Weekly Outlook: The market made an amazing streak of positive days in the Dow Jones last week that was the longest continuous winning streak since the 1960s. On Friday, however, the market lost that streak as weak economic data in the way of Michigan Consumer Sentiment reading was lower than expected as well as Empire Manufacturing declining month/month. Consumer Sentiment for March was lower, likely due to questions over sequestration, tax refund delays, and payroll tax increase. This coming week, the market has a lighter amount of data, some interesting earnings reports, and a crucial Fed rate decision. On top of that, a continued stalemate in Italian elections as well as other issues that have been ignored during the recent market success could seep out this week with a lack of other major news.
Economic data will be pretty light this week at home. We get some housing data this week that will be important at the outset. The NAHB Housing Market Index will be released on Monday, along with Housing Starts and Building Permits on Tuesday. All three reports are expected to see increases from February readings, so any misses there could be problematic for the market and especially housing stocks. Moving into Wednesday, the market will get Crude Inventories as well as the FOMC Rate Decision (discussed further below). On Thursday, the market will react to initial jobless claims, Existing Home Sales, Philly Fed Index, and Leading Indicators. A bevy of data on Thursday will be key to the market, but individually, the reports are minor. Jobless claims have been declining strongly, so more signs of a healthier job market will be important. Overall, we believe data will only have a slight impact on the market.
Outside of the U.S., Europe and Asia will continue to be important to the market, especially with a quieter week for American markets. Some important developments to watch this week will be the China Property Price report on Monday. Property in China has become a worrisome bubble in China, and if prices are falling there, it could be a sign of a worrisome bubble to watch in the emerging market. On Tuesday, Europe will get the important German ZEW Survey, which gives economic sentiment in the eurozone. Some data, as of late, has been solid in Europe, and it will be interesting to see if that trend can continue to show a bottom. Wednesday will be the Bank of England minutes from their last meeting as well as employment information, which should be interesting. Thursday, we get the HSBC China Flash Manufacturing index, which will definitely be key to the markets. Finally, we get the German IFO index report on Friday. That report will give a great insight into the business climate in Germany. It's a busy week overseas, and those developments will play a role in potential market upside.
We actually have a fairly interesting earnings season, as the companies with a December-February earnings season are mostly reporting this coming week. Reports from Oracle (ORCL), Nike (NKE), FedEx (FDX), General Mills (GIS), Discover Financial (DFS), Adobe (ADBE), and Dollar General (DG) will definitely play a crucial role in the market this week. Many are curious to see how spending/business trends were in February as sequestration and new tax increases influenced consumer appetite as well as business expansion/contraction. DFS, NKE, FDX, GIS, and DG should give the best look into those trends, while ORCL and ADBE will be better for business appetite bellwethers. Watch these reports throughout the week, as misses or disappointment in these reports could spell trouble for the markets. With the market as pumped up right now as it is, the upside from these reports probably remains curbed.
The Federal Reserve, overall, may play the most crucial role to the market this week. Over the past three weeks, the market has enjoyed significant upside. A lot of the positive attitude and buyer interest has resulted from Ben Bernanke stating that the Federal Reserve had no plans to take its foot off the pedal of the market. One reason some analysts believe the Fed might actually start to change their tune is that unemployment is dropping. The Fed has linked its borrowing rate to employment levels, and if those drop, the borrowing rate for banks will increase. Additionally, as employment becomes better, the Fed will likely remove QE. The continuous capital injections from the Federal Reserve are creating a lot of solid market conditions. Any sign that those conditions will not continue at their same rate will be detrimental to the market.
So, where are we headed this week?
For awhile now, we have been waiting for the market to top out. Friday's failure of the current run and the Federal Reserve's major moment this week will be crucial to market sentiment. We would expect a flat to slightly downward move into the report on Wednesday, with a lot of movement/volatility for stocks from Wednesday on as a lot of the key reports, data points, and market developments will be occurring later in the week. If the Fed signals any potential movement towards not continuing their current plans, you can expect a fairly strong movement down to end the week as a lot of traders/investors lock in gains.
Stocks To Trade:
One stock with solid movement along with good potential in market correction periods is Altria. The maker of cigarettes and wine has solid potential for growth, good value, and some positive headline developments that we believe can create more upside opportunity. If the market is going to go through any correction period, consumer staple stocks do well in those market conditions. Right now, MO has growth potential on top of fitting well into this market condition. The company is expected to see around 8% earnings growth this year, along with potentially 10% earnings growth in 2014. Despite that strong growth potential, the future PE of the company is just 13. That level shows very solid value, and we believe that it's a signal of opportunity. Further, Altria has a 5% dividend, which is very attractive for investors as well, and that we believe should attract interest from investors looking for the combination of yield, growth, and value. Where is growth going to come from for MO?
Altria is the leader in the U.S. market with half of the market share, but the U.S. continues to see declining volumes. Therefore, if Altria is going to see more upside, it has to see growth in growing markets domestically and internationally. Altria has nearly 3/4 of sales based in the highly regulated American market. Altria is not likely to move much internationally, but the company has seen good growth in domestic brands. In the past three years, we have seen MO's wine and beer segment grow 39%. The company's stake in SABMiller will continue to be a place of growth, as well as its expanding wine market. The company also has done smart acquisitions like buying John Middleton Cigars and UST (maker of Copenhagen and Skoal). The movement into cigars and smokeless tobacco helps to diversify and expand the company's product lineup.
We believe that MO is a great stock to buy as we head into potential uncertainty in the market.
Trade #1: MO, Long
Buy Point: Over $34
One place we believe to avoid putting money is gold and SPDR Gold ETF. The problem for gold is that the commodity has a lot of potential headaches right now that could develop into issues. The risk is too high for gold right now, in our opinion. That risk starts with the Fed meeting this week. Any signal at all from the Fed that they may consider limiting QE will hurt gold. QE provides strong capital to the market, keeps the dollar low, and drops yield on bonds. Investors looking for low-risk yield will revert back to bonds as they become more popular again as well as the dollar strengthens. The Fed's decision is unknown, but we believe the best move for investors is the one that risks the least capital. On top of that issue, the commodity has lost upside catalysts. Economic indicators show strong retail sales and more consumer confidence. The lack of weak indicators has hurt the "safe haven" play. If the market starts to drop on a Fed move, though, gold will follow the market as we have noted above.
Here is a comment from Barclays about more of this lost upside catalyst:
Speculative positions have eased, driven by long liquidation and fresh gross shorts, while ETP holdings have continued to trickle lower. Net outflows have reached 27 tonnes so far this month, with the bulk of net redemptions taking place in the largest product, GLD. Total metal held in trust remains elevated at 2623 tonnes but is 143 tonnes off the all-time high. Outflows for the year to date have reached 137 tonnes, compared with modest net inflows of 71 tonnes over Q1 13 and net outflows of 50 tonnes in Q1 11.
Right now, we believe it is best to avoid gold as a large portion of your portfolio for safety. With the overall environment for stocks still strong, we like more consumer staple stocks. Additionally, we believe that bonds will start to gain more traction of central bank capital injections slow. We like a bear call spread versus shorting gold as trading could be range bound for some time.
Trade #2: GLD, Apr20, 160/162 Bear Call Spread
Max Gain: 12%
Another stock that we believe may start to have a bearish run over the next several weeks to months is Google. The problem for GOOG is that we believe that the investing community continues to ignore a troubling trend for Google -- declining return on assets that has lasted five years. Why is this trend troubling? It's taking GOOG more and more assets to create the same amount of profits. We believe that its a sign of weakness for the company as its declining return on assets shows a lack of economic moat, and the company taking on new initiatives to maintain that same level of profits means that the company has not seen strong demand for its products or that the company is seeing less use of paid ads from the original draws like Gmail and Search. The company does not breakdown profit for the public, so it impossible to know exactly what is occurring there. The company has brought on lots of new initiatives like Google+, Google Offers, Google Wallet, and others that, as of now, are not producing the profits we believe justify current pricing.
Some signs that value is not there at these elevated levels is that price/sales is above 5 currently. Below 3 tends to show decent value, while below 2 shows strong value. At 5, shares appear fair valued, even bordering on overvalued. PE sits at 25 currently. Arguments will be made that future PE will drop to around 15, which is a decent sign of value. Yet, we believe that once again the ROA issue makes us believe that estimates are too high for the coming year, as we have seen no signs that the company's ROA will reverse. Here is some conversation from our EquityAnalytics report on Google that has a 2013 Hold rating and $720 price target for the company:
The company continues to dedicate a lot of money to new ventures that are not paying off. How do we know? The argument we are making above about increasing capex and working capital can be seen in the company's decreasing ROA and ROIC. The company has seen ROIC come down from 23.7 to just fewer than 16 in the TTM from 2005 to present. Return on assets have also decreased in the same timeframe from 21.6 to 13.3. Both declining measures of profitability show that assets are growing much faster than profits. The decline in profits is shown in our model as well as continued strong working capital increases as those assets continue to grow. What we are getting at for GOOG is that its business has added to the business (assets) but it has not been paying off (profits).
What's the issue?
We have previously noted that Motorola is definitely going to weigh on the bottom line for some time. We believe Google+ is also a drag on the company. Motorola could turn out to be something very profitable if the company can make money off the patents in the way of exciting hardware, but that is a big question mark. Another sign that Google+ may be struggling is that the company is now funneling people to have a Google+ when they sign up for Google account. Forcing people to use the product is not a positive. The company sees Google+ as a necessary defense to Facebook, who does create a threat with its social networking business.
What we are getting at is that maybe the so-called ironclad ad revenue is not so ironclad. Sure, the company is dominating search, but people are finding other ways of using their time on the Internet -- using their phones, Facebooking, and even using LinkedIn (LNKD). The move into Motorola and Google+ are definitely defensive measures, it sees FB and the move onto mobile as trends that will last, but it has not mastered these businesses in the way it has mastered search. Thus, we see a decline in profitability. We do not see that changing in the next couple years, and therefore, we are holding back our price target.
For now, we believe it's best to take your profits in Google.
Trade #3: GOOG, Short
Sell Point: Failure of $800
Finally, we want to take a look at Groupon for this week and moving forward. The down and out coupon company caught some attention on Friday after Legg Mason's Bill Miller commented that it had tremendous opportunity moving forward. We wanted to take some time to break down the company in the wake of these comments to see if Miller has a point. Miller sees opportunity for Groupon due to absolutely zero expectations and a combination of strong cash holdings with no debt. Further, the company has some successful people at the helm with former CEO Andrew Mason now out of the picture. Right now, GRPN is trading with a future PE at 18 and price sales at 1.5. The price/sales ratio does show good value, while future PE does not. What that means is that the company is heavily discounted from its top line, but not from its bottom line. Thus, the issue remains margins for GRPN, which have continued to be razor thin. Can those turn around?
We continue to believe that GRPN lacks an economic moat and has no way to curb competition. Living Social and Google Offers are tough competition, as Amazon (AMZN) backs Living Social and has large muscles to flex, along with GOOG. At the same time, the worst may be over for the company. While no moat exists, the fervor for coupon shops has crowded, bubbled, and likely burst. From here, what's next? One of the promising parts of GRPN's future is that it does have a strong amount of cash to be used, as well as no debt. The company held $1.2B cash/cash equivalents in the latest TTM. That cash holding can allow for GRPN to invest into data analytics, do potential share buybacks, and create good value. We are not sold yet, and we believe we need to see at least one quarter of increased rates before we can start to talk about a bottom being in for the company. Yet some green shoots are there for GRPN.
Trade #4: GRPN, Long
Buy Point: Need more information.