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Summary

This week is a crisis week for the market and could signal some potentially detrimental problems for the market if the market does not pass a debt-ceiling rise by October 17th. Further, the market has a heavy week of inputs with a large slate of earnings to digest as well. Earnings will likely take a backseat to the happenings of the government because a default will be a major market moment that will create extremely negative circumstances for the economy and stock market. Look for the market to move with the shifting headlines throughout the week, while earnings may navigate the intraday movement after what should be a week of gap ups and gap downs.

Chart Overview

(click to enlarge)

Here is the chart we are seeing for the S&P 500 (NYSEARCA:SPY) right now. There is good support at the 1650-1660 area on the S&P. That level is key right now. If that breaks, we do not see much support until 1625 and then 1600. Some analysts believe a 25-30% correction could occur on a default, which would take us to 1350 area where we started the year. The Dow Jones (NYSEARCA:DIA) is a bit weaker.

Economic Data

Date

Data Report

Market Expectations

Previous Report

October 15

Empire Manufacturing - October

4.5

6.3

October 16

CPI - September

0.1%

0.1%

October 16

NAHB Housing Market Index - October

57

58

October 16

Fed's Beige Book - October

N/A

N/A

October 17

Initial Claims - 10/12

330K

374K

October 17

Housing Starts - September

915K

891K

October 17

Building Permits - September

932K

918K

October 17

Industrial Production - September

0.3%

0.4%

October 17

Philadelphia Fed - October

7.0

22.3

October 18

Leading Indicators - September

0.6%

0.7%

This is the potential economic data calendar this week, but some of this data will not be released due to the government shutdown. What will definitely be released are the Empire Manufacturing report, NAHB Housing Market Index, Fed Beige Book, and Philadelphia Fed Index. The market will try to draw what it can from the reports given, but economic data will take a backseat to the market's government dilemma. Of those expected, we will be watching the Housing Market Index and Fed Beige Book.

Foreign Markets

Outside of the USA, Europe and Asia will continue to take a backseat to the government situation, and these markets continue to follow along with the government debt situation. Of the information that is to be released overseas, the important points to watch are Chinese consumer prices and producer price index. Additionally, the Chinese Business Climate Index to start the week is important. After that, we get the German ZEW Economic Survey on Tuesday as well as Japanese industrial production. Wednesday, the market will get British employment information as well as retail sales on Thursday. Finally, we get Chinese GDP, industrial production, and retail sales on Friday. It is a busy week overseas, so it will be interesting to see how much impacts the market.

Earnings

 

 

Date

Key Company

October 15

Johnson and Johnson (NYSE:JNJ)

October 15

Coca-Cola (NYSE:KO)

October 15

Citigroup (NYSE:C)

October 15

Intel (NASDAQ:INTC)

October 16

IBM (NYSE:IBM)

October 16

Bank of America (NYSE:BAC)

October 16

Pepsico (NYSE:PEP)

October 17

Google (NASDAQ:GOOG)

October 17

Phillip Morris (NYSE:PM)

October 17

Verizon (NYSE:VZ)

October 18

General Electric (NYSE:GE)

October 18

Schlumberger (NYSE:SLB)

It is a big week of earnings this week with a lot of the major blue chip stocks to report. Their outlooks with the government shutdown looming are going to be crucial as well as how they see the rest of the year progressing. The most important report we will be watching is Google. We have discussed the company at length in several articles, and we are not big on the stock right now. We believe that GOOG is going to continue to be held back until their assets make better returns for the company. Here is our take on the company:

Return on assets continues to decline. In 2007, the company's ROA was 19%. At the end of 2012, ROA was 12.9%. In the Q1 of 2013, ROA had come down another 3 basis points. The issues for GOOG is that they continue to grow business, grow assets, acquire companies to compete for advertising revenue dollars. The company has built platforms like Google +, Google Offers, and acquired companies to enhance current offerings.

The company needs to see a jump in return on assets in order to change this continued fate, and we believe until that happens the company will continue to see limited upside. Their ROA is the key to the report for us.

Fed Outlook

The Fed continues to take a backseat to the government crisis, but we will get some interesting reports due to the Fed to see just how the economy is progressing. On Wednesday, we get the Fed Beige Book as well as several speeches from Fed regional presidents. We get more speeches on Thursday along with the Philly Fed Index, and another speech on Friday. It's a busy week of speeches, but the Fed is not going to be changing their current plan until sometime later this year with Yellen coming in as well as the current crisis. The Fed is one of the only things keeping this market supported right now.

Conclusion

It appears that we will have quite a busy week. We have important data, lots of major earnings, the government crisis, Fed involvement, and a busy week overseas. How are we going to keep it all straight? The market will be focusing mostly on the government situation, and we look at the rest as just icing to direct the downside/upside movements. Without a deal by Friday, this market could be in for a MAJOR correction.

Stock To Watch

Ticker: Bank of America

Bank of America reports earnings on Wednesday this week, and the company has been held in check since their last report. In the company's last report, BAC reported a 70% rise in profits due to cost cutting measures. The company saw its revenue rise nearly 4% as well. The company has been cutting costs since 2011 to raise profits while organic revenue stalls as the loan market continues to drag. With costs cut, the company just needs a better overall market for consumers, small businesses, and mortgages. Further, the company has seen its bad asset costs continue to drop, which has helped profits rise as well.

Going into this quarter, the question is can the company start to produce the revenue and operation expansion that CEO Brian Moynihan said would start to develop last quarter. Another quarter of profit expansion without some better green shoots on the revenue side will likely be a disappointment. The company is expected to see EPS grow to 0.989 from 0.25 along with an 8% rise in revenue. A beat of the revenue estimate will be the key to this report giving investors more hope.

Besides revenue, the main things that investors should watch for is if Bank of America says anything about 2014, the government crisis, and what they see moving forward. Expectations for revenue are not strong for 2014 as mortgage rates are expected to rise, and that will hurt already low demand. The company, though, can hedge some of that with gains in their asset management side. Further, it will be important to see that legal costs have come down again.

A good report will show a better than expected revenue increase, legal costs dropping, and decent outlook moving forward. We have priced out BAC worth around $12. The key things we see holding it back are the company's high legal costs as well as their lack of revenue growth opportunities. If these change, we would see BAC worth more, so we will be watching for this.

Step 1.

Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.

 

 

 

2013 Projections

2014 Projections

2015 Projections

2016 Projections

2017 Projections

Operating Income

7800

11500

13000

14350

14700

Taxes

2184

3220

3640

4018

4116

Depreciation

2800

2900

2950

3000

3100

Capital Expendit.

-1500

-1600

-1700

-2000

-2200

Working Capital

0

0

0

0

0

Available Cash Flow

6916

9580

10610

11332

11484

Step 2.

Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012). WACC for BAC: 6.6%

 

2013

2014

2015

2016

2017

PV Factor of WACC

0.9381

0.8800

0.8255

0.7744

*

PV of Available Cash Flow

6488

8430

8759

8776

*

Step 3.

For the fifth year, we calculate a residual calculation. Taking the fifth year available cash flow and dividing by the cap rate, which is calculated by WACC subtracting out residual growth rate, calculate this number. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. Cap Rate for BAC: 3.6%

 

2017

Available Cash Flow

11484

Divided by Cap Rate

3.6%

Residual Value

319000

Multiply by 20167PV Factor

0.7744

PV of Residual Value

247037

Step 4.

Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:

  

Sum of Available Cash Flows

32453

PV of Residual Value

247037

Cash/Cash Equivalents

111744

Interest Bearing Debt

262480

Equity Value

128754

Step 5.

Divide equity value by shares outstanding:

  

Equity Value

128754

Shares Outstanding

10740

Price Target

$12

Source: Bank Of America And Google Set For Big Reports, Weekly Outlook