ISM’s February Non-Manufacturing Index reading, the latest consumer credit figures and the February reports on job creation and unemployment from ADP (ADP) and the Bureau of Labor Statistics. With Home Depot (HD) reporting relatively mild December weather, any pronounced shortfall in December Construction Spending will likely serve to confirm the economy is on a slowing vector. Much like we did above with ISM’s February Manufacturing Index we’ll be looking into the Non-Manufacturing data to determine demand and inflation dynamics as well as the tone of the services economy.

On the jobs front, while we will be watching the numbers created, including any aberration owing to the recent federal government shutdown, it will be the wage and hours worked data that we’ll be focusing on. Wage data will show signs of any inflationary pressures, while hours worked will indicate how much labor slack there is in the economy. The consumer is in a tighter spot financially speaking, which was reflected in recent retail sales and personal spending data. Recognizing the role consumer spending plays in the overall speed of the U.S. economy, we will be scrutinizing the upcoming consumer credit data rather closely.

In addition to the hard data, we’ll also get the Fed’s latest Beige Book, which should provide a feel for how the regional economies are faring thus far in 2019. Speaking of central bankers, next Wednesday will bring the results of the next European Central Bank meeting. Given the data depicted in the February IHS Markit reports we discussed above, the probability is high the ECB will join the Fed in a more dovish tone.

While the velocity of earnings reports does indeed drop dramatically next week, there will still be several reports worth digging into, including Ross Stores (ROST), Kohl’s (KSS), Target (TGT), BJ’s Wholesale (BJ), and Middle-class Squeeze Thematic Leader Costco Wholesale (COST) will also issue their latest quarterly results. Those reports combined with the ones this week, including solid results from TJX Companies (TJX) last week should offer a more complete look at consumer spending, and where that spending is occurring. Given the discussion several paragraphs above, TJX’s results last week, and the monthly sales reports from Costco, odds are quite good that Costco should serve up yet another report showcasing consumer wallet share gains.

Outside of apparel and home, reports from United Natural Foods (UNFI) and National Beverage (FIZZ) should corroborate the accelerating shift toward food and beverages that are part of our Cleaner Living investing theme. In that vein, I’ll be intrigued to see what Tematica Select List resident International Flavors & Fragrances (IFF) has to say about the demand for its line of organic and natural solutions.

The same can be said with Kroger (KR) as well as its efforts to fend off Thematic King Amazon (AMZN) and Walmart (WMT). Tucked inside of Kroger’s comments, we will be curious to see what the company says about digital grocery shopping and delivery. On Kroger’s last earnings conference call, Chairman and CEO Rodney McMullen shared the following, “We are aggressively investing to build digital platforms because they give our customers the ability to have anything, anytime, anywhere from Kroger, and because they’re a catalyst to grow our business and improve margins in the future.” Now to see what progress has been achieved over the last 90 or so days and what Kroger has to say about the late-Friday report that Amazon will launch its own chain of supermarkets.

 

Tematica Investing

As you can see in the chart above, for the most part, our Thematic Leaders have been delivering solid performance. Shares of Costco Wholesale (COST) and Nokia (NOK) are notable laggards, but with Costco’s earnings report later this week which will also include its February same-store sales, I see the company’s business and the shares once again coming back into investor favor as it continues to win consumer wallet share. That was clearly evident in its December and January same-store sales reports. With Nokia, coming out of Mobile World Congress 2019 last week, we have confirmation that 5G is progressing, with more network launches coming and more devices coming as well in the coming quarters. We’ll continue to be patient with NOK shares.

 

Adding significantly to our position in Thematic Leader Dycom Industries

There are two positions on the leader board – Aging of the Population AMN Healthcare (AMN) and Digital Infrastructure Dycom Industries (DY) – that are in the red. The recent and sharp drop in Dycom shares follows the company’s disappointing quarterly report in which costs grew faster than 14.3% year over year increase in revenue, pressuring margins and the company’s bottom line. As we’ve come to expect this alongside the near-term continuation of those margin pressures, as you can see below, simply whacked DY shares last week, dropping them into oversold territory.

 

When we first discussed Dycom’s business, I pointed out the seasonal tendencies of its business, and that likely means some of the February winter weather brought some added disruptions as will the winter weather that is hitting parts of the country as you read this. Yet, we know that Dycom’s top customers – AT&T (T), Verizon (VZ), Comcast (CMCSA) and CenturyLink (CTL) are busy expanding the footprint of their connective networks. That’s especially true with the 5G buildout efforts at AT&T and Verizon, which on a combined basis accounted for 42% of Dycom’s January quarter revenue.

Above I shared that coming out of Mobile World Congress 2019, commercial 5G deployments are likely to be a 2020 event but as we know the networks, base stations, and backhaul capabilities will need to be installed ahead of those launches. To me, this strongly suggests that Dycom’s business will improve in the coming quarters, and as that happens, it’s bound to move down the cost curve as efficiencies and other aspects of higher utilization are had. For that reason, we are using last week’s 26% drop in DY shares to double our position size in DY shares on the Thematic Leader board. This will reduce our blended cost basis to roughly $64 from the prior $82. As we buy up the shares, I’m also resetting our price target on DY shares to $80, down from the prior $100, which offers significant upside from the current share price and our blended cost basis.

If you’re having second thoughts on this decision, think of it this way – doesn’t it seem rather strange that DY shares would fall by such a degree given the coming buildout that we know is going to occur over the coming quarters? If Dycom’s customers were some small, regional operators I would have some concerns, but that isn’t the case. These customers will build out those networks, and it means Dycom will be put to work in the coming quarters, generating revenue, profits, and cash flow along the way.

In last week’s Tematica Investing I dished on Warren Buffett’s latest letter to Berkshire Hathaway (BRK.A) shareholders. In thinking about Dycom, another Buffett-ism comes to mind – “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” Since this is a multi-quarter buildout for Dycom, we will need to be patient, but as we know for the famous encounter between the tortoise and the hare, slow and steady wins the race.

  • We are doubling down on Dycom (DY) shares on the Thematic Leader board and adjusting our price target to $80 from $100, which still offers significant upside from our new cost basis as the 5G and gigabit fiber buildout continues over the coming quarters.

 

As the pace of earnings slows, over the next few weeks I’ll not only be revisiting the recent 25% drop in Aging of the Population Thematic Leader AMN Healthcare to determine if we should make a similar move like the one we are doing with Dycom, but I’ll also be taking closer looks at wireless charging company Energous Corp. (WATT) and The Alkaline Water Company (WTER). Those two respectively fall under our Disruptive Innovators and Cleaner Living investing themes. Are they worthy of making it onto the Select List or bumping one of our Thematic Leaders? We’ll see…. And as I examine these two, I’m also pouring over some candidates to fill the Guilty Pleasure vacancy on the leader board.

 

 

Weekly Issue: Factors making the stock market melt up a head-scratcher

Weekly Issue: Factors making the stock market melt up a head-scratcher

Key points inside this issue

  • Our long-term price target on Disruptive Innovator leader Nokia (NOK) shares remains $8.50.
  • We will continue to be long-term shareholders with Disruptive Innovator Select List resident Universal Display (OLED). Given the improving outlooks, our near-term price target for OLED shares is getting lifted to $150 from $125, and I will revisit that target as we move through the balance of 2019.

 

Reading the latest from the Oracle of Omaha

Over the weekend, the Oracle of Omaha, Warren Buffett, released his annual letter to shareholders of Berkshire Hathaway (BRK.A). This letter has become a must-read among institutional and individual investors alike because it not only reveals changes in Berkshire’s top investment portfolio positions, but it also has contained ample comments on the economy and markets as well as an investing lesson or two.

Out of the gate, we learned that once again Team Buffett outperformed the major stock market indices in 2018. As Buffett got underway, he casually reminded readers to be buyers of “ably managed businesses, in whole or part, that possess favorable and durable economic characteristics” and to do so at sensible prices. While it may seem somewhat self-serving this sounds very much like our thematic investing strategy that looks to identify companies benefitting from structural economic, demographic, psychographic and technological changes at prices that offer commanding upside vs. potential downside.

In the past, Buffett has commented that stocks are akin to pieces of paper and it’s the businesses behind them that are the drivers of revenue and profits. It’s an idea we are very much in tune with as we view ourselves as buyers of thematically well-positioned business first, their shares second. No matter how attractive a stock’s price may be, if its business is troubled or facing thematic headwinds, it can be a tough pill to swallow.

As Buffett later noted, “On occasion, a ridiculously high purchase price for a given stock will cause a splendid business to become a poor investment — if not permanently, at least for a painfully long period.” I certainly agree with that statement because buying a stock at the wrong price can make for a painful experience. There are times, to be patient, but there are also times when the thesis behind owning a stock changes. In those times, it makes far more sense to cut bait in favor of better-positioned companies.

Buffett then shared that “prices are sky-high for businesses possessing decent long- term prospects,” which is something we’ve commented on several times in recent weeks as the stock market continued to melt up even as earnings expectations for the near term have moved lower. We’ll continue to take the advice of Buffett and focus on “calculating whether a portion of an attractive business is worth more than its market price,” for much like Buffett and his team work for Berkshire shareholders, Tematica and I work for you, our subscribers.

Mixed in among the rest of the letter are some on Buffett’s investing history, which is always an informative read, and a quick mention that “At Berkshire, we hope to invest significant sums across borders” and that it continues to “hope for an elephant-sized acquisition.” While I can’t speak to any acquisition, especially after the debacle that is now recognized as Kraft Heinz (KHC), the focus on investing across borders potentially speaks to our New Global Middle-class and Living the Life investing themes. Given Buffett’s style, I suspect Team Buffett is more likely to tap into the rising middle-class over luxury and travel.

Several times Buffett touched on his age, 88 years, as well as that of its key partner Charlie Munger, who is 95. There was no meaningful revelation on how they plan to transition the management team, but odds are that will be a topic of conversation, as will Kraft Heinz Co. (KHC) at the annual shareholder meeting that is scheduled for Saturday, May 4. More details on that can be found at the bottom of the 2018 shareholder letter.

If I had to describe the overall letter, it was a very solid one, but candidly not one of the more memorable ones. Perhaps that reflects 2018 as a whole, a year in which all major market indices fell into the red during the last quarter of the year, and a current environment that is characterized by slowing global growth.

 

More signs that the domestic economy is a-slowin’

In recent issues of Tematica Investing and in the recent Context & Perspectives pieces penned by Tematica’s Chief Macro Strategist Lenore Hawkins, we’ve shared how even though the U.S. economy looks like the best one on the global block, it is showing signs of slowing. We had further confirmation of that in the recent December Retail Sales Report as well as the January Industrial Production data that showed a drop in manufacturing activity. The December Durable Orders report that showed orders for non-defense capital goods excluding aircraft dropped 0.7% added further confirmation. Moreover, the report showed a downward November revision for the category to a fall of 1.0% vs. the prior 0.6% decline.

Much the way we focus on the order data inside the monthly ISM and IHS Markit PMI reports, the order data contained inside the monthly Durable Orders report gives us a sense of what is likely to come in near-term. These declining orders combined with the January declines in Industrial Production suggest slack is growing in the manufacturing economy, which means orders for new production equipment are likely to remain soft in the near-term. 

This past Monday we received another set of data that point to a slowing U.S. economy. We learned the Chicago Fed National Activity Index (CFNAI) fell to -0.43 in January from +0.05 in December. This index tracks 85 indicators; we’d note that in January, 35 of those indicators made positive contributions to the index, but that 50 made negative contributions, which produced the month-over-month decline.

Before we get all nervous over that negative January reading for the CFNAI, periods of economic expansion have been associated with index values above -0.70, which means the economy continued to expand in January, just at a much slower pace compared to December. Should the CFNAI reading fall below -0.70 in February or another coming month, it would signal a contraction in the domestic economy.

In response, Buffett likely would say that he and the team will continue to manage the portfolio for the long term, and that’s very much in sync with our thematic investing time frame.

 

Watch those dividends… for increases and for cuts!

Ahead of Buffett’s shareholder letter, shares of Kraft Heinz (KHC) tumbled in a  pronounced manner following several announcements, one of which included the 35% cut in its quarterly dividend to $0.40 per share from $0.625 per share. That’s a huge disappointment given the commonplace expectation that a company is expected to pay its dividend in perpetuity. It can increase its dividend or from time to time declare a special dividend, but as we’ve seen time and time again, the cutting of a company’s dividend is a disaster its stock price. We’ve seen this when General Motors (GM) and General Electric (GE) cut their respective dividends and again last week when Kraft made a similar announcement.

Those three are rather high profile and well-owned stocks, but they aren’t the only ones that have cut quarterly dividend payments to their shareholders. In December, L Brands (LB), the company behind Victoria’s Secret and Bath & Body Works, clipped its annual dividend by 50% to $1.20 per share from $2.40 per share and its shares dropped from $35 to $24 before rebounding modestly. On the company’s fourth-quarter earnings conference call, management of Century Link (CTL)  disclosed it would be cutting the telecom service provider’s annual dividend from $2.16 to $1.00 per share. Earlier this month, postal meter and office equipment company Pitney Bowes (PBI) declared a quarterly dividend of $0.05 per share, more than 73% fall from the prior dividend of $0.1875 per share. Other dividend cuts in recent weeks were had at Owens & Minor (OMI), Manning & Napier (MN), Unique Fabricating (UFAB), County Bancorp (ICBK), and Fresh Del Monte (FDP).

What the majority of these dividend cuts have in common is a challenged business, and in some cases like that for Pitney Bowes, the management team and Board have opted to carve out a new path for its capital allocation policy. For Pitney, it means shifting the mix to favor its share buyback program over dividends given the additional $100 million authorization that was announced which upsized its program to $121 million.

As I see it, there are several lessons to be had from these dividends:

One, outsized dividend yields as was the case back in September with L Brands can signal an opportunity for dividend income-seeking investors, but it can also represent a warning sign as investors exit shares in businesses that look to have operating and/or cash flow pressures.

This means that Two, we as investors always need to do the homework to determine what the prospects for the company’s business. As we discussed above, Buffett’s latest shareholder letter reminds investors to be buyers of “ably-managed businesses, in whole or part, that possess favorable and durable economic characteristics” and to do so at sensible prices. Through our thematic lens, it’s no surprise that L Brands and Pitney Bowes are hitting the headwinds of our Digital Lifestyle investing theme, while Kraft Heinz is in the grips of the consumer shift to Cleaner Living. Perhaps Kraft should have focused on something other than cost cuts to grow its bottom line.

Third, investors make mistakes and as we saw with the plummet in the share price at Kraft Heinz, it can happen to Buffett as well. There’s no shame in making a mistake, so long as we can learn from it.

Fourth and perhaps most important, while some may look at the growing number of dividend cuts on a company by company basis, if we look at them in aggregate the pace is greater than the number of such cuts, we saw in all of 2018. While we try not to overly excited one way or another, the pace of dividend cuts is likely to spur questions over the economy and where we are in the business cycle.

 

Putting it all together

As we move into March, more than 90% of the S&P 500 group of companies will have reported their quarterly results. As those results have been increasingly tallied over the last few weeks, we’ve seen EPS expectations move lower for the coming quarters and as of Friday’ stock market close the consensus view is 2019 EPS growth for the S&P 500 will be around 4.7%. That is significantly lower than the more than 11% EPS growth that was forecasted back at the start of the December quarter.

For those keeping score, the consensus for the current quarter points to a 2% growth rate. However, we’re starting to see more analysts cut their outlooks as more figures are reported. For example, JPMorgan (JPM) now sees the current quarter clocking in at 1.5% due to slower business investment spending. For now, JP sees a pick-up in the June quarter to a 2.25% forecast. But in our view, this will hinge on what we see in the coming order data.

Putting it all together, we have a slowing economy, EPS cuts that are making the stock market incrementally more expensive as has moved higher over the last 9 weeks, marking one of the best runs it has had in more than 20 years, and a growing number of dividend cuts. Sounds like a disconnect in the making to me.

Clearly, the stock market has been melting up over the last several weeks on increasing hopes over a favorable trade deal with China, but as I’ve been saying for some time, 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.

We will continue to tread carefully in the near-term, especially given the likelihood that following the disappointing December Retail Sales report and consumer-facing data, retailers are likely to deliver underwhelming quarterly results. Despite favorable weather in December, we saw that yesterday with Home Depot (HD),  and historically it’s been a pretty good yardstick for the consumer. In all likelihood as the remaining 10% of the S&P 500 companies report, we’re going to see further negative revisions to that current 4.7% EPS growth rate for this year I talked about.

 

Tematica Investing

A few paragraphs above, I touched on the strength of the stock market thus far in 2019, and even though concerns are mounting, we have seen pronounced moves higher in a number of the Thematic Leaders as you can see in the chart below. We’ll continue to monitor the changing landscapes and what they may bring. For example, in the coming weeks both Apple and Disney (DIS) are expected to unveil their respective streaming services, and I’ll be listening closely for to determine what this means for Digital Lifestyle leader Netflix (NFLX).

Nokia and Mobile World Congress 2019

We are two days into Mobile World Congress 2019, arguably THE mobile industry event of the year and one to watch for our Digital Lifestyle, Digital Infrastructure, and Disruptive Innovator themes. Thus far, we’ve received a number of different device and network announcements from the event.

On the device side, more 5G capable handsets have been announced as well as a number of foldable smartphones that appear to be a hybrid between a large format smartphone and a tablet. Those foldable smartphones are sporting some hefty price tags as evidenced by the $2,600 one for Huawei’s model. Interesting, but given the size of the device as well as the price point, one has to question if this is a commercially viable product or simply a concept one. Given the pushback that we are seeing with big-ticket smartphones that is resulting in consumers not upgrading their smartphones as quickly as they have in the past, odds are some of these device announcements fall more into the concept category.

On the network side, the news to center on comes from Verizon (VZ), which said it expects to have its 5G network in 30 U.S. cities by the end of 2019. That’s hardly what one would call a vibrant, national 5G network, and makes those commercial 5G launches really a 2020 event for the mobile carriers and consumers. It does mean that over the next several quarters, those mobile operators will continue to build out their 5G networks, which is positive for our shares of Nokia (NOK). As the 5G buildout moves beyond the U.S. into Europe and Asia, this tailwind bodes rather well for the company and helps back its longer-term targets. 

This 5G timetable was also confirmed by comments from Intel (INTC) about the timing of 5G chipsets, which are now expected to be available by the end of 2019 and are not likely to hit devices until 2020. Given the timing of CES in early January and the Mobile World Congress 2020 in February, odds are it means we will see a number of device announcements in early 2020 that will hit shelves in the second half of the year. Many have been wondering when Apple (AAPL) will have a 5G powered iPhone, and based on the various chipset and network comments, odds are the first time we’ll hear about such a device is September-October 2020. 

If history is to be repeated, we are likely to see something similar to what we saw with the first 3G and 4G handsets. By that, we mean a poor consumer experience at least until the 5G networks are truly national in scale and the chipsets become more efficient. One of the issues with each additional layer of mobile technology is it requires additional radio frequency (RF) chips, which in turn not only consume more power but also present internal design issues that out of the gate could limit the size of the battery. Generally speaking, early versions of these new smartphones tend to have less than desirable up-times. This is another reason to think Apple will not be one of those out of the gate 5G smartphone companies, but rather it will repeat its past strategy of bringing its product to market at the tipping point for the chipsets and network deployments. 

Circling back to our Nokia shares, while there are just over a handful of 5G smartphones that have been announced, some of which are expected to become available later this year, over the coming 18 months we will see a far greater number of 5G devices. This should drive Nokia’s high margin, IP licensing business in the coming quarters. As this occurs, Nokia’s mobile infrastructure should continue to benefit from the growing number of 5G networks being built out, not only here in the US but elsewhere as well.

  • Our long-term price target on Disruptive Innovator leader Nokia (NOK) shares remains $8.50

 

Universal Display shares get lit up

Last week I previewed the upcoming earnings report from Select List resident Universal Display (OLED) and following that news the shares were off with a bang! Universal posted earnings of $0.40 per share, $0.08 per share better than the consensus expectations, on revenue that matched the Wall Street consensus of $70 million. Considering the tone of the smartphone market, I view the company’s quarterly results as “not as bad a feared” and, no surprise, the guidance reflects the continued adoption of organic light-emitting displays across a growing number of devices and vendors. For the current year, Universal has guided revenue to $325 million-$350 million, which is likely to be a step function higher as we move through the coming quarters reflecting the traditional year-end debut of new smartphones, TVs and other devices.

Longer-term, we know Apple (AAPL) and others are looking to migrate more of their product portfolios to organic light-emitting diode displays. This shift will drive capacity increases in the coming several quarters — and recent reports on China’s next round of display investing seems to confirm this happening per its latest Five-Year Plan. As we have seen in the past, this can lead to periods of oversupply and pricing issues for the displays, but the longer-term path as witnessed with light-emitting diodes (LEDs) is one of greater adoption. 

As display pricing improves as capacity grows, new applications for the technology tend to arise. Remember that while we are focused on smartphones and TVs in the near-term, other applications include automotive lighting and general lighting. Again, just like we saw with LEDs.

  • We will continue to be long-term shareholders with Disruptive Innovator Select List resident Universal Display (OLED). Given the improving outlooks, our near-term price target for OLED shares is getting lifted to $150 from $125, and I will revisit that target as we move through the balance of 2019.

 

 

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

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

Key points in this issue:

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

 

As expected, more negative earnings revisions roll in

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

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

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

 

Tematica Investing

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

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

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

 

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

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

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

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

 

Nokia gets several boosts ahead of its earnings report

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

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

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

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

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

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

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

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

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

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

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

 

USA Technologies gets an “interim” CFO

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

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

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

 

 

 

Adding downside protection and naming a new Thematic Leader

Adding downside protection and naming a new Thematic Leader

Key points inside this issue

  • As more investors reassess coming growth expectations, we are adding ProShares Short S&P500 (SH) to hedge both the Thematic Leaders and the Select List. While not a thematic position but one that will limit near-term downside, we will evaluate this position on as needed basis in the coming weeks.
  • Calling Nokia up to the Thematic Leaders
  • Adding Skyworks Solutions to the Contender’s List
  • Cannabis rumors swirl around Altria

 

Adding some downside protection with SH shares

It’s not often we get a mid-week break for the stock market, and the reason behind yesterday’s stock market closure was a solemn one. It did offer a respite from the wild swing we saw in the market between Monday and Tuesday, which resulted in a demonstrable move lower for all the major market indices. As I shared on Monday, despite the seeming forward motion on US-China trade, there remains much work to be done and a number of headwinds that, as expected, are leading investors to question 2019 EPS growth prospects.

Yesterday, China’s Commerce Ministry released a statement calling trade talks between Presidents Xi and Trump at the G20 Summit in Argentina “very successful.” The statement said the Chinese and U.S. trade and economic delegations will “actively advance the work of consultation” in 90 days in accord with “a clear timetable” and “road map” but offered little concrete details. Odds are this will add to the uncertainty that led Monday’s rally to finish the day off its highs and helped drive the market lower on Tuesday.

In my view, this will keep the market on pins and needles as we digest the coming economic data points to be had that I shared on Monday as well as those for next week that include November reports for inflation, Retail Sales and Industrial Production. As more investors question earnings growth prospects vs. the current stock market multiple, the risk is we could see more downside, especially if those same investors suspect tariffs will indeed be eventually raised to 25% from 10% along with further interest rate hikes. A recent survey of 500 institutional investors by Natixis showed that 65% see a change coming, with the biggest threats being geopolitical tensions and rising interest rates. Between the wage data to be had in Friday’s Employment Report and next week’s PPI and CPI reports, we also run the risk of seeing potentially hawkish comments following today’s latest Fed Beige Book. That report showed tariff driven price increases have spread more broadly through the U.S. economy.

As we get these and other data points ahead of the Fed’s essentially baked in the cake rate hike on December 19, I’ll continue to heed the Thematic Signals we collect each week. Given the market mood, however, I’m adding some downside protection to help insulate subscriber assets in the near-term in the form of ProShares Short S&P500 (SH), an inverse ETF for the S&P 500.

  • As more investors reassess coming growth expectations, we are adding ProShares Short S&P500 (SH) to hedge both the Thematic Leaders and the Select List. While not a thematic position but one that will limit near-term downside, we will evaluate this position on as needed basis in the coming weeks.

 

Samsung set to bring 5G into the prime time

Amid the trade news between the United States and China out of the G-20 summit, there was other news that we’ve been waiting on patiently. Subscribers know that one of our core investment thesis for our positions in Dycom Industries (DY),  AXT Inc. (AXTI), Nokia (NOK) and to a lesser extent Applied Materials (AMAT) shares is the deployment of 5G networks and devices. In the last few months, we’ve heard of beta rollouts from both AT&T Inc. (T) and Verizon Communications Inc. (VZ) as well as fixed wireless testing that could be a replacement for broadband to the home. The thing that has been missing is the to-date elusive announcement on a 5G smartphone that will ride 5G networks and their data speeds, something that will make the speed of the current 4G LTE network look something out of the dial-up days. If you remember those days, you know what I’m talking about — all that’s missing is the wonky connect garble noise.

Let me rephrase: That announcement was elusive until this past Monday when Verizon shared that smartphone users in the United States will be able to use Verizon’s 5G wireless network in the first half of 2019 starting with devices from Samsung. While details of the devices were scant — no models or price points — it is expected that Samsung will be revealing a proof concept this week at the annual Qualcomm Inc. (QCOM) Snapdragon Summit in Maui, Hawaii. Given the location of the unveiling, it seems like a sure bet Qualcomm and its chipsets will be powering the device. No surprise, considering that Samsung long has been a core customer of Qualcomm.

The key point here is the largest smartphone company by volume will be debuting its first 5G market in the coming months.

 

Calling Nokia up to the Thematic Leaders

From our perspective, I see this development as confirming our view on a few levels. Operators are not ones to launch a network unless devices are available for them to monetize that network and all the investments that led to it. That’s a positive for Nokia as it confirms the pending multi-year upswing in 5G infrastructure demand is firmly in front of it, as is the opportunity for its IP licensing business. Second, given Verizon’s timetable of “the first half of 2019,” it means the supply chain soon will be firing up to deliver the components necessary for these devices, including the incremental number of RF (radio frequency) semiconductors needed for 5G. That means incremental wafer demand for AXT during what is a seasonally slow period for smartphones.

As a result, I am calling shares of Nokia up from the Select List to the Thematic Leaders to fill the Disruptive Innovatorsvoid. With Samsung, AT&T, and Verizon having now laid out a timetable for 5G deployments for both networks and devices, we now have a far firmer timetable for a pick up in demand for mobile infrastructure business as well as high margin licensing business. My price target on NOK shares remains $8.50.

  • We are adding Nokia (NOK) shares to the Thematic Leaders for our Disruptive Innovators investing theme. Our price target remains $8.50

 

Adding Skyworks Solutions to the Contender’s List

That incremental RF semiconductor demand for 5G I mentioned a few paragraphs above also means more power amplifiers, switches, filters and other components that will once again increase the dollar content per device for Skyworks Solutions (SWKS) and its competitors. We’ve owned SWKS shares before, and more recently they’ve been battered around as more signs of stalling smartphone demand have emerged leading suppliers to cut their forecasts.

I’ve no intention in jumping into that fray ahead of the seasonally slowest time of the year for smartphone demand – the first half of the calendar year. Rather, we’ll put a pin in SWKS shares, add them to the Contender List and look to revisit them as a Disruptive Innovator play as we either put the March quarter behind us or a new US-China trade deal is inked.

 

Cannabis rumors swirl around Altria

After we published Monday’s Tematica Investing issue, there was much chatter suggesting that Guilty Pleasure Thematic Leader Altria Group (MO) could be interested in acquiring Cronos Group (CRON), a Canadian cannabis company. That speculation sent CRON shares 11% higher on the day and also lifted MO.

As you know, I have held the view that Altria would look to diversify its business away from tobacco and ride the wave of cannabis legalization in the U.S. The key here is legalization across the entire U.S., which would ease manufacturing, distribution, sales and marketing efforts by Altria rather than being an ad-hoc effort. Until the federal ban is lifted, there are also issues with how a company such as Altria would deposit its revenue and profits.

For those looking at Cronos as a positive for Altria’s U.S. business, I think that is a bit presumptuous as the timing of U.S. cannabis legalization remains tenuous. A potential acquisition such as this, however, would give Altria a toehold in the cannabis space, which is legal in Canada, and allow it to learn the business and test market product for an eventual launch in the U.S. when the time is right.

For now, a potential acquisition of Cronos is just speculation, but in principle, it fits with our long-term view of where Altria is likely headed. Now we have to see what Altria does next.

 

 

Weekly Issue: Economic reality is catching up with the stock market

Weekly Issue: Economic reality is catching up with the stock market

 

Coming into this week I said it would likely be another volatile one, and as much as I would like to say I was wrong, I wasn’t. Over the last five days, the individual price charts of the major stock market indices resembled a roller coaster ride, finishing lower week over week. This trajectory continued what we’ve seen over the last few weeks, which has all the major market indices in the red for the last month and that has erased most of their year to date gains.

Stepping back, yes, the market is trading day to day as expected but while there are pockets of strength we are seeing a growing number of companies miss top-line expectations. Coupled with guidance that in some cases may be conservative, but in other reflects a syncing up with the economic and other data of the last few months, investors have become increasingly nervous. This is evidenced in the wide swing over the last month at the CNN Fear & Greed Index, which now sits at Extreme Fear (6) down from Greed (65) several weeks ago. Looking at the AAII Investor Sentiment Survey this week, bullish sentiment fell to 28% from 34%, the fourth weakest reading for bullish sentiment this year. Bearish sentiment rose from 35% to 41%, the highest reading since the last week of June.

What this tells us is pessimism over the near-term direction of the stock market is at its highest level in months, which in turn is likely giving way to what we call a “shoot first and ask questions later” mentality. As almost any seasoned investor will say, that is one of the biggest mistakes one can make as it tends to let emotion, not logic and fact, rule the day.

What times like this call for is stepping back, collecting data shared in earnings releases and corresponding conference calls and presentations, to update our investing mosaic. We’ve had several Thematic Leaders and residents on the Tematica Investing Select List, including Chipotle Mexican Grill (CMG), Amazon (AMZN), Altria (MO),  Alphabet/Google, and Nokia (NOK) report this week as well as a dozens of others, such as AT&T (T), Verizon (VZ), Lockheed Martin (LMT), McDonald’s (MCD), iRobot (IRBT), and Hilton (HLT) report this week. That’s why I’ll be spending the weekend pouring over earnings releases and conference call transcripts, using our thematic lens to update our investing mosaic as needed. It also means furnishing you with a number of updates very early next week.

As I revisit our investing mosaic, the questions being asked will include ones like “Are we seeing any slowdown in the shift to digital commerce, the cloud, streaming content, the move to foods that are better for you?” and so on. Odds are the answers to those and similar questions will be no, which means we will continue to sit on the sidelines as earnings expectations for the market are adjusted likely leading the risk to reward dynamics in share prices to become more favorable. As calmer waters emerge in the coming weeks, we will use one of our time-tested strategies and scale into our Thematic Leader positions as well as those in the Select List where it makes sense.

 

What to Watch Next Week

As we trade the end of October and Halloween for the start of November next week, we have another barn burner one ahead for September quarter earnings as more than 1,000 companies will report their results and update their outlooks. We also have a full plate of economic data coming at us, some of which will influence the second edition of the September quarter’s GDP reading while others will start to put some shape around the GDP reading for the current quarter. To set the table for that data following the initial September quarter GDP print of 3.5%, the New York Fed’s Nowcast model is looking for 2.4% while The Wall Street Journal’s Economic Forecast Survey of more than 60 economists is calling for 2.9%. Thus far we have yet to see any forecast from the Atlanta Fed’s Nowcast model for the December quarter, however, odds are it will once again start out overly bullish and find its way closer to the economic reality of the quarter. We like to kid the Atlanta Fed, but it did start out modeling September quarter GDP of 4.7%. Of course, we would have loved to have seen that, but we’re in the business of letting the economic data talk to us. The fact the Citibank Economic Surprise Index (CESI) has been negative for several months, meaning the data is coming in below expectations, was a clue the Atlanta Fed would have to refine its outlook.

So, what do we have on tap from an economic data perspective?

Monday will bring the September Personal Income and Spending report, one that will we will be watching closely to see if consumers continued to spend above wage gains. Tuesday has the October Consumer Confidence reading for October, and the recent stock market gyrations could take some wind out of the September confidence gains. As we gear into the holiday shopping season, we’ll be closely watching the Expectations component for signs of any softening. Also, on Tuesday, we have Apple’s (AAPL) latest event at which it is widely expected to unveil its latest iPad and Mac models. The ADP Employment Report for October, as well as the 3Q 2018 Employment Cost Index report, will be had on Wednesday, and we expect them to receive more than a passing scrutiny given the growing scarcity of workers with needed skillsets and wage gains.

Thursday we will get the October auto and truck sales and we’ll be looking to see if those sales continue to resemble what we’ve seen in the housing market of late – fewer unit sales, but ones with higher price tags. Also, in focus, that day will be the October ISM Manufacturing Index, where we will be eyeing its order and backlog data as well as employment metrics. Rounding out Thursday, we’ll get the September Construction Spending Report. The first Friday of the new month usually means it’s time for the employment report, and yes, we will indeed be getting the October Employment report one week from today. While we expect many to be focused on the speed of job creation, we’ll be digging into the qualitative factors of the jobs created and who is taking them as well as focusing on the degree of wage gains.

Turning to next week’s earnings calendar, it is simply chock full of reports and once again Thursday will be the day with the heaviest flow – just under 400 companies on that day alone.  Just like this week, among the sea of reports to be had, there will be several, including Facebook (FB) and Apple that will capture investor attention given the impact they could have on the market. As we move through the week, we’ll be adding to our investment mosaic along the way.

Enjoy the weekend, stock up on all those tricks and treats and get some rest for the week ahead. I’ll be back with more early next week.

 

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.

 

WEEKLY ISSUE: Scaling deeper into Dycom shares

WEEKLY ISSUE: Scaling deeper into Dycom shares

Key points from this issue:

  • We are halfway through the current quarter, and we’ve got a number of holdings on the Tematica Investing Select List that are trouncing the major market indices.
  • We are using this week’s pain to improve our long-term cost basis in Dycom Industries (DY) shares as we ratchet back our price target to $100 from $125.
  • Examining our Middle-Class Squeeze investing theme and housing.
  • A Digital Lifestyle company that we plan on avoiding as Facebook attacks its key market.

 

As the velocity of June quarter earnings reports slows, in this issue of Tematica Investing we’re going to examine how our Middle-Class Squeeze investing theme is impacting the housing market and showcase a Digital Lifestyle theme company that I think subscribers would be smart to avoid. I’m also keeping my eyes open regarding the recent concerns surrounding Turkey and the lira. Thus far, signs of contagion appear to be limited but in the coming days, I suspect we’ll have a much better sense of the situation and exposure to be had.

With today’s issue, we are halfway through the current quarter. While the major market indices are up 2%-4% so far in the quarter, by comparison, we’ve had a number of strong thematic outperformers. These include Alphabet (GOOGL), Amazon (AMZN), Apple (AAPL), AXT Inc. (AXTI), Costco Wholesale (COST),  Habit Restaurant (HABT), Walt Disney (DIS), United Parcel Service (UPS), Universal Display (OLED) and USA Technologies (USAT).  That’s an impressive roster to be sure, but there are several positions that have lagged the market quarter to date including GSV Capital (GSVC), Nokia (NOK), Netflix (NFLX), Paccar (PCAR) and Rockwell Automation (ROK). We’ve also experienced some pain with Dycom (DY) shares, which we will get to in a moment.

Last week jettisoned shares of Farmland Partners (FPI) following the company taking it’s 3Q 2018 dividend payment and shooting it behind the woodshed. We also scaled into GSVC shares following GSV’s thesis-confirming June quarter earnings report, and I’m closely watching NFLX shares with a similar strategy in mind given the double-digit drop since adding them to the Tematica Investing Select List just over a month ago.

 

Scaling into Dycom share to improve our position for the longer-term

Last week we unveiled our latest investing theme here at Tematica – Digital Infrastructure. Earlier this week, Dycom Industries (DY), our first Digital Infrastructure selection slashed its outlook for the next few quarters despite a sharp rise in its backlog. Those shared revisions are as follows:

  • For its soon to be reported quarter, the company now sees EPS of $1.05-$1.08 from its previous guidance of $1.13-$1.28 vs. $1.19 analyst consensus estimate and revenues of $799.5 million from the prior $830-$860 million vs. the $843 million consensus.
  • For its full year ending this upcoming January, Dycom now sees EPS of $2.62-$3.07 from $4.26-$5.15 vs. the $4.63 consensus estimate and revenues of $3.01-$3.11 billion from $3.23-$3.43 billion and the $3.33 billion consensus.

 

What caught my eyes was the big disparity between the modest top line cuts and the rather sharp ones to the bottom line. Dycom attributed the revenue shortfall to slower large-scale deployments at key customers and margin pressure due to the under absorption of labor and field costs – the same issues that plagued it in its April quarter. Given some of the June quarter comments from mobile infrastructure companies like Ericsson (ERIC) and Nokia (NOK), Dycom’s comments regarding customer timing is not that surprising, even though the magnitude to its bottom line is. I chalk this up to the operating leverage that is inherent in its construction services business, and that cuts both ways – great when things are ramping, and to the downside when activity is less than expected.

We also know from Ericsson and Dycom that the North American market will be the most active when it comes to 5G deployments in the coming quarters, which helps explain why Dycom’s backlog rose to $7.9 billion exiting July up from $5.9 billion at the end of April and $5.9 billion exiting the July 2017 quarter. As that backlog across Comcast, Verizon, AT&T, Windstream and others is deployed in calendar 2019, we should see a snapback in margins and EPS compared to 2018.

With that in mind, the strategy will be to turn lemons – Monday’s 24% drop in DY’s share price – into long-term lemonade. To do this, we are adding to our DY position at current levels, which should drop our blended cost basis to roughly $80 from just under $92. Not bad, but I’ll be inclined to scale further into the position to enhance that blended cost basis in the coming weeks and months on confirmation that 5G is moving from concept to physical network. Like I said in our Digital Infrastructure overview, no 5G network means no 5G services, plain and simple. As we scale into the shares and factor in the revised near-term outlook, I’m also cutting our price target on DY shares to $100 from $125.

  • We are using this week’s pain to improve our long-term cost basis in Dycom Industries (DY) shares as we ratchet back our price target to $100 from $125.

 

Now, let’s get to how our Middle-Class Squeeze investing theme is hitting the housing market, and review that Digital Lifestyle company that we’re going to steer clear of because of Facebook (FB). Here we go…

 

If not single-family homes, where are the squeezed middle-class going?

To own a home was once considered one of the cornerstones of the American dream. If we look at the year to date move in the SPDR S&P Homebuilders ETF (XHB), which is down nearly 16% this year, one might have some concerns about the tone of the housing market. Yes, there is the specter of increasing inflation that has and likely will prompt the Federal Reserve to boost interest rates, and that will inch mortgage rates further from the near record lows enjoyed just a few years ago.

Here’s the thing:

  • Higher mortgage rates will make the cost of buying a home more expensive at a time when real wage growth is not accelerating, and consumers will be facing higher priced goods as inflation winds its way through the economic system leading to higher prices. During the current earnings season, we’ve heard from a number of companies including Cinemark Holdings (CNK), Hostess Brands (TWNK), Otter Tail (OTTR), and Diodes Inc. (DIOD) that are expected to pass on rising costs to consumers in the form of price increases.
  • Consumers debt loads have already climbed higher in recent years and as interest rates rise that will get costlier to service sapping disposable income and the ability to build a mortgage down payment

 

 

And let’s keep in mind, homes prices are already the most expensive they have been in over a decade due to a combination of tight housing supply and rising raw material costs. According to the National Association of Home Builders, higher wood costs have added almost $9,000 to the price of the average new single-family since January 2017.

 

 

Already new home sales have been significantly lower than over a decade ago, and as these forces come together it likely means the recent slowdown in new home sales that has emerged in 2018 is likely to get worse.

 

Yet our population continues to grow, and new households are being formed.

 

This prompts the question as to where are these new households living and where are they likely to in the coming quarters as homeownership costs are likely to rise further?

The answer is rental properties, including apartments, which are enjoying low vacancy rates and a positive slope in the consumer price index paid of rent paid for a primary residence.

 

There are several real estate investment trusts (REITs) that focus on the apartment and rental market including Preferred Apartment Communities, Inc. (APTS) and Independence Realty Trust (IRT). I’ll be looking at these and others to determine potential upside to be had in the coming quarters, which includes looking at their attractive dividend yields to ensure the underlying dividend stream is sustainable. More on this to come.

 

A Digital Lifestyle company that we plan on avoiding as Facebook attacks its key market

As important as it is to find well-positioned companies that are poised to ride prevailing thematic tailwinds that will drive revenue and profits as well as the share price higher, it’s also important to sidestep those that are running headlong into pronounced headwinds. These headwinds can take several forms, but one of the more common ones of late is the expanding footprint of companies like Alphabet (GOOGL), Amazon (AMZN) and Facebook (FB) among others.

We’ve seen the impact on shares of Blue Apron (APRN) fall apart over the last year following the entrance of Kroger (KR) into the meal kit business with its acquisition of Home Chef and investor concerns over Amazon entering the space following its acquisition of Whole Foods Market. That changing landscape highlighted one of the major flaws in Blue Apron’s subscription-based business model –  very high customer acquisition costs and high customer churn rates. While we warned investors to avoid APRN shares back last October when they were trading at north of $5, those who didn’t heed our advice are now enjoying APRN shares below $2.20. Ouch!

Now let’s take a look at the shares of Meet Group (MEET), which have been on a tear lately rising to $4.20 from just under $3 coming into 2018. The question to answer is this more like a Blue Apron or more like USA Technologies (USAT) or Habit Restaurant (HABT). In other words, one that is headed for destination @#$%^& or a bona fide opportunity.

According to its description, Meet offers  applications designed to meet the “universal need for human connection” and keep its users “entertained and engaged, and originate untold numbers of casual chats, friendships, dates, and marriages.” That sound you heard was the collective eye-rolling across Team Tematica. If you’re thinking this sounds similar to online and mobile dating sites like Tinder, Match, PlentyOfFish, Meetic, OkCupid, OurTime, and Pairs that are all part of Match Group (MTCH) and eHarmony, we here at Tematica are inclined to agree. And yes, dating has clearly moved into the digital age and that falls under the purview of our Digital Lifestyle investing theme.

Right off the bat, the fact that Meet’s expected EPS in 2018 and 2019 are slated to come in below the $0.39 per share Meet earned in 2017 despite consensus revenue expectations of $181 in 2019 vs. just under $124 million in 2017 is a red flag. So too is the lack of positive cash flow and fall off in cash on the balance sheet from $74.5 million exiting March 2017 to less than $21 million at the close of the June 2018 quarter. A sizable chunk of that cash was used to buy Lovoo, a popular dating app in Europe as well as develop the ability to monetize live video on several of its apps.

Then there is the decline in the company’s average total daily active users to 4.75 million in the June 2018 quarter from 4.95 million exiting 2017. Looking at average mobile daily active users as well as average monthly active user metrics we see the same downward trend over the last two quarters. Not good, not good at all.

And then there is Facebook, which at its 2018 F8 developer conference in early May, shared it was internally testing its dating product with employees. While it’s true the social media giant is contending with privacy concerns, CEO Mark Zuckerberg shared the company will continue to build new features and applications and this one was focused on building real, long-term relationships — not just for hookups…” Clearly a swipe at Match Group’s Tinder.

Given the size of Facebook’s global reach – 1.47 billion daily active users and 2.23 billion monthly active users – it has the scope and scale to be a force in digital dating even with modest user adoption. While Meet is enjoying the monetization benefits of its live video offering, Facebook has had voice and video calling as well as other chat capabilities that could spur adoption and converts from Meet’s platforms.

As I see it, Meet Group have enjoyed a nice run thus far in 2018, but as Facebook gears into the digital dating and moves from internal beta to open to the public, Meet will likely see further declines in user metrics. So, go user metrics to go advertising revenue and that means the best days for MEET shares could be in the rearview mirror. To me this makes MEET shares look more like those from Blue Apron than Habit or USA Technologies. In other words, I plan on steering clear of MEET shares and so should you.

 

 

WEEKLY ISSUE: Confirming Thematic Data Points Continue to Pour In

WEEKLY ISSUE: Confirming Thematic Data Points Continue to Pour In

Key points inside this issue:

  • Oh how the stock market has diverged over the last week
  • Ahead of Apple’s (AAPL) upcoming annual product refresh, we are boosting our price target to $225 from $210 for the shares.
  • Our price target on Amazon (AMZN) shares remains $2,250.00
  • Our price target on Costco Wholesale (COST) remains $230.00
  • Our price target on Nokia (NOK) shares remains $8.50
  • Our price target on AXT Inc. (AXTI) shares remains $11.50
  • Our price target on Dycom (DY) shares remains $125.00
  • Here come earnings from Habit Restaurant (HABT)

 

Oh how the stock market has diverged over the last week

Last week the divergence we saw in the major domestic stock market indices continued as both the Dow Jones Industrial Average and the S&P 500 powered higher while the Nasdaq Composite Index and the small-cap heavy Russell 2000 retreated. The technology-heavy Nasdaq moved lower following drops in Facebook (FB) and Twitter (TWTR) late last week, while the Russell’s move lower likely reflecting potential progress on trade following a positive meeting between the US and EU.

In recent weeks, we’ve shared our view that 2Q 2018 earnings season would likely lead to the resetting of earnings expectations, and it appears that is indeed happening. The stock market, however, didn’t expect that resetting to happen with Facebook, Twitter, Netflix (NFLX) and other high fliers. We also shared how that resetting could lead to some downward pressure in the overall market, so we’re not surprised by how it is digesting these realizations.

Also weighing on the market is the realization the 2Q 2018 GDP figure of 4.1%, which was propped up by government spending and some pull forward in demand ahead of tariff phase-ins, is not likely to repeat itself in the current quarter. As we noted above, there was some progress on trade between the US and EU last week — more of an agreement to work on an agreement — and there are still tariffs with Canada, Mexico, and China to face. And as much as we would like to see last week’s progress as hopeful, we’ve heard from a number of companies about how under the current environment higher input costs will weigh on margins and profits in the back half of the year. The response has companies boosting prices to pass along those increased costs, which could either sap demand or stoke inflation concerns.

We saw that rather clearly in the IHS Markit Flash US PMI for July last week. The headline flash PMI index clocked in at 55.9, a three-month low with the manufacturing component at a two month higher while services slipped month over month. One of the key takeaways was summed up by Chris Williamson, Chief Business Economist at IHS Markit who said, “…the July flash PMI is in line with the average for the second quarter and indicative of the economy growing at an annualized rate of approximately 3%.” The same flash report also showed a steep increase in prices with survey respondents citing the impact of tariffs, but also supply chain delays, which in our experience tends to be a harbinger of further price increases.

Because we’re still in the thick of earnings, we’ll continue to assess the situation as more company commentary becomes available and what it means for profits in the coming quarters. Odds are, however, the Fed, is seeing the above and will remain on a path to boost interest rates in the coming months. We’ll get more on that later today when the Fed exits its latest FOMC policy meeting. Barring a meaningful pick up in wage growth it could lead to more restrained consumer spending. We see that as positives for incremental consumer wallet share gains at Amazon (AMZN) and Costco Wholesale (COST) as we head into the seasonally strong shopping season.

  • Our price target on Amazon (AMZN) shares remains $2,250.00
  • Our price target on Costco Wholesale (COST) remains $230.00

 

Apple delivers and boosting our price target in response

We are boosting our price target on Apple (AAPL) shares to $225 from $210. This boost follows last night’s solid June quarter results and guidance, which topped expectations as investors and consumer prepare for the latest iteration of iPhone and other Apple products to hit shelves in the coming months. Here are some of the highlights from Apple’s June quarter:

  • Reported EPS of $2.34 vs. the consensus forecast of $2.18 on revenue of $53.265 billion vs. the expected $52.43 billion.
  • Year over year revenue grew 17% with led by double-digit increases at iPhone, Services and Other while Mac and iPad revenue declined vs. year-ago levels.

Moreover, the company forecasted September quarter revenue to grow double digits sequentially with prospects for an improving gross margin profile. That combination is leading Wall Street to take its EPS expectations higher, and I suspect we will see a number of price target increases this morning.

As exciting as this is — as well as proof positive the Apple model is not broken as some doomsayers would suggest — in several weeks Apple will take the wraps off its revitalized Fall 2018 new product lineup that is expected to have a number of new models across iPhones and iPads. Some products, like iPads, are expected to get new features such as FaceID, while the iPhone X lineup should expand to larger screen sizes as well as lower cost models utilizing an LCD screen instead of an organic light emitting diode (OLED) one. I see the Apple enthusiasm once again cresting higher as that date approaches.

Now let’s break down the quarter’s results:

iPhone revenue grew 20% year over year to $29.9 billion despite tepid smartphone industry dynamics. During the quarter Apple sold 41.3 million iPhones, which paired with the 19% year over year improvement in average selling price (ASP) to $724 vs. $606 in the year-ago quarter drove the revenue improvement. That surge in ASP reflects ongoing demand from the company’s premium iPhone products – iPhone X, iPhone 8 and iPhone 8+.

The Services business grew 30% year over year to $9.5 billion, roughly 18% of overall Apple revenue vs. 16% in the year-ago quarter. The total number of paid subscriptions rose 30 million sequentially to hit 300 million, up from 185 million exiting the June 2017 quarter. I see this as a positive given the subscription nature of iCloud, Apple Music, Apple Care, Texture and other offerings that drive not only cash flow but revenue predictability. During the earnings call, Apple tipped that it has over 50 million Apple Music listeners “when you add our paid subscribers and the folks in the trial…”

As the Services business continues to grow across the expanding Apple device install base, accounting for a greater portion of revenue and profits, odds are investors will begin to re-think how they value Apple shares, especially as the company’s dependence on iPhone sales is lessened at least somewhat. That will be especially true as Apple tips its original content plans, from both a programming perspective as well as pricing and subscription plan one.

Other products grew 37% vs. the year-ago quarter driven by wearables (Apple Watch, Air Pods, Beats) to account for 7% of overall revenue for the quarter.

For the September quarter, Apple guided revenue to $60-$62 billion with gross margin between 38.0-38.5% (vs. 38.3% in the June quarter). That double-digit sequential revenue improvement looks strong heading into the Fall unveiling of new devices, including multiple iPhone models, which as I mentioned earlier is expected to include a larger screen sized iPhone X model as well as a new iPhone X model and a lower priced one with an LCD screen. That implies a rebound in unit volume growth tied with favorable ASPs to drive iPhone revenue growth in the coming quarters. Of course, I continue to see the next major upgrade cycle tied to 5G, which increasingly looks to go live in North America during 2019 and outside the US thereafter.

Investor confidence in new products and Apple’s new product pipeline should be bolstered by the growth in R&D spending that has now outpaced revenue growth in 24 of the last 25 quarters. Historically speaking, when this has happened in the past, it was a forbearer of Apple unveiling a number of new products, including a new product category or two. While it would be easy to read into the possibilities of potential products as 5G goes mainstream, we’ll continue to focus on the near-term upgrades to be had in a few month’s time and what it means for Apple’s businesses.

Exiting the quarter, Apple’s balance sheet had a net cash position of $129 billion even after retiring some 112 million shares during the quarter. On a dollar basis that was $20.7 billion spent on share repurchases during the quarter, including the last part $10 billion of its prior authorization. That leaves roughly $90 billion under its current $100 billion authorization and we continue to see the company supporting the shares with that mechanism.

Finally, last night Apple’s board of directors has declared a cash dividend of $0.73 per share of the Company’s common stock. The dividend is payable on August 16, 2018, to shareholders of record as of the close of business on August 13, 2018.

In sum, it was a stronger than expected quarter that showed Apple’s various strategies bearing fruit with more to come as it updates existing products and introduces new ones as well as new services. If there was one disappointment in the earnings release and conference call it was the lack of discussion around 5G and original content efforts, but my thinking on that is good things come to those who wait.

  • Ahead of Apple’s (AAPL) upcoming annual product refresh, we are boosting our price target to $225 from $210 for the shares.

 

Nokia scores the biggest 5G contract win thus far

Earlier this week, T-Mobile (TMUS) named Nokia (NOK) as a supplier for $3.5 billion in 5G network gear, making this the largest 5G deal thus far. This is clear confirmation of the coming network upgrade cycle that bodes well for not only Nokia’s infrastructure business but will expand the addressable market for its licensing business as well.

Nokia’s deal with T-Mobile US is multi-year in nature, which means the $3.5 million will be spread out over eight-plus quarters. To put some perspective around the size of that one contract, over the last two quarters, Nokia’s infrastructure business has been averaging a little over $5 billion per quarter.  In our view, this speaks to the diverse nature of the customer base across not only the US but the EU, Africa, and Asia.

The thing is, 5G networks will be coming to each of those geographies over the coming years, and for those further out deployments, mobile carriers will be adding incremental 4G LTE capacity.  In other words, we are at the beginning of the 5G buildout, and it may seem like it has taken longer than expected to emerge, the data points from smartphone components to network builds suggest 2019 will be the beginning of a multiyear upcycle in mobile infrastructure demand.

And a quick reminder, we see the coming 5G buildout and the necessary smartphones and other devices driving demand for AXT Inc.’s (AXTI) compound semiconductor substrates. Those shares have been bouncing around like ping-pong balls of late, but we’ll continue to focus on the long-term drivers such as 5G and the eventual smartphone upgrade cycle.

And I would be remiss if I didn’t touch on Dycom Industries (DY) as well. To me, this T-Mobile US news says it is serious about building out its 5G network, and I strongly suspect both AT&T (T) as well as Verizon (VZ) will be sharing their own buildout plans in the coming days and weeks. These carriers are all about one-upping each other be it on data plan pricing or how good their networks are. As AT&T and Verizon fight back, it’s a solid reminder of the activity to be had for Dycom’s specialty contracting business.

  • Our price target on Nokia (NOK) shares remains $8.50
  • Our price target on AXT Inc. (AXTI) shares remains $11.50
  • Our price target on Dycom (DY) shares remains $125.00

 

Here come earnings from Habit

Quickly turning to Habit Restaurants (HABT), the company will report its quarterly earnings after today’s market close. Consensus expectations are looking for EPS of $0.03 on revenue of roughly $100 million for the June quarter. Ahead of that report, Wall Street is coming around to the Habit story. On Monday, investment firm Wedbush bumped up their price target to $15 from $12 and upped their rating to Outperform from Buy. Yes, I am wondering where they’ve been for the last 30% plus rally in HABT shares…

The gist of the upgrade reflects the positive impact to be had from recent price increases as well as premium pricing associated with delivery. Those are certainly positive drivers for revenue and margins, however, I continue to see the bigger thesis centering on the company’s geographic expansion. That expansion means more burgers and shakes being sold in more locations, drive-thru, and delivery. In other words, it’s the platform that allows for these other margin improving activities. This means I’ll be watching the company’s capital spending plans for the coming quarters.

As tends to be the case, I’ll be reassessing our $11.50 price target with tonight’s earnings report given the shares have sailed right through it over the last few days.

  • Heading into tonight’s earnings report, our price target on Habit Restaurant (HABT) shares remains $11.50.

 

Weekly Issue: Trade Meetings and Earnings Reshape Market Outlook

Weekly Issue: Trade Meetings and Earnings Reshape Market Outlook

Key points from this issue:

  • Earnings from Boeing (BA) and General Motors (GM) signal markets will trade day-to-day as trade meetings and earnings season heat up.
  • Our price target on Dycom Industries (DY) shares remains $125
  • Our AXTI price target remains $11.
  • Our price target on Nokia (NOK) shares remains $8.50
  • Our long-term price target for Farmland Partners (FPI) shares remains $12.
  • As we head into the seasonally strong second half of the year for United Parcel Service (UPS), our price target on the shares remains $130.

 

This week we’ve moved into the meaty part of 2Q 2018 earnings season, and so far, we’ve seen a number of companies beat top and bottom line expectations. Some market observers will point out that some 20%-25% of the S&P 500 group of companies are in that boat, and are declaring “victory” for the market. With today’s earnings from Boeing (BA) that and General Motors (GM), the market is trending lower as Boeing’s outlook falls short of Wall Street expectations while GM cut its outlook due to higher commodity prices. As you probably guessed, one of the culprits for GM is higher aluminum and steel prices.

My take on that is with 75%-80% of the S&P 500 yet to report, that claim while it could prove to right, it also could be a bit premature. As I shared with Oliver Renick, host at the TD Ameritrade Network a few days ago, we’ve only started to see the impact of initial trade tariffs and if the international dance continues we could see far more tariff jawboning put into action.

Consider a tweet from President Trump this morning that suggests a tariff follow through is possible.

 

 

But last night Trump tweeted a path forward to eliminating tariffs and other trade barriers between the Eurozone and the US ahead of his meeting today with the European Commission President Jean-Claude Juncker today to discuss trade, including tariffs on autos.

It would appear Trump is attempting to keep his negotiating opponents off balance in the hopes of improving trade relations from a US perspective. But it also seems that others have read Trump’s Art of the Deal by now as according to EU trade commissioner Cecilia Malmstrom, the Commission is also preparing to introduce tariffs on $20 billion of U.S. goods if Washington imposes trade levies on imported cars.

While I would love to see some forward progress coming out of these talks, but just like with China the probability is rather low in my opinion. Much like with the China trade talks, things have escalated so that both sides will be looking to claim some victory to report back to their countrymen and women.  This likely means that as we migrate over the next few weeks of earnings, we will have to continue to watch trade developments, especially if more recent and wider spread tariffs wind up being enacted.

With more on the earnings and trade to be had in the coming days, we should be ready for day-to-day moves in the market, which will make it challenging for traders and options players. As they struggle, we’ll continue to take a longer-term focus, heeding the signals to be had with our thematic investing lens. Now, let’s get to some updates and other items…

 

Checking in on 5G spending from Verizon and AT&T

With both Verizon Communications (VZ) and AT&T (T) reporting June quarter results yesterday, I sifted through their comments on several fronts but especially on 5G given our positions in mobile infrastructure and licensing company Nokia (NOK), specialty contractor Dycom (DY) as well as compound semiconductor company AXT Inc. (AXTI). The nutshell take is things remain on track as both carriers look to launch commercial 5G networks in the coming quarters.

Verizon delivered solid quarterly results, buoyed by its core wireless business that added 531,000 net retail postpaid subscribers, which included 398,000 postpaid smartphone net adds. We’ve talked about how sticky mobile service is with consumers as smartphones are increasingly a life link for their connected lives so it comes as little surprise that Verizon’s customer loyalty remains strong with the quarter marking the fifth consecutive period of retail postpaid phone churn at 0.80 percent or better.

In terms of capital spending, a figure we want to watch as Verizon gets ready to launch its commercial 5G network, the company shared its 2018 spend will be at the lower end of its previously guided range of $17.0-$17.8 billion. Now here’s the thing, the mix of spending will favor 5G, which confirms the bullish comment and tone we shared last week from Ericsson (ERIC) on the North American 5G market.

With AT&T, its net capital spending in the June quarter slipped to $5.1 million, down from roughly $6 million in the March quarter but the company shared it will spend roughly $25 billion in all of 2018. Doing some quick math, we find this spending is weighted to the back half of 2018, which likely reflects investments in its 5G network as well as the new first responder network, FirstNet, it is building. During the earnings call, management shared the company now has 5G Evolution in more than 140 markets, covering nearly 100 million people with a theoretical peak speed of at least 400 megabits per second with plans to cover 400 plus markets by the end of this year. In terms of true 5G, trials are progressing and AT&T is tracking to launch service in parts of 12 markets by the end of this year.

That network spend and 5G buildout bodes well for both our Dycom shares.

  • Our price target on Dycom Industries (DY) shares remains $125

 

In addition, a few days ago mobile chip company Qualcomm (QCOM) shared that its 5G antennas are ready from prime time. More specifically, Qualcomm is shipping 5G antennas to its device partners that include Samsung, LG, Sony (SNE), HTC and Xiaomi among others for testing. Moreover, Qualcomm said it stands ready for “large-scale commercialization” which likely means 5G devices are just quarters away instead of years away.

We’d note those device partners of Qualcomm’s mentioned above have all announced plans to bring initial 5G powered phones to market during the first half of 2019. That means the supply chain will be readying power amplifiers and switches that will enable these devices to communicate with the 5G networks, which bodes well for incremental compound semiconductor substrate demand at AXT. Because 5G is being viewed as an “access technology” that will move mobile broadband past smartphones and similar devices, I continue to see this as a positive for the higher margin licensing business at Nokia as well.

As a reminder, AXT will report its quarterly results after tonight’s market close, and expectations for its June quarter are clocking in at $0.08 per in earnings on $26.1 million in revenue, up 60% and roughly 11% year over year.

  • Our AXTI price target remains $11.
  • Our price target on Nokia (NOK) shares remains $8.50

 

Farmland Partners fights back

A few weeks ago, we shared not only our long-term conviction for Farmland Partners (FPI) shares but also prospects for continued drama in the coming months. Well, let’s say we’re not disappointed as this morning the company filed a lawsuit in District Court, Denver County, Colorado against “Rota Fortunae” (a pseudonym) and other entities who worked with or for Rota Fortunae in conducting a “short and distort” scheme to profit from the sharp decline in Farmland’s stock price resulting from false and misleading posting on Seeking Alpha. Farmland is seeking damages and injunctive relief for defamation, defamation by libel per se, disparagement, intentional interference with prospective business relations, unjust enrichment, deceptive trade practices, and civil conspiracy.

Are we surprised? No, especially since the Farmland management team signaled it would be moving down this path. While this will likely result in some incremental noise, we’ll continue to focus on the business and the long-term drivers of the agricultural commodities that drive it.

  • Our long-term price target for Farmland Partners (FPI) shares remains $12.

 

Paccar delivers on the earnings front, boosts its dividend

Tuesday morning, heavy and medium duty truck company Paccar (PCAR) delivered strong June quarter results, beating on both the top and bottom line. For the quarter, Paccar reported earnings of $1.59 per share, $0.16 better than the $1.43 consensus on revenues that rose more than 24% year over to year to $5.47 billion, edging out the $5.39 billion that was expected. The strength in the quarter reflects not only rising production and delivery levels that reflect the pick up in truck orders over the last 6-9 months, but also the ripple effect had on the company’s high margin financing business. Also too, as truck up time increases as does the number of Paccar trucks in service, we’ve seen a nice pick up in the company’s Parts business that carries premium margins relative to the new truck one.

During the quarter, Paccar repurchased 1.21 million of its common shares for $77.2 million, completing its previously authorized $300 million share repurchase program. The Board of Directors approved an additional $300 million repurchase of outstanding common stock earlier this month and given the current share price that is below that average repurchase price we suspect this new program will be put to use quickly. Also during the quarter, Paccar boosted its quarterly dividend to $0.28 per share from $0.25, and management reminded investors of the company’s track record of delivering quarterly and special dividends in the range of 45-55% of net income.

Given 111% year over year growth in the new heavy truck orders throughout the U.S. and Canada during the first half of 2018, we continue to be bullish on PCAR shares as we head into the second half of 2018. Even so, we’ll continue to analyze the monthly truck order data as well as freight indicators and other barometers of domestic economic activity to assess the continued strength in new truck demand. In the coming months, we expect long-time followers of Paccar will begin to focus on the potential year-end special dividend the company has issued more often than not.

  • Our price target on Paccar (PCAR) shares remains $80.

 

A quick note on United Parcel Service earnings

Early this morning, United Parcel Service (UPS) beat estimates by a penny a share, with an adjusted quarterly profit of $1.94 per share. Revenue beat forecasts, as well, boosted by strong growth in online shopping – no surprise to us given our Digital Lifestyle investing theme. UPS will host a conference call this morning during which it will update its outlook for the back half of the year, and that should help quantify the year over year growth in Amazon’s (AMZN) Prime Day 2018 ahead of its earnings report later this week.

  • As we head into the seasonally strong second half of the year for United Parcel Service (UPS), our price target on the shares remains $130.