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WEEKLY ISSUE: Is Inflation Rearing Its Ugly Head or Not?

WEEKLY ISSUE: Is Inflation Rearing Its Ugly Head or Not?

Today is the day that we here at Tematica, and other investors as well, have been waiting for to make some semblance of the recent stock market volatility. Earlier this morning we received the January Consumer Price Index (CPI), one of the closely watched measures of that now dirty word – inflation. As a quick reminder, the market swings over the last two weeks were ignited by the headline wage data in the January Employment Report, as well as other signs, such as rising freight costs that led us to add shares of Paccar (PCAR) to the Tematica Investing Select List earlier this week. This topic of resetting inflation expectations and what it may mean for the Fed and interest rates has been a topic of conversation on recent Cocktail Investing Podcast between Tematica’s Chief Macro Strategist Lenore Hawkins and myself.

 

What the January CPI Report Showed and Its Impact on AMZN, COST and UPS

The headline figures from the January CPI report showed the CPI rose 0.5% month over month in January, which equates to a 2.1% increase year over year. Keeping in sync with the headline figure, which includes all categories, the consensus expectation was for a 0.3% month over month increase. The driver of the hotter than expected headline print was the energy index rose, which climbed 3.0% in January, and we’ve witnessed this first hand in the gasoline price jump of late. Excluding the volatile food and energy components, the “core” CPI index was up 0.3% month over month in January, coming in a bit ahead of the expected 0.2% increase. On a year over year basis, that core figure rose 1.8%, which is in keeping with the 1.7%-1.8% over the last eight months. Month over month gas and fuel prices were up 5.7% and 9.5%, respectively.

Late yesterday, the American Petroleum Institute released data showing a 3.9 million barrel increase in crude stockpiles for the week ended Feb. 9, along with a 4.6 million barrel rise in gasoline stocks and a 1.1 million barrel build in distillates. With crude inventories once again on the rise as US oil production has risen in response to the recent surge in oil prices from September to late January, we’ve seen oil prices retreat to December levels and odds there is more relief to come.

As we wait for others, who if you’ve seen the whipsaw in stock market futures today are simply reacting to the January headline CPI figure, to get some clearer heads about themselves and digest the internals of the report, I’ll share our thoughts on the January Retail Sales report that was also published this morning.

Staring with the headline figure, January Retail Sales came in at -0.3% month over month, falling short of the 0.2% consensus forecast. Excluding auto and food, January core retail sales fell 0.3% month over month; on a year over year basis, retail sales rose 3.9% with nonstore sales leading the way (up 10.2%) followed by gas stations sales (up 9.0% year over year), which is of little surprise given our January CPI conversation above. We do see that nonstore figure as further confirmation for not only our Amazon (AMZN) and United Parcel Service (UPS) shares, but also our Costco Wholesale (COST) ones as it continues to embrace our Connected Society theme.

  • Our price target on Amazon (AMZN) shares remains $1,750
  • Our price target on Costco Wholesale (COST) shares remains $200
  • See my comments below for my latest thoughts on UPS shares

 

Market’s Knee-Jerk Reaction to January Retail Sales Offered Opportunity in PCAR, Not BGFV

Despite the 3.9% year over year January Retail Sales print, the market is focusing on the month over month drop, which was one of the weakest prints in some time. Here’s the thing, we here at Tematica have been talking about the escalating level of debt that consumers have been taking on as a headwind to consumer spending and despite the post-holiday sales, consumers tend to ramp spending down after the holidays. Odds are these two factors led to that month over month decline, but even so up 3.9% year over year is good EXCEPT for the fact that gas station sales are bound to fall as gas prices decline.

If we look at these two reports, my take on it is a skittish stock market is once again knee-jerk reacting to the headline figures rather than understanding what is really going on. The initial reaction saw Dow stock market futures fall from +150 to -225 or so before rebounding to -125. As data digestion occurs, odds are concerns stoked by the initial reactions will fade as well

With market anxiety still running higher compared to this time last year or even just six months ago, I expect the market to cue off the major economic data points to be had in the coming weeks building to the Fed’s next FOMC meeting on March 20-21. As I pointed out on this week’s podcast, at that meeting we’ll get the Fed’s updated economic forecast and I expect that will have chins wagging over the prospects of three or four rate hikes to be had in 2018.

In the meantime, I’ll continue to look for opportunities like I saw with Paccar (PCAR) shares on Monday, and avoid pitfalls like the one I mentioned yesterday with Big Five Sporting Goods (BGFV). And for those wondering, per the January Retail Sales Report, sporting goods sales 7.1% in January. Ouch! And yes, I always love it when the data confirms my thesis.

  • Our price target on Paccar (PCAR) shares remains $85

 

Waiting on Applied Materials Earnings Announcement

After today’s market close, Applied Materials (AMAT) will share its latest quarterly results, and update its outlook. As crucial as those figures are, in recent weeks we’ve heard positive things from semi-cap competitors, which strongly suggests Applied should deliver yet another good quarter and a solid outlook. Buried inside those comments, we’ll get a better sense as to the vector and velocity for its products, both for chips as well as display equipment.

Those comments on the display business will also serve as an update for the currently capacity constrained organic light emitting diode market, one that we watch closely given the position in Universal Display (OLED) shares on the Tematica Investing Select List. I see this morning’s announcement by Universal that it successfully extended its agreement with Samsung though year-end 2022 with an optional 2-year extension as reminding investors of Universal’s position in the rapidly growing technology. With adoption poised to expand dramatically in 2018, 2019 and 2020, I continue to see OLED shares as a core Disruptive Technologies investment theme holding.

  • Our price target on Applied Materials (AMAT) shares remains $70
  • Our price target on Universal Display (OLED) shares remains $225

 

 

Should We Be Concerned About UPS Amid Amazon Announcement?

Several paragraphs above I mentioned United Parcel Service (UPS) shares, and as one might expect the headline reception to the January Retail Sales Report has them coming under further pressure this morning. That adds to the recent news that our own Amazon (AMZN) would be stepping up its business to business logistics offering and competing with both UPS and FedEx (FDX). Of course, this will take time to unfold, but these days the market shoots first and asks questions later. At the same time, we are entering into a seasonally slower time of year for UPS, and while yes consumers will continue to shift toward digital shopping as we saw in today’s retail sales report, the seasonal leverage to be had from the year-end holidays is now over.

 

 

While it may sound like we are getting ready to give UPS shares the ol’ heave ho’, along with the February market gyrations, it’s been a quick ride to the $106 level from $130 for UPS shares, and this has placed them into the oversold category. From a share price perspective, the shares are back to levels last seen BEFORE both the 2017 Back to School and year-end holiday shopping seasons. With prospects for digital shopping to account for an even greater portion of consumer wallets in 2018 and 2019 vs. 2017, we’re going to be patient with UPS shares in the coming months as we wait for the next seasonal shopping surge to hit.

  • Our long-term price target on UPS shares remains $130.

 

TRADE ALERT: Freight pain leads to this Economic Acceleration/Deceleration addition

TRADE ALERT: Freight pain leads to this Economic Acceleration/Deceleration addition

 

KEY POINTS FROM THIS ALERT:

  • We are issuing a Buy on truck company Paccar (PCAR) with an $85 price target as part of our Economic Acceleration/Deceleration investment theme.

With the market’s volatility over the last several days, a number of stocks are revisiting levels that are 5%, 10%, 15% lower than they stood at end of January. And while investors have been thunderstruck by the market gyrations, the day to day data from the December quarter earnings season as well as recent economic data, has continued to confirm certain opportunities. One of the recurring drum beats this earnings season has been companies ranging from Tyson Foods (TSN, Hershey (HSY), Packaging Corp. of America (PKG), Sysco (SYY) and J.M. Smucker (SJM) to Tractor Supply (TSCO) and Prestige Brands (PBH) talking about rising freight costs and the impact on earnings.

One of the culprits is the national shortage in available trucks, which has sent shipping costs soaring, with retailers and manufacturers in some cases paying over 30% above typical rates to book last-minute transportation for cargo. This, of course, goes hand in hand with the accelerating shift toward digital commerce that we talk about, a shift that led Amazon to correctly assess back in 2013 that as more shoppers bought products online, “parcel volume was growing too rapidly for existing carriers to handle.” As that shift to digital commerce has happened, we’ve seen that forward-looking view come to play out, and odds are it’s only going to get worse. According to Statista, e-commerce sales accounted for 9.1% of total U.S. retail sales in 3Q 2017, but we see that only growing further. In South Korea, e-commerce represented 18% of all retail sales in 2016 with forecasts calling for that percentage to reach 31% by 2021. We may not reach such a level for years to come, but each percentage point that e-commerce gains, means more product that needs to be shipped from a warehouse to the buyer.

Historically, the trucking industry has been associated with the economic cycle. When the economy is growing, more goods (parts, subassemblies, products) need to be shipped to customers at factories, distribution sites, warehouses and so on. According to the American Trucking Association, the trucking industry accounts for 70.6% of tonnage carried by all modes of domestic freight transportation, including manufactured and retail goods. This has made freight traffic a good barometer of the economy, and the December year over year increase of 7.2% in the Cass Shipments Index capped off a year in which the ATA’s truck tonnage index rose 3.7%, the strongest annual gain since 2013.

 


As truck tonnage climbed in late 2016 and 2017, industry capacity has been tightening after tepid tonnage in most of 2015 and the first half of 2016 leading to the robust jump in freight costs we described above. This data point from DAT Solutions puts in all into perspective – “there were about 10 loads waiting to be moved for every available truck in the week ending Jan. 20, compared with three in the same week last year…”

 

As freight costs climbed in the back half of 2017, so too did heavy truck orders, which have continued to climb into 2018. According to ACT Research, December 2017, which saw a 76% increase in truck order volume was the best month for orders since December 2014. In full, due to the year-end surge, 2017 saw truck orders hit 290,000 units, up 60% year over year. That strength continued into January with monthly truck orders hitting some 47,000 units, the highest level since 2006.

 

 

This data is not surprising, given that for the first three weeks of January, national average spot truckload rates were higher than during the peak season in 2017, according to DAT. January was also the fourth consecutive month in which truck orders were above the 30,000 mark. Initial heavy truck forecasts put orders near 300,000 for 2018, however tight industry capacity combined with companies that are benefitting from tax reform and looking to replace older, less fuel-efficient trucks, we could see that some lift to that forecast in the coming months.

But that’s heavy truck orders, and while four months above 30,000 paves the way for a pick-up in business, the real question to focus on is heavy truck retail sales. Heavy truck, otherwise known in the industry as class 8 trucks, industry retail sales were 218,000 units in 2017, compared to 216,000 vehicles sold in 2016, with forecasts calling for 235,000-265,000 trucks to be sold in the U.S. and Canada during 2018.

Looking outside the U.S. and Canada, the data shows an improving European economy and that should give way to a favorable truck market there as well. European truck industry sales above 16-tonnes were a robust 306,000 trucks in 2017, and It is estimated that European truck industry sales in that category will be in the range of 290,000 to 320,000 trucks in 2018.

 

Paccar – more than a leading heavy truck company

And that brings us to Paccar (PCAR), whose shares have fallen some 15% as the domestic stock market moved sharply lower over the last two weeks. The company is an assembler of heavy-duty trucks, with an estimated market share near 31% in the U.S. and Canada, as well as medium duty trucks (think the kind you see being driven locally by United Parcel Services (UPS) and FedEx (FDX)). That business drove 53% of its truck deliveries in 2017, with the balance coming from Europe (36%) and other markets (11%). As truck retail sales improve in the U.S., Canada and Europe, even absent additional share gains, Paccar’s truck business in terms of revenues and profits should see a nice lift.

The improving truck market also bodes well for Paccar’s high margin truck financing business – while it generated just 6.5% of total revenue in 2017 with operating margins that are more than double the truck business, it accounted for 12% of overall operating profits.

The third leg to the Paccar stool is its Parts business (20% of 2017 revenue, 28% of 2017 operating profit), which stands to benefit from the time lag between truck orders and sales in a capacity constrained industry, where up-time for existing equipment will be crucial.

Given the industry dynamics and Paccar’s position, we are seeing revenue and earnings expectations move higher in recent weeks, with the current consensus calling for EPS of $5.34 this year up from $4.26 in 2017 on a 13% revenue increase to $20.6 billion. With the company only recently sharing its 2018 tax rate will be 23%-25% vs. 31% in 2017, we could see the 2018 consensus move higher in the coming weeks.

As mentioned above, Paccar’s share price has fallen some 15% in the last two weeks, which in our view makes the shares rather compelling given our $85 price target. That target equates to just under 16x 2018 EPS. Over the prior seven years, PCAR shares have bottomed at an average P/E of 12.2x, which derives a downside target of $67.65 based on current 2018 EPS expectations. On the upside, the average peak multiple over those same years of just over 17x hints at a potential price target near $95. Looking at a dividend yield valuation, we see upside vs. downside of $82 vs. $60.

As we add the shares, we’ll split the difference with an $85 price target, and we’ll look to aggressively scale into the shares should the market come under further pressure and drag PCAR shares closer to $60. In terms of sign posts to watch for the shares in the coming days and weeks, monthly heavy truck data as well as tonnage stats and manufacturing industrial production data is what we’ll be watching. As the current earnings season winds on, we’ll be focusing on the results and outlook from Rush Enterprises (RUSHA), which owns the largest network of commercial dealerships in the U.S., with more than 100 dealerships in 21 states.

 

The bottom line for this alert today:

  • On Monday morning we are adding Paccar (PCAR) shares to the Tematica Investing Select List.
  • Our price target for PCAR shares is $85, nearly 26% above where the shares closed on Friday February 9.
  • At this time we are not setting a protective stop loss, but instead will look to scale further into the shares should further pressure drag them closer to $60 per share. 

 

Entering Choppy Waters as Earnings Velocity Picks Up

Entering Choppy Waters as Earnings Velocity Picks Up

Actions from this post

Ratings changes included in this dated post

  • Maintain DOG, SH, RWM as “BUY”: We expect the volatility of the markets to once again be upon us, not just because the S&P Short Range Oscillator closed yesterday at 9.2 percent (compared to just 3.9 percent a week ago), but because that Oscillator is now back to 2x overbought levels. We continue to rate DOG, SH and RWM inverse ETFs Buy at current levels.
  • ADDING DIS MAY $105 CALLS: We are adding Disney (DIS) May $105 calls(DIS160520C00105000) that closed last night at $1.57 to the Tematica Pro Select List. We would buy these calls up to $1.85 and to minimize potential downside we are setting a stop loss at $1.15.
  • ADDING XLY MAY $80 CALLS: We are also adding Consumer Discretionary SPDR ETF (XLY) May $80 calls (XLY160520C00080000) that closed last night at $1.24 to the Tematica Pro Select List. We would be comfortable adding to the position up to $1.50; to manage downside risk, we are setting a stop loss at $1.00.
  • CONTINUE TO HOLD PCAR SHORT CALL: Data supporting our short call in Paccar (PCAR) shares continues to mount, but a key determinant of whether or not we scale into the position will be found in quarterly results from heavy truck retailer Rush Enterprises (RUSHA) due this morning.

Earnings season kicks into high gear this week. Despite the headline print of the Dow Jones Industrial Average, which has climbed just over 1 percent over the last week given the moves in the 30 stocks that comprise the index, we’re seeing choppy waters emerge following March quarter results from Netflix (NFLX), IBM (IBM) and Intel (INTC). Intel in particular shared it will cut 11 percent of its workforce as it shifts focus from PCs to other markets including data centers and the Internet of Things. To us here at Tematica, that means Intel is finally catching up with what is driving the Connected Society. 

Intel is not alone in announcing layoffs — also this week Nordstrom (JWN) shared it will cut 400 jobs at its corporate headquarters, which raises questions over spending habits of more well off consumers. To us, it means consumers are turning elsewhere to shop —another confirming datapoint of not just our Cashstrapped Consumer thematic, but also the Connected Society — and we continue to see Amazon (AMZN) as a primary beneficiary (see more on this below). We’ve also started to see more ratings downgrades on the likes of Boeing (BA), Bloomin Brands (BLMN), Intel, Badger Meter (BMI), Spirit Airlines (SAVE) and Toll Brothers (TOL) to name a few.

In short, we expect the volatility of the markets to once again be upon us, not just because the S&P Short Range Oscillator closed yesterday at 9.2 percent —compared to 3.9 percent just a week ago — but because that Oscillator is now back to 2x overbought levels.

To us this means, continuing to hold onto our heeding positions that are our inverse ETFs — ProShares Short Dow30 ETF (DOG), ProShares Short S&P 500 (DOG) and ProShares Short Russell2000 (RWM) — as well as our more defensive positions in Health Care Select Sector SPDR ETF (XLV) and iShares Barclays 20+ Year Treasury Bond ETF (TLT).

Adding Disney Calls and Another Call Trade on the House of Mouse, Marvel, Lucas

Despite the growing gloom, there are still bull markets to be had with companies poised to benefit. One of those is easily found in our Content is King investing theme and in yesterday’s Tematica Investing we added shares of content and merchandising champ Disney (DIS) to the Tematica Select List. If you missed it, you can read it here, but in a nutshell Disney has several powerful catalysts that have started to kick in thus far in 2016 with several more coming over the next several quarters. The more well known ones are found on the upcoming slate of Marvel, Lucasfilm, and Pixar movies that range from Captain America, Dr. Strange, Star Wars and Finding Dory. Those films will drive merchandizing and other key content platforms, such as gaming and music to name a few. Disney has also adopted surge pricing at its existing theme parks and in June it will open its largest park in China dubbed Shanghai China.

From our perspective these layered catalysts kick in over the next few months, and while we see DIS shares as a core holding for our Content is King investing theme, we see each catalyst adding to the share price.

In order to capture greater returns, we’re adding the DIS May $105 calls(DIS160520C00105000) that closed last night at $1.57 to the Tematica Pro Select List. We are comfortable buying these calls up to $1.85; to limit downside in the position, we are setting a stop loss at $1.15.

Adding a Multi-Thematic ETF Call

Also in yesterday’s Tematica Investing we shared another way to invest and capture the upside we see in DIS shares — through the Consumer Discretionary SPDR ETF (XLY), which counts DIS shares as its third largest holding behind Amazon.com (AMZN) and Home Depot (HD). In addition to meaningful upside to be had with DIS shares, we see Amazon benefitting from the continued shift to online and mobile shopping that is a key tenant of our Connected Society investing theme, while Home Depot is a natural beneficiary of the spring season. Other key holdings of XLY include Comcast (CMSCA), McDonald’s (MCD) and Starbucks (SBUX) and each of these are potential candidates in our Connected Society, Fattening of the Population and Affordable Luxury/Guilty Pleasure investing themes, respectively.

Given the upside to be had at Disney and these other core holdings, we are adding the XLY May $80 calls (XLY160520C00080000) that closed last night at $1.24 to the Tematica Pro Select List. We would be comfortable adding to the position up to $1.50; to manage downside risk, we are setting a stop loss at $1.00. 

Rush Enterprises to Give Direction on Paccar Short

Along with the market melt up, we’ve witnessed the short in heavy truck company Paccar (PCAR) move against us these last several days despite weak fundamentals. The most notable was the disappointing March Industrial Production reading, which marked the 6th month of contrition out of the last 7 months. In the below chart, we see the historically tight correlation between the year over year change in Industrial Production has diverged in 2016, but as we have seen time and time again, at some point fundamentals catch up with a climbing stock price.

We see the weakening fundamentals for Paccar that include lackluster economic activity, falling heavy truck orders and weak guidance from Paccar competitor Navistar (NAV) all weighing on Paccar’s March quarter performance and current quarter outlook.

IUSCIPIY_PCAR_chart-5

We will get further insight into the tone of the heavy truck market and Paccar’s prospects this morning when Rush Enterprises (RUSHA), a retailer of commercial vehicles and related services, which includes a network of commercial vehicle dealerships, reports its March quarter earnings. In the company’s 2015 10-K filing with the SEC, Rush notes that “We are dependent upon PACCAR for the supply of Peterbilt trucks and parts, the sale of which generates the majority of our revenues.” As such, we see Rush’s results as a guiding hand for what Paccar will likely say when it reports its March quarter results next Tuesday (April 28).

After analyzing Rush’s quarterly results and digesting comments on its related earnings conference call, we will assess the prospects of adding to our Paccar short position and/or revisiting a put position in PCAR shares. Should we make any such additions to the Tematica Select List we will issue a special alert detailing the specifics of our actions.

Recap of Action Items from this Week

  • Continue to Hold inverse ETF’s DOG, SH and RWM, as well as defensive ETF TLT.
  • Adding DIS May $105 calls (DIS160520C00105000) up to $1.85 with a stop loss at $1.15.
  • Adding XLY May $80 calls (XLY160520C00080000) up to $1.50 with a stop loss at $1.00.
  • Continue to Hold short position in PCAR