Weekly Issue: We Must Maintain Context and Perspective
As we bring the first month of 2018 to a close, the market has gotten a little wobbly over the last few days as rising yields put stocks under pressure as some fretted that higher interest rates could snuff out the recent market rally. Given the economic data of late, odds are we will see higher interest rates this year as the Fed looks to tighten throughout the year. It’s a question of degree as the market is already starting to consider a potential fourth rate hike this year. We’ll get more on that along with the changing of the guard at the Fed later today when the Fed breaks from its latest FOMC policy meeting.
Maintaining Some Market Perspective
As I often say, context and perspective are key for investors. Let’s keep in mind the 500 point move lower in the Dow Jones Industrial Average early in the week is far from what it was 5, 10, or even 20-years ago. With the economy set to at worst continue to muddle along with GDP below 3%, we’re not heading for a bear market in the near-to-medium term.
The next few days will also bring the usual start of the month data, pulling back the curtain on how the economy faired in January. Based on the data received thus far, it paints a firmer picture compared to the initial 4Q 2017 GDP print we received last Friday. In this week’s Cocktail Investing podcast Tematica Chief Macro Strategist Lenore Hawkins and I break that GDP report down and share some observations from the recent Inside ETF 2018 conference as well as Bitcoin. It’s another great conversation and here’s a link to this week’s episode.
For my money, it will likely be a few months until we see the flow through from tax reform related benefits that have been announced in droves by companies. That doesn’t mean we won’t pay attention to the near-term data — of course we will. Rather, because the market tends to move on relative performance I’ll be looking to see if the actual acceleration to be had matches what’s increasingly expected. If it does, it likely means we’ll see the market pick back up and continue to grind higher as current rich valuations become less so. If not, given the market’s current “priced to perfection” status we could see more volatility like the last few days. Such volatility is not a bad thing in my opinion as it would allow us to take advantage of potential disconnects between businesses and stock prices. Case in point, is the opportunity we are seeing with Universal Display and Apple.
Market Overreacts to Apple News, Hitting OLED Too
There is little doubt we will see far more devices utilizing organic light emitting diode displays over the next few years. Evidence of that was abundant at CES 2018, yet our shares of Universal Display have fallen more than 20% over the last two weeks as the talking heads on TV are like a dog with a bone when it comes to Apple’s iPhone X volumes in the first half of this year. As I shared in last week’s issue, I see it as an overreaction, but we have seen this before as companies that directly or indirectly supply Apple bob and weave based on the latest iPhone chatter.
We’ll continue to be patient investors with Universal Display (OLED) shares and watch organic light emitting diode display adoption over the coming quarters. For newer subscribers or ones that missed the sharp move higher in recent months for OLED shares, the current price offers another opportunity to take a bit from the apple so to speak. My advice would be wait to make a move on OLED shares until AFTER Apple reports its quarterly results on Thursday, so any additional “bad” Apple news is reflected in OLED shares. Long-term, the opportunity for Universal Display remains very bright, especially given the favorable tax treatment to be had for intellectual property companies as part of tax reform. Those reforms reduce tax on foreign income from goods and services produced in the U.S. using patents and other intellectual property to 13.125% until the end of 2025, after which the rate rises to 16.4%. Previously, royalties paid to a unit in the U.S. would have been taxed similarly to other U.S. income, for which the top corporate tax rate was 35%. I expect Universal Display to talk more about these positive implications when it reports its December quarterly results in February.
With Apple, it remains thematically well positioned with our Connected Society and Cashless Consumption investment themes and is positioning itself to ride the Content is King tailwind as well. Later this week, Apple will report its quarterly results and if we see weakness in the shares as the herd digests the “news” I’m inclined to scale into the position as the shares settle out.
- Our price target on Apple (AAPL) shares remains $200
- Our price target on Universal Display (OLED) shares remains $225.
State of the Union and Infrastructure
Last night President Trump gave what is being described as a presidential State of the Union. As expected, it was part victory lap and part agenda setting as he shared a preliminary framework to “rebuild our crumbling infrastructure” and bolster the country’s security. Adding in the benefits from tax reform and it all rings similar to our Economic Acceleration/Deceleration, Tooling & Re-tooling and Safety & Security investing themes.
To me, the infrastructure discussion is something we’ve been waiting on for some time, as has the Association of American Civil Engineers and their infrastructure report card. Lest you might have forgotten, the grade has been a consistent D+ for some time. In the coming days and weeks, Washington will cobble together a bill to target in Trump’s words “at least $1.5 trillion for the new infrastructure investment we need.”
The key will be how this rebuilding is paid for given the national debt and tax reform implications on the deficit near-term. The solution is looking increasingly like Federal spending will be partnered with State and local spending as well as public-private partnerships. The bottom line is this – the details will be forthcoming and as those firm up we’ll have greater clarity on when we’re likely to see jobs being created, equipment roll, and shovels hit the ground.
Helping speed the process, Trump called for streamlining the permitting and approval process to get “it down to no more than two years, and perhaps even one.” Team Trump has been busy slashing unnecessary regulations that have hamstrung businesses, and hopefully we will see more of this with the pending infrastructure bill. Rather than jump the gun and risk a timing issue by moving companies from the Tematica Contender List to the Select List, I’ll be watching the infrastructure bill like a hawk over the coming weeks. To paraphrase Orsen Welles in his famous Paul Masson wine commercial, we will add no stock before it’s thematic time.
Select List Moves and a Stop Out
Along with the overall market, the Tematica Select List has seen its share of positions come under pressure. It’s going to happen from time to time — after all the market can’t climb higher and higher forever. Not fun to hear I know, but it’s the truth. Expect the best, prepare for the worst as they say. We did that with several positions on the Select List with select stop loss usage, and that led to our being stopped out of AXT Inc. (AXTI) yesterday. While I may not be thrilled given the prospects for 5G networks and devices as well as a growing optical communications market, AXT shares were another victim of the Apple chatter I talked about earlier. For now, I’m placing AXTI shares on the Contender List and I’ll look for the right time to put them back on to the Select List.
Earlier this week, I shared my take on Corning’s (GLW) quarterly results, and the shares continue to drift lower today. Despite the action of the last few days, we remain nicely profitable in the position, but I’m still assessing price points to double down in the shares.
The other company that reported earnings in the last few days was Starbucks (SBUX), and candidly they put up some figures that were less than expected, which led the shares to trace back to their early December levels. While China was a bright spot for the company with same-store sales up 6% year over year, the reality was its holiday 2017 offerings simply didn’t resonate with consumers. That is a rare thing for Starbucks, but when this has happened in the past the company has quickly responded. Odds are they will again as we enter the spring season, but for now, the shares will be a “show me” story until they can once again demonstrate they are setting the beverage trend. I have full faith that they will and see the recently introduced Blonde Espresso as a step in the right direction.
- Even though we will be patient with Starbucks (SBUX) shares, I am trimming our price target to $68 from $74, which still offers roughly 20% upside from current levels before accounting for the current 2.1% dividend yield.
Buckle up as the Earnings Train is Here
As I shared a few days ago, we have a full plate of earnings coming later today and tomorrow. It will be a barn burner of a time, and while things could get a little bumpy the underlying thematic tailwinds remain intact. As such, we’ll use any meaningful pullback to better our cost basis should the opportunity arise. In case you missed it, here’s a link to which companies are reporting as well as their respective consensus expectations.
As you might imagine, I expect to have much to share with you in the coming days.
